Educating financial advisers about leveraged-index funds is one goal that Dan O'Neill embraced when he took over last month as Direxion Funds' chief executive.
Many advisers are cautious about leveraged-index funds, which often use derivatives to magnify the performance of a market index, because of frequent trading and volatility.
If used in a portion of a portfolio, these funds can deliver improved risk return, Mr. O'Neill said.
The Boston-based firm recently joined with Wilshire Funds Management, a global investment management firm in Santa Monica, Calif., to launch a model portfolio using leveraged-index funds, which are capped at 20%.
"The funds may increase your risk but they can also decrease your risk if you use them wisely," Mr. O'Neill said.
"They can make your portfolio more stable," he said. "There is volatility there, but if it's understood and measured before it's used, then it's perfectly acceptable."
Timing is an issue, said Wenli Tan, a fund analyst at Chicago-based Morningstar Inc.
"We don't think investors can time the market perfectly," she said.
"Investors can be going in and out of the funds, often at the wrong time," Ms. Tan said. "We don't think these funds are suitable for long-term investors."
Of course, Direxion's funds primarily are used by advisers who practice tactical asset allocation.
ALLOCATION QUESTION
Then there is the question of how much of their portfolio investors should put in leveraged-index funds.
"Someone may want to have a small portion of their portfolio in these funds just to enhance a return," Ms. Tan said. "But if it's a significant portion, your risk will increase significantly."
Leveraged-index funds can complement a portfolio, Mr. O'Neill said.
'They do need to be monitored all the time," he said. "The type of person who wants to buy and hold a fund, leave it alone and look at it three years later is a person who shouldn't be buying these types of funds."
Direxion Funds, which reported $1.5 billion in assets on Feb. 29, is one of a handful of firms that offer leveraged-index funds.
The funds use leverage, generated through the use of futures or swaps, to increase their exposure to an index by some multiple, usually between 125% and 250%. The objective is that the fund will achieve daily returns which are that multiple of the return of the target index.
Direxion's bear funds provide leveraged short exposure to target indexes and can be used to implement hedges within a portfolio. The funds can be used in other strategies, such as portable alpha and long/short.
The Direxion Commodity Bull 2x Fund (DXCLX) returned 87.6% and the Latin America Bull 2x Fund (DXZLX) 83.7% last year, the top performances among equity funds, according to Morningstar.
Year-to-date through last Tuesday, the funds were both in negative territory, however. Direxion Commodity Bull 2x was down 2.49%and Direxion Latin America Bull 2x was down 0.10%.
"The funds do a good job in trading daily return, but over the long term they fail to meet the stated goal. Consider the trailing three-year period and the returns will lag because of negative compounding," Ms. Tan said.
"Negative compounding can easily be combated by taking money off the table or putting more in," Mr. O'Neill said.
Direxion Funds also have higher expense ratios than pure index funds — 1.81% for the firm's average domestic and international stock funds and 1.86% for its taxable bond fund, according to Morningstar.
"But we provide leverage," Mr. O'Neill said.
Direxion is trying to educate advisers. The firm's updated website includes educational material, a fund tracking system and white papers.
Direxion also launched a new fund, the India Bull 2x Fund (DXILX), on March 12.
Some advisers will be hard to persuade.
If the clients understand the risk, then they may want to use the leveraged-index funds, said Joseph Alexopoulos, principal of Los Angeles-based Aequitas Wealth Management, which has $15 million in assets.
"If they can appreciate those risks, then it's suitable for an investment objective. You really have to have the stomach for these things," Mr. Alexopoulos said. "But I wouldn't bet the farm; when you're wrong, you're really wrong."
"You have to have a very, very high risk tolerance," he said. "You could get burned; you are playing with fire."
E-mail Sue Asci at [email protected].
