Think emerging markets are going down, like, today? Well here's one way to play it.
Direxion, a money manager based in Boston, has an exchange-traded fund that lets investors book daily gains whenever there are losses in the main stock index covering emerging markets. Those include China, where growth is slumping, and Brazil, which is mired in a multi-year recession. Then, you can take it to the next level: The fund carries "3-times leverage" to triple the returns. So a 5% one-day loss in the index would translate to a 15% profit.
The risk, of course, is that emerging markets suddenly shoot up -- for triple the losses. But with the benchmark MSCI Emerging Markets Index (EEM) - Get Report up just 1.9% this month following a 17% rout during the three prior months, there are plenty of pundits warning of a new downturn. They include Swiss bank UBS, ratings firm Standard & Poor's and even former Federal Reserve Chairman Ben Bernanke.
"Emerging markets in general is such a popular theme right now that we've seen huge inflows," said Sylvia Jablonski, a managing director at Direxion.
Assets in the ETF, called the Daily Emerging Markets Bear 3x Shares (EDZ) - Get Report , swelled to $216 million in September as the MSCI index plunged. They fell by half as the stocks rebounded this month. In the past few days, the assets have started to climb again.
UBS strategist Bhanu Baweja wrote in an Oct. 27 note that emerging-market currencies are set to weaken, since commodity prices are likely to stay weak while borrowers in the countries face the prospect of refinancing their dollar-denominated debts at higher interest rates.
"Today, EM sentiment is taking a break from perceived extreme negativity," Baweja wrote. "However, fundamentals are still slowly worsening."
S&P said, in an Oct. 28 report, that the potential for further credit-rating downgrades in emerging markets remains "elevated," and in an appearance the same day at the London School of Economics, Bernanke characterized the countries as "the most meaningful risk" to the global financial system right now.
Direxion created the EDZ ETF in 2008, and until recently its mirror opposite -- the Daily Emerging Markets Bull 3x Shares -- attracted most of the attention. The firm also offers more targeted bets: There are funds to profit from a crash in Chinese and Russian stocks; another provides three times the gains when Indian stocks rise.
The so-called "negative leverage" -- winning big from losing -- in the emerging-markets bear fund comes from a trick in how it's structured. Unlike a regular ETF, it has no underlying stocks. The whole thing is built out of derivatives contracts with seven banks: Credit Suisse, Deutsche Bank, Citigroup, Merrill Lynch, Morgan Stanley, UBS and BNP Paribas.
The contracts are essentially wagers between the fund and the banks, in which they agree to pay off at three times the daily movement in the MSCI index, depending on who's right.
Theoretically, institutions could trade the derivatives directly; Direxion does all the structuring so investors can trade the whole thing just like a stock.
"The reason why they would use the ETF is that you have the ease of holding a long position, and that gives you short exposure," Jablonski said.
This is not a buy-and-hold investment: Because of a mathematical -- but real -- phenomenon known as "decay," losses can compound and, over time, wipe out previous gains for traders who aren't paying attention.
Let's just say that it isn't for amateurs.
"These are marketed primarily to institutions and sophisticated traders who understand the risks of leverage and compounding," Jablonski said.