Why Direxion Created New ETFs That Mimic Pair Trading Strategies

Until recently, Direxion was primarily known as the largest provider of leveraged and inverse ETFs. But over the last year that’s changed, beginning last February with the launch of five “Portfolio Plus” ETFs that only employed 25 percent leverage.

Last month the company added to its product suite, but this time offering exposure to a new trading strategy: pair trading. The 10 new Relative Weight ETFs allow investors to make a pair trade via one security, by using leverage to gain overexposure to one market while simultaneously shorting a correlated market.

The funds allow investors to exploit temporary trends in growth vs. value, U.S. vs. international, defensive vs. cyclical, developed markets vs. emerging markets, and large cap vs. small cap equities. The funds are rebalanced monthly.

To understand a little more about why Direxion expanded their ETFs beyond straight leverage and inverse strategies, we caught up with Andy O’Rourke, managing director, chief marketing officer at Direxion.

Explain the logic of taking complex strategies like pair trading and putting them into one security. Why create ETFs that do this?

O’Rourke: If you think about it, most investors that apply any thought to their portfolio tend to have some form of a macro theme. They might believe it’s time for large caps to outperform small caps, or growth to outperform value, so people have those beliefs. They just don’t necessarily have a simple way to implement that or a way they can access both sides of those beliefs.

So what we’ve essentially built is something that gives you the ability to go both ways in terms of your positioning of both of those asset classes, meaning taking extra exposure to the asset class that you think is going to outperform and put a short position to juxtapose that for the underperforming portion.

This is meant for active investors then?

O’Rourke: Anyone can have a belief in a macro theme like that, but do they believe in it forever? Do they think growth will always outperform value? Probably not. What they believe is it’s probably something that’s going to be more medium term, so I would describe that at the short end being a six-month period, but it could be extended maybe upwards of five years depending on all the dynamics.

They are not meant to be active trading strategies. They are very different from the 2x and 3x leveraged ETFs. These are much closer to the strategic longer-term plan, not things that you’re going to set and forget for 10 years. They’re for anyone who has those beliefs, understands how these products work and want to put them in place for some period of time.

Are you trying to take strategies that you know people employ and condense them down to one security?

O’Rourke: For sure, simplicity is a key part of this. For a lot of people, accessing the short side is impossible for them or very difficult or cost prohibitive. These are two related asset classes, so, for the most part, they are highly correlated. They are asset classes that move together, but at times may converge or diverge. So it’s those periods of time where people want to implement these strategies, and we built a product so they could do it.

Another theme that goes through all of our products is these are for people who have these beliefs before they come to us. In other words, they have the conviction. If somebody is trading 3x gold miners, it’s because they believe there’s some momentum there and they had that thought before they came to us. The same is true with these products.

Why create ETFs that replicate a pair trading strategy as opposed to other types of trading strategies?

O’Rourke: The underlying themes and topics here are in the news daily. That is the sort of regular conversation that’s going on. People wouldn’t be talking about those types of comparisons as much as they do if they weren’t part of people’s day-to-day strategies.

There are all these strategies, multi-factor smart beta, but we think this strategy is a lot simpler than that frankly. You’ve got to make sure you understand the product before you start using it, but it’s pretty straightforward. It just aligns with the thought that you want to go overweight something or underweight something.

Is the reason you’re introducing new products because the retail investor is becoming better informed?

O’Rourke: I think there are certain people out there that are always interested in learning about new products. Generally speaking, there’s so much access to good education out there that I would agree.

It’s not just the retail market. There’s a wide spectrum even in the advisor market of those that have varying degrees of knowledge about all these different types of products. There’s a lot of advisors out there that are still very old school, not venturing too far into more innovative products, and I think eventually they feel pressure to learn more.

The ETF structure provides that platform to build strategies that are actually long-time strategies that have been used by more sophisticated investors, but they’re able to be packaged now to make it easier for people to get access to them.