Sizing Up Long/Short ETF Tools

Direxion Funds, sponsored by Rafferty Asset Management, is well-known for its ETF tools for tactical traders, with a long lineup of leveraged and inverse funds the day-trading crowd has come to rely on.

The firm boasts $13 billion in 88 U.S.-listed ETF assets today.

However, earlier this year, Direxion launched a family of long/short ETFs built like no other—capturing 150 (long)/50 (short) exposures of entire sectors, factors and regions, with the goal of expanding its reach to a broader set of investors who think more long term than day traders. 

The lineup (below) is highly intuitive from a design perspective. Offered in pairs, these ETF portfolios go long defensive sectors, short cyclicals, and vice versa; or long developed equities, short emerging markets. There’s a long-value, short-growth equities ETF, and an ETF that takes the flip side of that trade. In short, these ETFs essentially offer leveraged (1.5x) exposure to a segment or theme, and short (-0.5x) exposure to another, capturing the relative performance between the two.

The pairs of ETFs launched earlier this year include:

• Direxion Russell 1000 Value Over Growth ETF (RWVG)
• Direxion Russell 1000 Growth Over Value ETF (RWGV)

Each of these ETFs has about $29 million in assets, and cost 0.46% in expense ratio (ER).

• Direxion MSCI Cyclicals Over Defensives ETF (RWCD)
• Direxion MSCI Defensives Over Cyclicals ETF (RWDC)

These ETFs have $18 million and $14 million in assets, respectively, and cost 0.45% in ER.

• Direxion Russell Large Over Small Cap ETF (RWLS)
• Direxion Russell Small Over Large Cap ETF (RWSL)

Each of these ETFs has about $16 million in assets, and cost 0.46% in ER.

• Direxion MSCI Developed Over Emerging Markets ETF (RWDE)
• Direxion MSCI Emerging Over Developed Markets ETF (RWED)

RWDE has $15 million in assets and costs 0.52% in ER; RWED has $13 million and costs 0.58% in ER.

• Direxion FTSE Russell US Over International ETF (RWUI)
• Direxion FTSE Russell International Over US ETF (RWIU)

RWUI has $15 million in assets and costs 0.46% in ER; RWIU has $14 million and costs 0.55% in ER.

We recently spoke with David Mazza, head of product for Direxion, to talk about what these ETFs bring to the table, and how investors are using them. Here’s what he had to say:

ETF.com: What drove Direxion to break into new territory and launch this family of long/short products? What’s the big picture?

David Mazza: These strategies are developed in an intuitive way, really centered on the way many investors make major decisions when building the equity part of a portfolio. At its core, investors have an opinion on the U.S. versus international stocks, or emerging market over developed market stocks, or value over growth.

However, the primary way they’ve historically expressed those views in portfolios is by over- or underweighting one of those particular pairs. The challenge is that you’re actually only expressing part of that view, because you're never able to actually fully underweight a particular position. That's where the idea behind the relative weight strategy came about—it’s a way to be more capital efficient in your exposure.

You gain 150% on the long side, plus 50% on the short side. If your view is correct, you would have the ability to outperform that traditional long-only approach.

ETF.com: In this kind of approach, the direction matters, but also the relative performance between the two segments, because a 150/50 would magnify that relative performance, right? Take RWDE, for example. Since inception, the fund—long-developed, short-emerging—has actually outperformed both the iShares Core MSCI EAFE ETF (IEFA) and the iShares Core MSCI Emerging Markets ETF (IEMG).

Chart courtesy of StockCharts.com

Mazza: Yes. If your view is incorrect, by having amplified exposure, you would underperform. But we offer both sides of the pairs. We may have an opinion on what particular area of the markets may do best, but we want to give people the tools so they can implement both sides of the view.

ETF.com: On that, one in each pair is going to be underperforming, by design. Timing here is critical.

Mazza: Yes. What's interesting is there's a lot of cyclicality to markets. Over a very long run, the difference between any particular market segment is a lot lower than I expected, even value over growth, only within a few basis points. I'm talking decades.

But over rolling one-year periods or three-year periods or five-year periods, or even shorter, the difference can be massive. Just look at a couple of weeks ago: The longstanding underperformance of value began to be reversed very quickly. Our value-over-growth strategy had excellent performance, outperforming the traditional value approach by over 1% in just one week.

These ETFs are not intended for people to be trading them on a daily basis. These are for intermediate viewpoints—somewhere between six months to, say, five years when you'd expect a trend to play out.

ETF.com: How do you implement these ETFs? Would you replace other ETFs with them?

Mazza: I would expect these ETFs primarily to be used as your tool for over- and underweighting. I don't think it's going to replace the entirety of a growth/value position or a cyclical/defensive sector position.

But if you have a view or you have a model—whether it's informed from fundamental analysis or quantitative analysis—this is the tool for you, because it allows you to differentiate yourself from what others may be doing.

Again, if your views are right, you’ll outperform without taking on significantly more volatility. They're not intended to fully replace what people are doing, but they're really intended to be a portfolio construction complement.

ETF.com: To your point, these strategies don't introduce necessarily another level of volatility to your portfolio.

Mazza: That was really interesting from our research. Because they're index-based, taking long-standing definitions of growth and long-standing definitions of value, you're still biased toward having a long-only exposure. It's not a true long/short strategy where you have a significant amount of tracking error relative to the market. It's 150% long and only 50% short.

So, you’re more influenced by the performance of the long side, and the spread that you're capturing from the long outperforming the short, in that case, is your additional benefit. That structure allows more people to use them in wider parts of the portfolio than a true long/short, which would be much more of an alternative.

ETF.com: Some say this type of long/short strategy relies on two things to work: market timing and luck—that you’re on the right side of the trade. How do you respond to that?

Mazza: We all know the old saying: “It's time in the markets, not timing the markets that matters for long-term wealth creation.” That’s something I would agree with.

But what we know is there are long-term cycles that exist within markets. We don't believe these are intended for someone to try to predict a short-term short-covering sector or factor rotation.

These are intended for someone to have a view, say, “If I've been persistently underweight emerging markets, this is a capital efficient way to undo that underweight without introducing a significant amount of bias.”

You certainly do need to get the view right—the view needs to play out for you to get that benefit of outperformance. But the portfolios aren’t built on a narrow view. They use the Russell 1000 Value and the Russell 1000 Growth or MSCI Emerging Markets IMI and MSCI EAFE IMI. It's not just a few securities that define growth or a few securities that define value that drive outperformance, and that helps.

ETF.com: Who’s the target investor here?
Mazza: These ETFs were launched in January. In the short time period they’ve been around, the primary audience has been advisors, particularly those who build portfolios. Many of them are looking for ways to take that view, and they say, “This is a tool I've never had before because I've been long-only constrained.” And this is doing long/short in an index-based way.

So, the due diligence process is really on the structure (150/50) and not on the definitions of value or growth, or large cap or small cap. They're off the shelf. They have histories that go back decades. We're just combining them in a way that they've never been combined for the majority of investors.

Contact Cinthia Murphy at [email protected]