Direxion, the creator of Daily Financial Bull 3X (FAS), recently filed to launch a 130/30 strategy ETF to add to their leveraged product line. It's a good time for Direxion to diversify: UBS (UBS), Edward Jones and Ameriprise (AMP) have halted the sales of leveraged funds, while Morgan Stanley (MS) and Wells Fargo (WFC) currently have the funds under review.)Leveraged funds lave been Direxion's bread and butter, sky rocketing the ETF issuer into the public and regulatory spotlight. Rather than betting on 3 times long and 3 times short pairs like Emerging Markets Bull 3X ( EDC) and Emerging Markets Bear ( EDZ), a 130/30 fund would combine both long and short strategies in one fund. The 130/30 strategy has historically been used by hedge funds to outperform market returns. These funds try to outperform a benchmark by holding 130% long exposure to individual securities the manager believes will outperform the market and 30% short exposure to securities expected to fall behind the market. The result is leverage in both directions. While Direxion was already beaten to the punch, this issuer's recent press will certainly help to gain public knowledge of the new fund. ProShares, another popular leveraged fund provider, has already launched the ProShares Credit Suisse 130/30 ETF ( CSM). While the new fund has yet to gain trading traction, average volume is not anemic. First Trust, creator of First Trust Natural Gas ( FCG), also launched its own 130/30 ETN, the First Trust Enhanced 130/30 Large Cap Index ( JFT), more than a year ago. Investors should continue to be aware that ETNs reflect the credit-worthiness of their exposure, adding an extra layer of risk. Issuers like Direxion and ProShares have taken great pains to stay ahead of the regulatory juggernaut with descriptive warning labels. Both issuers warn that leveraged funds are designed for daily exposure, not long-term positions. The new 130/30 ETF would take aim at a longer time period -- these hedge fund strategies take time to play out.
Two important questions remain: Will potential investors fully understand new strategies before investing, and do new "hedge fund ETFs" fit with what customers are demanding from the fund universe? In the post-Madoff trading world, the issue of suitability is particularly important. Yes, 130/30 strategies have outperformed their benchmarks relatively well, but any product that uses swaps or futures to enhance returns adds another layer of risk. Are strategies that are difficult to understand suitable for long-term accounts? While the first generation of these products is tested in daily trading, investors should probably sit tight. The question of volatility and liquidity is also an important one. The true test of these products will be the volume that they are able to attract and the aberration between the fund's share price and NAV. Any publicity is good publicity and Direxion is certainly on the radar. Investors should give these funds time to prove their worth before investing. While the 130/30 strategy has worked in other incarnations, the ETF model presents new challenges. How far will potential regulation extend? Funds that triple one direction? Funds that use leverage in any capacity? Investors should wait for the answers to these important questions before wagering capital on these early-to-market funds.