This summer, both FINRA and the Securities and Exchange Commission (SEC) weighed in with their thoughts on these controversial funds and ultimately declared that investors should seek the advice of an investment professional who understands how these funds work. The agencies also took care to note that the ETFs need to be more closely monitored than their plain-vanilla brethren. (Read their statement here).

That’s the end of it, right? Not so fast.

Since then, ProShares was hit with a lawsuit regarding the UltraShort Real Estate (NYSEArca: SRS), while Direxion was hit with a suit that focuses on the performance of the Financial Bear 3X Shares (NYSEArca: FAZ). (How leveraged and inverse ETFs work).

There are two issues at play in these suits:

1. Did the providers give proper disclosure about these funds? Yes, they did. Leveraged and inverse ETF providers have taken care to ensure that investors don’t buy these funds without understanding how they operate. This, coupled with the SEC and FINRA warnings, should do much to mitigate any confusion or misunderstanding.

2. The investors filing these suits were “surprised” by how their funds performed. There has been no shortage of education on these funds. Anyone who has done their due diligence would have found a number of sources to use when evaluating them and enough information to determine whether they were worth the risks they entail.

ETF Database put together a good article explaining the issue of compounding. While compounding can work against investors in highly volatile markets, it can work an investor’s favor at other times. Read on to see how.

ETF trading volume jumped from $142 billion in 2004 to $3 trillion in 2008, and settling around $1.4 trillion in June 2009, write Yan Zilbering and Donald Bennyhoff for IndexUniverse. Since 2008, nost of the ETF trading volume has been centered around a narrow selection of ETFs from the 850 or so available as of June 2009.

The top 20 most heavily traded ETFs by dollar volume amount to around 80% of total ETF trades. At the forefront are the most established ETFs with the most assets that are popular among investors of all types. The included ETFs account for about 50% of all ETF trading volume and they track the most common, broad-based domestic indexes:

• SPDRs S&P 500 (SPY): avg. daily turnover since Jan. 2008 is 43%
• PowerShares QQQ (QQQQ): avg. daily turnover since Jan. 2008 is 43%
• iShares Russell 2000 Index (IWM): avg. daily turnover since Jan. 2008 is 54%
• DIAMONDS Trust, Series 1 (DIA): avg. daily turnover since Jan. 2008 is 28%

There are also a group of nine narrowly focused sector and sub-sector ETFs, which represent around 16% of ETF trades, used to implement various strategies through the easy access of specific areas of the market.

• Financial Select Sector SPDR (XLF): avg. daily turnover since Jan. 2008 is 45%
• Energy Select Sector SPDR (XLE): avg. daily turnover since Jan. 2008 is 40%
• Oil Services HOLDRs (OIH): avg. daily turnover since Jan. 2008 is 54%
• SPDR Gold Shares (GLD): avg. daily turnover since Jan. 2008 is 6%
• iShares Dow Jones US Real Estate (IYR): avg. daily turnover since Jan. 2008 is 58%
• iShares MSCI EAFE Index (EFA): avg. daily turnover since Jan. 2008 is 4%
• iShares MSCI Emerging Markets Index (EEM): avg. daily turnover since Jan. 2008 is 12%
• iShares FTSE/Xinhua China 25 Index (FXI): avg. daily turnover since Jan. 2008 is 20%
• iShares MSCI Brazil Index (EWZ): avg. daily turnover since Jan. 2008 is 18%

The last set includes seven leveraged ETFs, which produce the multiple or inverse returns of the broad market or sector. This group is usually used for capitalizing on the short-term movements in the markets.

• Ultra S&P500 ProShares (SSO): avg. daily turnover since Jan. 2008 is 61%
• UltraShort S&P500 ProShares (SDS): avg. daily turnover since Jan. 2008 is 109%
• Ultra QQQ ProShares (QLD): avg. daily turnover since Jan. 2008 is 90%
• UltraShort QQQ ProShares (QID): avg. daily turnover since Jan. 2008 is 178%
• UltraShort Financials ProShares (SKF): avg. daily turnover since Jan. 2008 is 242%
• Direxion Daily Financial Bull 3X Shares (FAS): avg. daily turnover since Jan. 2008 is 128%
• Direxion Daily Financial Bear 3X Shares (FAZ): avg. daily turnover since Jan. 2008 is 241%

By looking at the data, it is noticeable that the more heavily traded ETFs traded at a higher turnover rate. ETFs tracking volatile sectors have been traded at even higher levels.

Max Chen contributed to this article.

Since March 9, the Russell 1000 Financial Services Index has gained nearly 62% on positive news from analysts and improving economic data.  Now compare that to a more concentrated fund that tracks the financials, the Direxion Financial Bull 3X (FAS), which has returned a whopping 260% over the same period.  This fund is designed to return three times what a financial index would return, which it has done and thus makes it attractive to riskeir investors.

On the contrary, the inverse version of the aforementioned index, the Direxion Financial Bear 3X (FAZ), has plummeted close to 90% over the same period.  It is fairly obvious how compounding works and volatility can influence the returns of these levered ETFs, states David Gaffen of The Wall Street Journal.

Despite the continuous volatility in levered ETFs, they are still becoming more popular.  Perhaps it is because these ETFs enable investors an easy way to take leveraged long or short bets on a sector.  There are, however, plenty of opponents of these volatile investing tools.  The truth is that these tools work exactly as they’re supposed to.

As with everything else, the more concentrated the ETF is, the more volatile it is.  It’s the same concept of keeping all your eggs in one basket.  For this reason, we recommend that you remain diversified and have a strategy, such as the 200-day moving average strategy.

Share your thoughts about leveraged ETFs in our forums.

Kevin Grewal contributed to this article.

Previously, the company used daily returns to calculate a fund’s performance, and the new twist will track monthly prices within their underlying benchmarks. Theoretically, this should help investors hold the ETFs for a longer period of time, assuming the fund is held throughout the month, from the beginning, not the end.

Re-balancing techniques used by Direxion aren’t likely to completely smooth short-term differences between benchmark and fund returns, Coleman points out. Daily deviations are bound to occur. The objective is to hold monthly returns while trading the dailies around those.

A few of the ETFs from the provider already in the lineup and trading are:

• Direxion Large Cap Bull 3x Fund (BGU): down 28.3% year-to-date

• Direxion Financial Bear 3x Fund (FAZ): down 47.8% year-to-date

In fact, there are 106 such funds that are holding around $46 billion in assets and trading volumes of these indexes has skyrocketed.  Just take a look at the Direxion Financial Bear 3x fund (FAZ), whose trading volume last week totaled a whopping 23.1 million shares on 2 million outstanding shares, implying that traders are holding the index for an average of 34 minutes, states Jason Zweig of The Wall Street Journal.

Why have these funds become so popular?  Perhaps it could be the way that they are designed, they are meant to amplify the opposite returns of an index.  Some try to double or even triple these opposite returns.  In a time when the markets are going down, which is recently more often than not, these inverse indexes can go up two or three times. Additionally, some believe that these are great tools for a long-term hedge against falling markets.

This sounds like a great way to beat the markets, but these indexes come with risks:

• First of all, they are extremely volatile.  There returns are predictable relative to the index only if owned for one day or less and over long time periods the funds can wander away from the underlying index like a stray dog. 
• Secondly, if the market doesn’t follow a straight path, the swings will make it very difficult just to break-even.  Each loss requires a even bigger gain to get back to square one.  In essence, these funds are not a buy and hold vehicle.

For a safer strategy, we recommend that you consider the trend-following strategy.  If you still want to live on the edge and play with these funds, do your homework and really understand how they work.

Investors have a cornucopia of ETFs to choose from with 843 exchange-traded products currently available, writes Ron Rowland for Seeking Alpha. There are some oddballs that have trading sessions with zero volume and high bid/ask spreads. But there is also a select group known as the “ETF Billion Dollar Club” that has risen above the crowd in providing more than $1 billion per day in trades.

The average daily value traded (ADVT) is a good indicator for liquidity. It is the volume multiplied by price, and is sometimes referred to as $ Volume. Higher liquidity means there will most likely be someone out there willing to take the other side of a trade.

There are 17 members in this exclusive club as of February, 2009:

1. SPDR S&P 500 (SPY): ADVT of $30,767,683,584
2. PowerShares QQQ (QQQQ): $5,251,502,080
3. ProShares UltraShort Financials (SKF): $4,627,046,400
4. ProShares UltraShort S&P500 (SDS): $4,580,779,008
5. iShares Russell 2000 (IWM): $3,093,236,480
6. DIAMONDS Trust (DIA): $2,625,997,824
7. SPDR Gold Trust (GLD): $2,470,299,648
8. SPDR Select Sector Financial (XLF): $2,082,540,544
9. ProShares Ultra S&P 500 (SSO): $1,905,811,200
10. SPDR Select Sector Energy (XLE): $1,795,240,832
11. iShares MSCI Emerging Markets (EEM): $1,746,615,296
12. ProShares UltraShort Real Estate (SRS): $1,577,850,496
13. ProShares UltraShort QQQ (QID): $1,458,607,744
14. iShares Dow Jones U.S. Real Estate (IYR): $1,244,349,184
15. iShares MSCI EAFE (EFA): $1,222,589,568
16. Direxion Financial Bear 3x Shares (FAZ): $1,221,666,944
17. United States Oil Fund (USO): $1,034,414,528

Direxion Shares exchange traded funds (ETFs) are a new tool offering forward thinking investors innovative options and market exposure, and they’ve just expanded their family a little more.

The first-of-its-kind ETF provider has added six more funds to its family, and they now offer a total of 14 triple leveraged ETFs. The new offerings focus on developed markets, emerging markets and the technology sector.

The new funds are:

• Developed Markets Bull 3x Shares (DZK)
• Developed Markets Bear 3x Shares (DPK)
• Emerging Markets Bull 3X Shares (EDC)
• Emerging Markets Bear 3x Shares (EDZ)
• Technology Bull 3x Shares (TYH)
• Technology Bear 3x Shares (TYP)

These ETFs enable an investor to navigate through the market  with bull and bear fund flexibility, and effectively allocate capital to seek improved risk adjusted returns, advertises Direxion Shares. In layman’s terms, they are designed to seek 300% of the daily performance, or 300% of the inverse of the daily performance of the four indexes that they track, and are intended to be used as a supplement in a portfolio.

The Direxion funds have been seen tremendous success, being utilized by hedge fund managers, institutional investors, and other active investors, who have pushed the 3x funds over $800 million in assets.  Additionally, Direxion plans to continue their ongoing liquidation of seven of their traditional funds to focus on more international fund offerings, states in an interview between Eric Rosenbaum of Index Universe and Andy O’Rourke of Direxion Funds.

In addition to the new launches, the company also has filed for bull/bear India and China ETFs.

The other eight funds currently being offered are:

• Direxion Large Cap Bull 3X Shares (BGU)
• Direxion Small Cap Bull 3x Shares (TNA)
• Direxion Energy Bull 3x Shares (ERX)
• Direxion Financial Bull 3x Shares (FAS)
• Direxion Large Cap Bear 3x Shares (BGZ)
• Direxion Small Cap Bear 3x Shares (TZA)
• Direxion Energy Bear 3x Shares (ERY)
• Direxion Financial Bear 3x Shares (FAZ)

Direxion has launched eight ETFs that are leveraged bull and bear funds designed to seek 300% of the daily performance, or 300% of the inverse of the daily performance, of the four indexes they track.

Among the reasons that Direxion went with triple leverage is that they’d be first on the market with a new and different product, instead of getting lost in a sea of similar products.

“ETFs that are first-movers tend to have an enormous advantage. We didn’t want to come out with products similar to what was already out there,” says Dan O’Neill, president and chief investment strategist. “We believe that that’s what’s going to distinguish them and that will hopefully be a point of attraction for clients. We’ve gone with high leverage because we think it’s attractive.”

When these funds first appeared in registration, there was a bit of chatter about whether triple leverage was a great idea for investors. After all, someone who isn’t careful or mindful of the risks could land themselves in hot water with the standard long and short funds, let alone one that offers triple leverage.

But O’Neill cautions against viewing these or any other leveraged fund in a vacuum.

“The question we have is how you’re going to use them. What matters is how you use them in a broader portfolio. If you use them to hedge, it may lower your risk profile,” he says.

The funds aren’t meant to be the centerpiece of any investors’ portfolio, but as part of an overall strategy. Putting all of your eggs in one basket is never a good idea.

“When someone hears ‘three beta,’ the assumption might be that someone would put 100% of their assets in that fund. They’re meant to be complementary or supplements. They can be used wisely.”

O’Neill says that most of the criticism has come from those who see ETFs as something where every fund needs to be suitable for every investor, but that simply isn’t the case.

“There are lots of investment tools used at the margins or only used by certain players. This is a suite of products that can be used very wisely by certain investors,” says O’Neill.

The early appearance is that professional investors will find these funds of particular interest, including hedge funds, registered investment advisors and proprietary trading desks on Wall Street, says Bill Franca, Direxion’s head of sales.

“I don’t think they’re going to be used by passive investors who are checking their portfolio once every six months. That’s not what these products are for,” Franca points out.

“They’re meant to be used by people who are managing their portfolios very actively, by professional, sophisticated investors,” O’Neill adds.

Overall, these funds are just another tool in the shed for investors who want more leverage. Franca says, “”We believe that leveraged ETFs have already proven their versatility in the marketplace. We feel that there’s definitely a place for leverage because of the ability of different firms to achieve leverage because of what’s going on in the market today.”

The new funds are:

• Direxion Large Cap Bull 3X Shares (BGU)
• Direxion Small Cap Bull 3x Shares (TNA)
• Direxion Energy Bull 3x Shares (ERX)
  
• Direxion Financial Bull 3x Shares (FAS)
• Direxion Large Cap Bear 3x Shares (BGZ)
• Direxion Small Cap Bear 3x Shares (TZA)
• Direxion Energy Bear 3x Shares (ERY)
• Direxion Financial Bear 3x Shares (FAZ)