Two Summer Tips to Save Your Life

So you think you want to look at alternative investments for individual investors and invest like many institutions do. Well look no further than DirexionShares mutual funds. This is a fine example of the proliferation of leveraged exchange traded funds (ETF’s) – these funds are supercharged in that they give you two (2X) and three times (3X) the return on an index. Take for example, the fund with the ticker symbol GASX - it's an ETF that is 3X short natural gas stocks. In other words if the index is down 10 percent the fund should be up about 30 percent. Our predilection for doubling up to catch up in this market is being exploited by many funds – but remember, slow and steady wins the race.

The benchmark index for this fund was down just over 22 percent for the last 12 months ended March 31, 2012. Therefore, the GASX fund should be up about 66 percent, which sure helps. But alas, the fund is up 10.6 percent over the same period. Up is good, but what happened to about 56 percentage points of return?

Fund Objective

“The Direxion Daily Natural Gas Related Bear 3X ETF seeks daily investment results, before fees and expenses, of 300% of the inverse (or opposite) of the performance of the ISE Revere Natural Gas Index ^TM. There is no guarantee the fund will meet its stated investment objective.”

The answer is underlined. The fund is not beholden to its own objective. From its inception nearly two years ago, GASX is down 38.5 percent. The benchmark index is up 17 percent for the same period. If you bet against natural gas companies two years ago, you would have been right, but this ETF would have lost you close to 40 percent.

What makes this even more interesting is that its mirror image, GASL, the 3X long natural gas index ETF is down about 57 percent for the year ended March 31, 2012 (only about 10 percent away from where it should be at 3X the index). And it’s down 48 percent for the period since inception about two years ago (where it should be up around 50 percent).

What gives? This is what's known as leveraged ETF slippage. The concept of “tracking error” or “slippage” is now front and center. ProShare Advisors, one of the top structured ETF firms just got hit with a lawsuit. From the Wall Street Journal:

A lawsuit seeking class-action status claims that ProShare Advisors and others violated a securities act by failing to disclose risks inherent in its ProShares UltraShort Real Estate fund, an inverse leveraged exchange-traded fund, including the risk of a "spectacular tracking error."

Now if you want to find alternative ways of losing money in alternative investments, try some of the other Direxion ETFs. Indian equities, long-term treasuries, semiconductors - whatever. Who said that derivatives and leverage was just for the big guys? With these sloppy funds over time you lose either way. And the higher the volatility the more you lose.

It is in fact remarkable that this is a retail product. But no worries, there is proper disclosure.

Fact sheet disclosure: - Investing in the funds may be more volatile than investing in broadly diversified funds. The use of leverage by a fund increases the risk to the fund. The Funds are not suitable for all investors and should be utilized only by sophisticated investors who understand leverage risk, consequences of seeking daily leveraged investment results and intend to actively monitor and manage their investment. The Funds are not designed to track the underlying index over a longer period of time.

Well, duh!

As always, consult an accredited financial advisor before diving in, there are sharks in the water. Also, wait at least one hour after eating before going swimming.

CBlakely CFP ®, CTFA     06/2012

Sources: Sober Look, WSJ, Bloomberg, LP.