Making The Case For 1.25X Leveraged ETFs

February 24, 2015

Just when you thought that the leveraged ETF niche has been carved out and accounted for, New York-based Direxion Shares has come out with what it calls “lightly levered” ETFs that have 1.25X exposure.

 

To hear Direxion President Brian Jacobs speak to this new ripple in the world of leveraged ETFs, the company aims to give investors a more easily managed investment tool than the 2X and 3X ETFs that have ruled the leveraged roost so far. But, no less, Jacobs told ETF.com that Direxion is looking to reinvent the leveraged ETF for an advisory channel increasingly focused on asset allocation in portfolio construction.

 

 

ETF.com: Can you comment on your new 1.25X funds?

 

Brian Jacobs: We launched four­­­­­, what we call lightly levered ETFs. And these would be four major asset categories where we apply just a 25 percent leverage. So it's the S&P 500; it's small cap; it's FTSE developed markets; and FTSE emerging markets.

 

The concept behind this is th­at, for years, advisors and professional investors have told us: “We like the idea of using leverage, but 200 percent or 300 percent is just too much for us. But we also like the idea of something where we can use leverage that we might be able to buy and hold for longer than a few days.”

 

And, as you know, with our regularly leveraged strategies of 3x ETFs, those are really trading vehicles.

 

So as we thought about what investors are trying to do—they're looking for more precise tools to build a better portfolio—we said, let's try for “lightly levered” ETFs, as we coined the term—and provide all the background data and backtest it and list it on the New York Stock Exchange.

 

So, what we're providing is a vehicle that allows an advisor or a sophisticated investor to put a light amount of leverage in. They're priced at 50 basis points, so it's relatively inexpensive and cheaper than if they had to go out and borrow on a margin account to get that leverage.

 

ETF.com: What are the tickers on those strategies?

 

Jacobs: There's LLSP [Direxion S&P 500 Bull 1.25x ETF (LLSP)], which is the S&P 500. There's LLSC [Direxion Daily Small Cap Bull 1.25x ETF (LLSC)], which is the Russell 2000 small cap; LLDM [Direxion Daily FTSE Developed Markets Bull 1.25X ETF (LLDM)], which is the FTSE developed markets; And then LLEM [Direxion Daily FTSE Emerging Markets Bull 1.25X ETF (LLEM], which is the FTSE emerging markets.

 

ETF.com: Any reason why you chose the FTSE as opposed to MSCI?

 

Jacobs: Yes, it's who we worked with, and we were able to work something out with them. By the way, we're at an all-time high on those levered assets.

 

ETF.com: As a firm, you mean?

 

Jacobs: Yes, with volatility coming back into the marketplace, people like our levered strategies. With a 3x fund, you need to get the asset class correct. And you need to get the timing correct, when to get in, when to get out.

 

But with these “lightly levered” strategies, you still need to get your asset class right, but the negative impact of the compounding effect—as long as you rebalance on a quarterly basis, monthly basis—that you would see in a 3x fund is really very much diminished with just 25 percent levered.

 

ETF.com: So you're saying that with a 1.25X “lightly levered” fund you can let it run for three months before doing the rebalance?

 

Jacobs: Yes.

 

 

ETF.com: It's still a daily rebalanced portfolio, right?

 

Jacobs: It is.

 

ETF.com: So path dependency is obviously still a factor with 1.25X, but much less significant than with, say, a 3X fund?

 

Jacobs: It's greatly diminished than the 2x or 3x, absolutely.

 

ETF.com: How do you frame that in your prospectus? You still must be rather cautious, no?

 

Jacobs: Yes, we are.

 

ETF.com: These are just bull shares, right?

 

Jacobs: Yes, these are just bull shares.

 

ETF.com: You could technically short these if you wanted to, couldn't you?

 

Jacobs: You could, sure.

 

ETF.com: Is that an equivalent of having a bear series of these same series? Or does the path dependency make those much more of a complex proposition?

 

Jacobs: I guess it's simpler to have a bear version of it, but we don't anticipate doing that.

 

ETF.com: Why?

 

Jacobs: We already have -1X ETFs in other areas. So I don't think we would expect to do these 1.25X in a bear format.

 

But really how we're kind of positioning these 1.25X funds is for advisors doing asset allocation. They might be saying: “OK, active management's had a difficult year last year, but is there something I can use that's relatively inexpensive, that gives me the exposure in the asset class I believe in, but gives me a little bit more exposure. And that 25 percent leverage is that little bit more.

 

And so, that's how we sort of see it. It's sort of the bridge from the institutional trading world to more of an asset-allocation model.

 

ETF.com: Since these funds went live late in 2014, how have they been received?

 

Jacobs: We think they're being received fine. We're not aggressively marketing them. We're really reaching out. You're not seeing really any advertising on these. What we're doing is we're going out to professionals and asking them to consider testing them in their models and seeing how they do.

 

So I would expect these to slowly come into the marketplace. And we wanted to have folks that know leverage and have used it in the past. But it's a: "Try these in your models and see how they work." And if they're successful, we'll do more.

 

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