Direxion, the provider of a number of triple leveraged exchange traded funds (ETFs), is changing the objective for all of their leveraged index mutual funds (LIFs). While the ETFs aren’t impacted, this change is still an interesting one.

Investors should note that investing in index funds can be more volatile than investing in broader funds, Direxion says. The use of leverage increases risk to a fund, and the more a fund invests in leveraged instruments, the more it could magnify gains or losses to those investments.

The offered funds will include bull funds, which seek to produce 200% of the monthly performance of its benchmark, and bear funds, which seek to reflect 200% of the inverse of the monthly performance of its benchmark. Investments made at the start of the month and finish on the end of the same month should receive 200%, or -200% if inverse, of the return of the benchmark.

Within a month, the benchmark moves will impact the fund’s exposure and net assets equally. What results is a new ratio of exposure level to asset level. For example:

• Bull funds. If benchmark gains, exposure level and risk will drop below 200%. If benchmark declines, exposure level and risk will be over 200%.
• Bear funds. If benchmark gains, exposure level and risk will be higher than 200%. If benchmark declines, exposure level and risk will fall below 200%.

Every Day Finance notes that this could deliver returns that are more in line with what investors believe they should get in a leveraged or inverse fund by removing the “perceived” tracking error. Also, in a mutual fund that rebalances monthly, the erosion caused by fees from transactions within the fund could be minimized.

Depending on when the fund is purchased during the month, the intra-month purchase will have a higher or lower exposure level according to the type of fund, and exposure will remain constant through the rest of the month, or  until the position is sold.

If an investor decides to hold the fund through the end of the month, however, there will be a rebalancing. Exposure will be reset to 200% or -200% on the last day. Accordingly, gains will be added to the original principal and risk will be higher, or losses will be taken from the original principal and risk reduced.

For more information on leveraged and inverse funds, visit our long-short category. Read our special report on leveraged and inverse ETFs here.

Max Chen contributed to this article.

Tags: ETF 101, Long-Short ETFs