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Direxion Funds Leverages its Leap into ETFs


Direxion Funds of New York and Boston hopes to break new ground for itself as well as the leveraged ETF marketplace.

On April 30, Direxion Funds registered with the Securities and Exchange Commission 36 ETFs that will each leverage their exposure by 300%. These are the first ETFs to be managed by Direxion, as well as the industry's very first ETFs to employ 300% leverage. Rafferty Asset Management of New York will be the investment advisor for the Direxion ETF Trust.

Eighteen of the funds are bull-market ETFs designed to positively correlate to a specific index representing a market or sector and providing three times the return. The other 18 are bear ETFs designed to provide three times the inverse return of the indexes they track.

The group includes 12 domestic equity ETFs that track to broad market cap indexes, 14 international ones that track to individual countries or regions, and 10 more which track to single industries: commodities, energy, financial, homebuilders and real estate.

Direxion Funds isn't shy about the use of leverage. Of its 16 so-called bull mutual funds, both equity and fixed-income, the majority use leverage to provide 200% or 250% the return of its benchmarked index, although some provide 100% or 150%. Likewise, its 11 inverse or so-called bearish mutual funds largely provide 200% or 250% exposure to the chosen market or sector. Its first 250% leveraged equity mutual fund debuted in May 2006. The fund group has two dozen additional, similarly leveraged mutual funds in shelf registration.

In fact, Direxion Funds has built its reputation on employing more leverage than other mutual fund advisors, including Rydex Investments of Rockville, Md. and ProFunds of Bethesda, Md. who have typically leveraged up to a cap of 200%. So it makes sense for the company to be the one innovating ETFs with extra oomph by way of 300% market exposure.

Of course, whether or not that added leverage appeals to financial advisors as well as retail and institutional investors has yet to be seen.

Such leveraged investments can be appealing because if you want, say, a 6% exposure to a market, you only have to move two percent into that market, said Jeff Tjornehoj, research manager with Lipper. There are periods when having leveraged investments is great, but there's a whole lot of volatility inherent in such products and if you don't buy them at the right time there could be dire consequences, he noted. "There are very few investors with a strong interest in such highly levered investments," he added. "Direxion is trying to build a niche and not trying to be all things to all people."

"I think two times is a lot of leverage and for the vast majority of investors three times is too hot, too aggressive," agreed Jeffrey Ptak, director of exchange traded analysis at Morningstar and editor of Morningstar ETF. While 300% exposure might sound great for a day or two, the reality is that with the arithmetic variations related to compounding, three times leverage only works for a day or two, not for the long-run, he added.

"The first mover advantage is very, very important with these types of aggressive products," Ptak said.

ProShares, the ETF sister to ProFunds, was the first out of the box with leveraged and short ETF investments, debuting them June 2006. Rydex followed with six, three each long-leveraged and short-leveraged ETFs, in November 2007.

"ProShares is now one of the fastest growing ETF groups," Ptak said. "But Rydex has had trouble capturing market share and seizing some of that market from ProShares. It will be a tough slog [for followers]," he added.

Whether it's leveraged long or leverages short, investors over the past 10 years have stepped beyond the nine style boxes of investing and realized there are numerous other asset classes and ways of investing, said Michael Sapir, CEO of ProShares Advisors which has seen assets balloon to $17 billion over the past nearly two years. "It's been a macro move from simple style investing to more sophisticated strategies. "Investors who have used leverage have done well. They've seen the returns," he said. "What we've done is essentially create a whole new way for investors to consider investing."

The fact that ProShares has locked up nearly 99% of the market for short and leveraged ETFs sends a real message to current and would-be competitors. "It's a warning to others that it's a difficult market to be in," Sapir added. "The challenge is to be noticed."

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