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ETF Analysis: Direxion Small Cap Bull 3X

Launched in November of 2008, the Direxion Small Cap Bull 3X (TNA ) exchange-traded fund (ETF) is a leveraged, high expense-ratio fund from Direxion Investments that aims to produce 300% of the daily investment results of the Russell 2000 Index. In the period between 2010 and 2015, TNA performed well, with a rate over return exceeding 35%.

Its underlying index – the Russell 2000 – is comprised of approximately 2,000 small-cap stocks within the larger Russell 3000, which includes the 3,000 largest stocks in the United States. The Russell 2000 usually represents about 10% of the total market cap of the Russell 3000. This makes TNA a small-cap focused and U.S.-centric ETF. While TNA's management only binds itself to being 80% invested in the Russell 2000, the performance between the two mirrors very closely.

As a 3X leveraged ETF, TNA carries a three-to-one exposure to the performance of the Russell 2000. This means that, before fees and expenses, TNA should grow 3% for every 1% in the Russell 2000. This also works in reverse, however, and losses for TNA are equally exaggerated.

The sector composition of the Russell 2000 changes depending on changing market caps for listed U.S. companies. However, it's usual for nearly 25% to be financial services companies, with other significant exposure to health care, technology and consumer discretionary sectors. No single company's stock comprises more than 1% of the index.


ETFs rarely track their underlying indexes perfectly, but tracking errors tend to be exaggerated with leveraged funds. Errors can be caused by fund expenses -- the expense ratio for TNA is capped at 0.95% until September, 2016 -- index volatility, bid/ask spreads and differences in security composition between the index and the fund. These differences can also be exacerbated by brokerage fees, which are

not included in the expense ratio.

TNA isn't the most expensive ETF in its category, but it isn't going to be mistaken for a Vanguard fund either. It's investment adviser, Rafferty Asset Management LLC, creates long positions by investing in a combination of small-cap index and other, leveraged equity securities.

These other securities can include futures contracts, options, equity caps, floors and collars, swap agreements, short positions, reverse repurchases and other ETFs.

Suitability and Recommendations

The fund prospectus for the Direxion Small Cap Bull 3X highlights the risk of leveraged ETFs with the following scenario: if the underlying index drops 15% in one year (unlikely, but possible), and if the bull ETF functions like it should, your investment in will loses 42.62%.

This extreme price volatility is not for all investors. Leveraged ETFs have grown in popularity, but they exaggerate the market risks of traditional equities. Since TNA is focused exclusively on small caps on U.S. exchanges, it doesn't carry the kind of diversification that many other ETFs or mutual funds provide.

Leveraged ETFs make excellent complements to a more balanced portfolio, but they don't make sense as major components due to the added risk. The trailing three-year beta for TNA is 3.06, its alpha is -4.19 and it has a five-year Sharpe ratio of 0.89, so it isn't a great play for followers of modern portfolio theory (MPT). The investment doesn't offer a yield, so all returns need to be captured through capital gains and depend on volume and liquidity.

All told, the Direxion Small Cap Bull 3X ETF is a high-risk, high-reward play that is not suitable for everyone and is best utilized only by investors with experience in leveraged risk. This is also an actively managed investment and doesn't fit well into a buy-and-hold strategy.

Category: Forex

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