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Basil Gilmore
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2 Scottrade Disclosure - Investors should consider the investment objectives, charges, expense, and unique risk profile of an Exchange Traded Fund (ETF) carefully before investing. Leveraged and Inverse ETFs may not be suitable for all investors and may increase exposure to volatility through the use of leverage, short sales of securities, derivatives and other complex investment strategies. These funds' performance will likely be significantly different than their benchmark over periods of more than one day, and their performance over time may in fact trend opposite of their benchmark. Investors should monitor these holdings, consistent with their strategies, as frequently as daily. A prospectus contains this and other information about the ETF and should be obtained from the issuer. The prospectus should be read carefully before investing.

3 Rules of Engagement for Leveraged ETFs Speaker: Jordan M. Farris SVP, Product Strategy DirexionShares Moderator: Ray Fazzi Senior Editor Financial Advisor Magazine May 15, 2012

4 Important Disclosure Direxion is not affiliated with or employed by Charles Schwab & Co. Inc, and their presentation should not be construed as a recommendation or endorsement by Schwab. You must decide about the appropriateness of their products and services for you. Schwab does not supervise third-party firms and takes no responsibility to monitor the products or services they provide to you. The views expressed are for general information purposes only and are not intended to provide specific financial, accounting or legal advice. Schwab makes no representation about the accuracy of the information or its appropriateness for any given situation. The information and opinions contained in this presentation have been obtained from sources believed to be reliable, but no representation or warranty, express or implied, is made that such information is accurate or complete and it should not be relied upon as such. This presentation does not purport to make any recommendation or provide investment advice to the effect that any inverse or leveraged ETF is appropriate for all investment objectives, financial situations or particular needs. Prior to making any investment decisions, investors should seek advice from their advisers on whether any part of this presentation is appropriate to their specific circumstances. This presentation is not, and should not be construed as, an offer or solicitation to buy or sell any products. Expressions of opinion are those of Direxion only and are subject to change without notice. 4

5 Important Disclosure, cont. An investor should consider the investment objectives, risks, charges, and expenses of Direxion Shares carefully before investing. The prospectus and summary prospectus contains this and other information about Direxion Shares. To obtain a prospectus or summary prospectus, please visit The prospectus should be read carefully before investing. There is no guarantee of success with any technique, strategy or investment. The VIX (ticker symbol for the Chicago Board Options Exchange Volatility Index) is an index designed to track market volatility as an independent entity. The S&P 500 Index is a broadbased unmanaged measurement of changes in stock market conditions based on 500 widely held common stocks. One cannot invest in an index. The views in this presentation are intended to assist the audience in understanding the Funds investment methodology and do not constitute investment advice, nor is it a recommendation to buy or sell securities. 5

6 Who uses Inverse and Leveraged ETFs? Inverse and Leveraged ETFs are designed for sophisticated investors who: > Understand the risks associated with the use of leverage > Understand the consequences of seeking daily leveraged investment results > Intend to actively monitor and manage their investments These funds are not suited for conservative investors who: > Cannot tolerate substantial losses in short periods of time > Are unfamiliar with the unique nature and performance characteristics of funds that seek leveraged daily investment results > Are long term investors who do not monitor their portfolios frequently The risks associated with the funds are detailed in the prospectuses and summary prospectus, which include: adverse market condition risk, adviser s investment strategy risk, aggressive investment techniques risk, concentration risk, counterparty risk, credit and lower-quality debt securities risk, equity securities risk, currency exchange risk, daily correlation risk, daily rebalancing and market volatility risk, depository receipt risk, foreign and emerging markets securities risk, sector securities risk, interest rate risk, inverse correlation risk, leverage risk, market risk, non-diversification risk, shorting risk, small and mid cap company risk, tracking error risk, and special risks of exchange-traded funds, market timing activity and high portfolio turnover risk, investing in other investment companies and ETFs risk, commodities securities risk, geographic concentration risk, valuation time risk, derivatives risk, commodity-linked derivatives risk, wholly-owned subsidiary risk, tax risk, options and futures contracts risks, security selection risk, Debt Instrument Risk, Gain Limitation Risk, Leverage U.S. Government Securities Risk, and Special Risks of Exchange-Traded Funds. ETFs are bought and sold directly by shareholders in a primary market and trade throughout the day on an exchange. ETFs are bought and sold at market price (not NAV) and are not individually redeemed from the fund. Brokerage commissions will reduce the returns. Market price returns are based upon the midpoint of the bid/ask spread at 4:00 pm Eastern time (when the NAV is normally determined) and also do not represent the returns you would receive if you traded shares at other times. Investing the funds may be more volatile than investing in broadly diversified funds. The use of leverage by a fund means the Funds are riskier than alternatives which do not use leverage. Aggressive investing would include the use of futures, enhanced betas, and shorting securities. Shorting securities occurs when investors sell securities they don t own and are committed to repurchasing eventually. Alpha is a measure of performance on a a risk-adjusted basis. The excess return of the fund relative to the return of the benchmark index is a fund s alpha. Futures are financial contracts obligating the buyer to purchase an asset such as a physical commodity or a financial instrument, at a predetermined future date and price. Swaps are the exchange of one type of asset, cash flow, investment, liability or payment for another. Distributor: Foreside Fund Services, LLC 6

7 What we re covering today > Leverage How It Affects Risk and Return > Daily Investment Objectives Tactical Trading Tools > Compounding When Does It Matter? > How Can They Be Appropriately Used? > Myths > Risks: Counterparty > The Bottom Line 7

8 Leverage: The Basics > Leveraged ETFs are a combination of equity baskets and derivatives typically swaps or futures contracts. > This allows investors to gain exposure to specific indexes and sectors without the need for full dollar-for-dollar investment. Typical Composition of a 2x ETF Strategy Equities Derivatives Bull Funds 80%-100% 100%- 120% Bear Funds (inverse) 0% 200% Typical Composition of a 3x ETF Strategy Equities Derivatives Bull Funds 80%-100% 200%- 220% Bear Funds (inverse) 0% 300% 8

Hypothetical Example Index Rises 1% (in millions) * These performance numbers do not reflect daily operating expenses and financing

9 Daily Investment Objectives: 3x Bull Fund when the underlying index rises When the underlying index rises, fund assets rise. The fund must increase its exposure to the index so the total is once again equal to 300% of the fund s new level of net assets. Hypothetical Example Index Rises 1% (in millions) * These performance numbers do not reflect daily operating expenses and financing charges, are hypothetical in nature, and are not representative of actual Direxion Shares returns. There is no guarantee the funds will achieve their objective. 9

Leverage: Risk and Return 3x Bull Fund when underlying index rises The incremental return of the investment in this scenario would be $1,500, which is 3x the daily increase in the index (15%)

10 Leverage: Risk and Return 3x Bull Fund when underlying index rises The incremental return of the investment in this scenario would be $1,500, which is 3x the daily increase in the index (15%) multiplied by the amount of the total initial investment. These performance numbers do not reflect daily operating expenses and financing charges, are hypothetical in nature, and are not representative of actual Direxion Shares returns. There is no guarantee the funds will achieve their objective.

Hypothetical Example Index Falls 1% (in millions) * These performance numbers do not reflect daily operating expenses and financing

11 Daily Investment Objectives: 3x Bull Fund when the underlying index declines When the underlying index declines, fund assets decline. The fund must reduce its exposure to the index so the total is once again equal to 300% of the fund s new level of net assets. Hypothetical Example Index Falls 1% (in millions) * These performance numbers do not reflect daily operating expenses and financing charges, are hypothetical in nature, and are not representative of actual Direxion Shares returns. There is no guarantee the funds will achieve their objective. 11

12 Leverage: Risk and Return 3x Bull Fund when underlying index declines The loss on the investment in this scenario would be $1,500 which is 3x the daily decrease in the index (-15%) multiplied by the amount of the total initial investment. These performance numbers do not reflect daily operating expenses and financing charges, are hypothetical in nature, and are not representative of actual Direxion Shares returns. There is no guarantee the funds will achieve their objective.

13 The Risks of Compounding Example: Market Rises Steadily The fund s gains may be larger than expected. *These numbers do not reflect daily operating expenses and financing charges, are hypothetical in nature, and are not representative of any specific fund s returns. There is no guarantee the funds will achieve their objective. 13

14 The Risks of Compounding Example: Market Declines Steadily The fund s loss may be less than expected. *These numbers do not reflect daily operating expenses and financing charges, are hypothetical in nature, and are not representative of any specific fund s returns. There is no guarantee the funds will achieve their objective. 14

The Risks of Compounding Example: Market is Flat, Yet Volatile In volatile markets, the pursuit of daily investment targets will have a negative impact on the ETF's performance for periods longer

15 The Risks of Compounding Example: Market is Flat, Yet Volatile In volatile markets, the pursuit of daily investment targets will have a negative impact on the ETF's performance for periods longer than a single day. *These numbers do not reflect daily operating expenses and financing charges, are hypothetical in nature, and are not representative of any specific fund s returns. There is no guarantee the funds will achieve their objective. 15

99% Hypothetical Index Hypothetical 3x ETF Hypothetical 3x ETF Volatility

16 Compounding: Volatility Matters More is not always better Hypothetical Index experiences higher volatility. 3.84% % Hypothetical Index Hypothetical 3x ETF Hypothetical 3x ETF Volatility Hypothetical Index Hypothetical 3x ETF Hypothetical 3x ETF Information presented here is hypothetical and meant for illustrative purposes only.

17 Compounding: Volatility Matters Less is sometimes more The same index experience much less volatility than in the previous example. 100% 90% 120.0% 100.0% Index Return = 28.50% 3x Index Return = 85.50% 80% 70% 80.0% 60.0% Bull Fund Return = 91.68% Difference = 6.18% 60% 50% 40.0% 20.0% -3x Index Return = % Bear Fund Return = % 40% 0.0% Difference = 28.87% 30% 20% 10% 0% Average Volatility: 20% Day 1 Day 2 Day 3 Day 4 Day 5 Day 6 Day 7 Day 8 Day % -40.0% -60.0% -80.0% Volatility Hypothetical Index Hypothetical 3x ETF Hypothetical 3x ETF Warning! Greater than expected returns are nice, but compounded returns increase (for a bull fund) your exposure levels beyond 3x, making your position more sensitive to future market movements. Information presented here is hypothetical and meant for illustrative purposes only. 17

18 How Are Leveraged & Inverse ETFs Appropriately Used? Opportunistic Trading > Partial Leveraging > Hedging > Portable Alpha 18

19 Partial Leveraging: Gold Miners Divergence Between Gold Miners Index vs. Gold Value/Price in Dollars Spread in Dollars % Spread Between Gold Miners and Spot Gold Source: Bloomberg. Past Performance is not indicative of future results. 19

20 Hedging: Fixed Income Exposure > Short 3x ETFs can provide greater hedging efficiency. > Scenario: There is an FOMC (Federal Open Market Committee) announcement today. You are unsure if there will be a rate cut or hike. A significant portion of your portfolio is allocated to Long Term Fixed Income. Consider the following example: 1. Determine hedge 2. Allocate to a 3x Leveraged 20+ Year Treasury ETF $1 invested = $3 of negative exposure 3. After rate decision, choose to leave or remove hedge There is no guarantee of success with any technique, strategy or investment. 20

21 Portable Alpha: Developed and Emerging Markets Volumes spike as investors seek protection and opportunity in bear funds Leveraged Emerging Shares Traded Leveraged Developed Shares Traded 16,000,000 14,000,000 12,000,000 10,000,000 8,000,000 6,000,000 4,000,000 2,000, /31/2010 1/31/2011 2/28/2011 3/31/2011 4/30/2011 5/31/2011 6/30/2011 7/31/2011 8/31/2011 9/30/ /31/2011 2,500,000 2,000,000 1,500,000 1,000, , /31/2010 1/31/2011 2/28/2011 3/31/2011 4/30/2011 5/31/2011 6/30/2011 7/31/2011 8/31/2011 9/30/ /31/

22 Myths about Leveraged & Inverse ETFs Myth 1: They Exacerbate Market Volatility, Especially At The Close Myth 2: Bear Funds Exacerbate Market Declines 22

23 Myth 1: Exacerbating Market Volatility Myth: > End-of-day trading by Leveraged ETFs impacts volatility Reality: > Leveraged and leveraged inverse ETFs transact at (or near) the close: buying on up days if net long; selling on down days if net long. > Total net long and short exposure trading at end of the day is smaller than the sum of the bear and bull parts. > Market Volatility has been higher at the opening than it has been at the close. Arbitrage is the simultaneous purchase and sale of an asset in order to profit from a difference in the price. It is a trade that profits by exploiting price differences of identical or similar financial instruments, on different markets or in different forms. Arbitrage exists as a result of market inefficiencies; it provides a mechanism to ensure prices do not deviate substantially from fair value for long periods of time. 23

24 Volatility at the open is higher than it is at the close Leveraged ETFs do not rebalance at the open Five minute volatility High Volume NYSE Issues (basis points) Aug-11 Aug-10 Aug-09 Basis Points Aug-08 Aug-07 Aug % 9:35 10: : : : : : Past performance is not indicative of future results. Leveraged ETFs are not market participants in the first half hour of trading, yet volatility is very often at its highest level of the day. Therefore there must be other events that are affecting volatility much more than trading by leveraged ETFs. Top 100 issues: top 100 trading securities. Basis Point is a unit that is equal to 1/100 of 1%, and is used to denote the change in a financial instrument (i.e. 1% change = 100 basis points, and 0.01% = 1 basis point). 24

25 Myth 2: Intensifying Market Declines Myth: > Leveraged ETFs are creating net short positions in financials > Bear funds create large short exposures Reality: > Leveraged ETFs were net long financials through the most volatile markets > Short exposure positions of bear ETFs represent only a small fraction of overall short exposure. 25

26 Risks: Counterparty (CP) Exposure Is Counterparty Exposure a Risk? > Yes What do you do to mitigate that risk? > Constant credit analysis of counterparties > Diversification of swap exposure to 6 different counterparties > Tri-party Collateral Management: > Segregated Account held at Custodian for benefit of the counterparty > Daily Margin Management > Effectively reduces counterparty exposure to 1 day mark to market risk. 26

27 The Bottom Line > Monitor and Act When Necessary > Not meant to be held, unmonitored for long periods > Volatile Periods may need to adjust more frequently > Less Volatile Periods still need to monitor frequently > Don t have the resources, time or inclination? Don t use them. 27

28 CE Credits CIMA CE Credit To receive 1 CE hour toward the CIMA /CIMC /CPWA designations Log on to: Click on Non-IMCA Continuing Educational Hours Submittal Form CE Sponsor Name: Financial Advisor Magazine Customer ID: Program ID: 12FAM013 Complete form and follow submittal directions A recording and the slides of this presentation will be available at For more information on today s webinar please contact: Jordan M. Farris SVP, Product Strategy DirexionShares farrisj@direxionshares.com Sponsored by

29 Log on to: CE Credits CFP Board CE Credit Log in to your online CFP Board Account ( address and password are needed) CE Sponsor: Financial Advisor Magazine CE Sponsor ID Number: 2839 Program Name: Webinar Rules of Engagement for Leveraged ETFs Program ID: Hours Granted: 1.00 A recording and the slides of this presentation will be available at For more information on today s webinar please contact: Jordan M. Farris SVP, Product Strategy DirexionShares farrisj@direxionshares.com Sponsored by

Understanding Leveraged Exchange Traded Funds. An exploration of the risks & benefits

Understanding Leveraged Exchange Traded Funds An exploration of the risks & benefits Direxion Shares Leveraged Exchange-Traded Funds (ETFs) are daily funds that provide 300% leverage and the ability for