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Top ETF Stories of 2009: Leveraged Funds

On Wednesday, July 8, Direxion will execute a 1-for-5 reverse split of the shares of FAS and a 1-for-10 reverse split of the shares of FAZ. Because of the split, some investors will be left holding fractional shares that cannot be traded on NYSE Arca. According to Direxion's press release:

Thus, FAS and FAZ will redeem for cash a shareholder's fractional shares at the Funds' respective split-adjusted NAVs as of July 8, 2009. Such redemptions could cause a shareholder to realize a gain or loss in connection with the redemption of the shareholder's fractional share. Otherwise, the reverse split will not result in a taxable transaction for holders of FAS or FAZ shares. No transaction fee will be imposed on shareholders for such redemption.

Direxion will provide a one-time opportunity for shareholders to redeem their odd-lot shares. While the split will hike up the price of FAS and FAZ, potentially discouraging some investors from scooping up shares, further market volatility could erode the price of FAS and FAZ once again in the future.

The reverse split in FAS and FAZ should dampen the explosion in volume that the funds have seen in the past few months. Since the share price of FAS and FAZ has been so low -- approximately $8 and $5, respectively -- investors have had to buy more and more shares to have equivalent investments.

The drop in price has also potentially attracted investors who do not belong in leveraged funds. With higher share prices and lower share volume, the headlines for these funds may finally become representative of their actual meaning to the market.

In a Q&A available on their website, direxionshares.com, the issuer notes that the reverse split could be beneficial to their shareholders. The primary reason that Direxion is completing the split is the fees that are currently incurred by shareholders. Direxion notes:

The bid-ask spread is expected to decline as a percentage of the price paid per share. For instance, a penny spread on a $5 stock is 20 basis points (0.2%), while a penny spread on a $50 stock is 2 basis points (0.02%). Further, commissions charged by brokers who assess their clients on a per share basis will be smaller as investors will need to buy or sell fewer shares to meet their investment goals. In short, Direxion believes that the reverse splits will adjust the share prices to a more cost efficient level for the Funds' shareholders.

While investors may begrudge the taxable event that will result from redeeming odd-lot shares in the wake of the split, the reduction in transaction fees may be a satisfying reward.

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