Split Bares Weakness in Leveraged Funds - TheStreet

Split Bares Weakness in Leveraged Funds

Direxion is going through with a reverse stock split in February for five bearish funds that have been pummeled by the recent market rally.
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NEW YORK (

TheStreet

) -- Betting against equities hasn't worked out well for five of Direxion's leveraged funds. In mid-February, Direxion will be executing a reverse split for five bearish funds pummeled by the recent market rally.

Once again, news of a leveraged fund split underscores the complexity of these professional products, and emphasizes the danger that many of these funds pose to investors.

The five funds involved in Direxion's reverse split are the

Monthly Small Cap Bear 2X Fund

(DXRSX) - Get Report

,

Monthly Emerging Markets Bear 2X Fund

(DXESX)

,

Monthly Developed Markets Bear 2X Fund

(DXDSX)

,

Monthly NASDAQ 100 Bear 2X Fund

(DXQSX)

and the

Monthly S&P 500 Bear 2X Fund

(DXSSX) - Get Report

.

Direxion's official announcement notes that Feb. 12, 2010 will be the last date of the pre-"reverse split" price, and that Feb. 16, 2010, will be the first day reporting the post-"reverse split" price.

Since these funds have sunk under the weight of a rallying market, the reverse split will serve to lift the funds' NAVs. Direxion's latest move demonstrates that daily-tracking ETFs are not the only leveraged funds investors have to fear.

While the reverse-split may be unfamiliar to Direxion's mutual fund holders, the issue is fresh in the memory of leveraged ETF holders. Rather than tracking a monthly objective, like Direxion's mutual funds, Direxion's 3X ETFs track daily trading objectives.

Just as markets can

erode triple-leveraged ETFs

, a solid trend can crush monthly-tracking mutual funds. The Direxion Monthly NASDAQ 100 Bear 2X fell 73.30 during the one-year period ended Jan. 26. DXQSX is currently worth less than $5.

When funds are crushed by "adverse" market trends, transaction costs grow for buyers and sellers. This is especially the case for investors in triple-leveraged ETFs, who have to pay additional transaction costs to buy more of a fund in order to achieve the same hedge.

The five monthly mutual funds follow three daily ETFs in executing their reverse splits. The first Direxion ETF to execute a reverse split was the

Direxion Daily Mid Cap Bear 3X

(MWN)

.

Before MWN's split, the ETF was priced at $32.48 on June 24,2009. Following the 2-for-1 reverse split, MWN traded at $60.25 on June 25, 2009. Currently, MWN is priced at $23.74, the result of gradual market recovery.

In early July, Direxion attempted to set straight the popular

Direxion Shares Daily Financial Bull

(FAS) - Get Report

ETF and the

Direxion Shares Daily Financial Bear

(FAZ) - Get Report

with

a 3-for-1 split

. FAS is currently trading around $70 while FAZ has fallen to approximately $20.

If erosion were responsible for the previous decline, it is now trending -- not volatility -- that is to blame. When FAS and FAZ split 3-for-1, market volatility had eroded both the bullish and bearish bets. The next five mutual funds that Direxion splits are all bearish bets -- showing the weakness of leveraged bear bets in a strengthening market.

Whether you're dealing with monthly or daily leverage, it is important to

understand the complexity of these products

before investing.

For more on leveraged funds, check out the links to these articles on

leveraged ETF rule changes

;

four types of nontraditional ETFs

; and

a regulatory storm brewing for ETFs.

-- Written by Don Dion in Williamstown, Mass.

At the time of publication, Dion did not any positions in the funds mentioned.

Don Dion is president and founder of

Dion Money Management

, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.