A Narrow, Pricier ETF I May Buy

Why the just-launched Direxion Low Priced Stock ETF (LOPX) intrigues me.

The Direxion Low Priced Stock ETF (LOPX) owns only 50 stocks and has an expense ratio more than 10 times that of U.S. stock ETFs I typically recommend, yet I still may buy a little. When Heather Bell recently wrote about a new fund targeting penny stocks, it caught my eye. Here’s what this new ETF is and why I’m interested.

According to the Direxion website, LOPX seeks investment results, before fees and expenses, that track the Solactive Two Bucks Index. I had no clue what that was and thought it would be one of the 1 million+ indexes in existence that I wouldn’t touch. But upon further reading, I had an aha moment.

The Direxion Low Priced Stock ETF offers exposure to the 50 companies trading between $2 and $5 at the time of selection.

It must meet the following criteria:

• A minimum average daily value traded of $1 million over 3 months.
• A market capitalization of at least $85 million.
• A closing price between $2.00 and $5.00 (August selection date), or a closing price between $1.25 and $10.00 (February, May, and November selection dates).
• Securities that have had a reverse stock split between the last and current selection day are not eligible for inclusion.

Since I’m all about ultra-low-cost, diversified, cap-weighted stock ETFs owning thousands of stocks with expense ratios of 0.07% or lower, why did this narrow ETF with a 0.50% expense ratio interest me?

Because I’ve written before that beneath my dull exterior beats the heart of a gambler who just can’t resist acting on the thrill-seeking urge that indexing doesn’t satisfy. I try to buy one or two stocks a year with the following criteria for the fun part of my portfolio:

• After large price declines
• Priced below $10, preferably $5, which forces many institutional investors to dump
• Media noting money managers being fired for holding a particular stock
• Accounting scandals
• Insider trading allegations
• TV gurus saying the company is dead

I consider it like venture capital investment, where they would expect about five of every 10 investments to go belly up and hope to get one or two home runs. I talk about my home runs such as a 5000% return on Priceline.com, now Booking.com (BKNG) and other winners, and try to forget my losers such as Eastman Kodak and United Airlines.

Similarities & Differences

Hopefully you see some similarities, and I’ll point out some differences. David Mazza, managing director and head of product at Direxion, says the weighted average market capitalization is about $3 billion.

He states that the ETF structure of creations and redemptions should allow greater tax efficiency when constituents are sold at a gain without passing that gain to shareholders, until they sell the fund itself.

This is very similar to my gambling portfolio. And from the chart below from the fund’s most recent factsheet, you can see the one home run: AMC.

(Use our stock finder tool to find an ETF’s allocation to a certain stock.)

Yet there are differences as well. On the plus side is more diversification (50 stocks rather than one or two a year), a time savings and lack of clutter. So this is kind of automated gambling.  

I also happen to love the fact that their backtesting wasn’t particularly attractive. It may be the first new fund that didn’t produce spectacular results on a backtested bases. Typically, regression to the mean then happens, with underperformance and often extinction to follow.

On the negative side, it’s not as fun and may not satisfy my urge to gamble. But the biggest downside is that the index is rebalanced and reconstituted quarterly, and the average holding period is just over seven months.

It took many years for my Booking investment to get that 5000% return. AMC will soon be sold unless the price plunges. Admittedly, given it’s a meme stock, that may not be a bad thing.

My Take

Direxion says “LOPX may be considered a satellite holding to complement other broader positions within a portfolio.” I may consider this part of my “core and casino” approach.

In the world of ETFs, this fund is tiny, with only $4.9 million in assets. It’s unproven, and I don’t know if it will still be around in a few years. But it’s truly a contrarian strategy, and a 50 bps fee isn’t outrageous for such a strategy. It’s so much better than triple levered inverse ETFs, which I think have odds worse than Las Vegas.  

I’m still on the fence about buying a little, and would obviously use a limit order, since this is such a small fund. In fact, always use limit orders when buying stocks and ETFs, as markets can turn illiquid and you don’t want to buy or sell willing to accept any price.   

Whether for clients or myself, I limit a gambling portfolio to no more than 5% of one’s total portfolio. If I do buy LOPX, it will be a tiny part of my gambling portfolio.

Allan Roth is the founder of Wealth Logic LLC, an hourly based financial planning firm. He is required by law to note that his columns are not meant as specific investment advice. Roth also writes for the Wall Street Journal, AARP and Financial Planning magazine. You can reach him at [email protected], or follow him on Twitter at Allan Roth (@Dull_Investing) · Twitter.