New White Paper Delves Into The Profile Of Direxion's Relative Weight ETFs

A new whitepaper from leveraged ETF provider Direxion sheds light on the characteristics of highly correlated market segments, and how strategically overweighting and underweighting specific market segments can magnify returns over a short-to-intermediate time horizon. 

The strategy, known as relative weighting, involves pegging one market segment (such as growth) over another (such as value) in an effort to improve returns when the market call is correct. 

In comparing the risk/return profiles of a variety of index-based strategies to that of Direxion’s suite of relative-weight, 150/50 net spread ETFs—which incorporate both 150 percent long and 50 percent short components between two correlated market segments—the paper shows that the net returns from the ETF can be greater than those of a basic long index exposure strategy or a 75 percent overweight/25 percent underweight strategy, while maintaining almost identical risk profiles.

“These are pockets and segments of the markets that the vast majority of investors are watching, following, have exposure to, and are sort of core pieces of portfolios today. And that drove us to explore, what people are doing today,” said Direxion V.P. of Product & Institutional Strategy Inkoo Kang. 

Among the paper’s takeaways is just how consistently market cycles influence correlated indices to move in tandem over extended periods.

For example, the difference between the annualized total returns for emerging markets and developed markets since January 1995 through the end of December 2018 was only 0.47 percent. Comparably, the annualized total return differentials for value and growth stocks over the same time horizon was 0.27 percent.

The differences were slightly greater between the large-cap Russell 1000 and the small-cap Rusell 2000 indices at 0.8 percent. The largest difference over the sample period was between the Russell 1000 and FTSE All World ex-US at just over 5 percent.

Source: Bloomberg; for the period 12/30/1994 through 12/31/2018. Base level index data for the MSCI USA Cyclical and Defensive Sector Indexes starts on 12/31/1998. Past performance is not indicative of future results. One cannot invest directly in an index. Index performance does not represent actual fund or portfolio performance. A fund or portfolio may differ significantly from the securities included in the index. Index total return performance assumes reinvestment of dividends, but does not reflect any management fees, transaction costs, or other expenses that would be incurred by a fund or portfolio, or brokerage commissions on transactions in fund shares. Such fees, expenses and commissions could reduce returns.

However, while the annualized return rates hewed fairly close between pairs, the average calendar year differential between pairs of indices proved much wider. The average yearly difference in return between index pairs ranged from just over 7 percent in the case of the Russell 1000 and 2000 indices all the way to 15 percent between the MSCI Emerging Markets and Developed Markets indices.

The data reveals how crucial the aspect of timing is to investors intent on implementing strategies based on market cycles. Determining which segments to allocate assets, and how frequently an investor intends to do that, ultimately determines the success of cyclical strategies, according to Direxion Head of Product, Dave Mazza.

“The correlation of those indices is actually high,” Mazza said of the MSCI Emerging Markets and Developed Markets indices. “And the performance differential is below 50 basis points. Which is stuff investors may say, ‘Does it even matter?’ But depending on my time horizon, I may not have the benefit of that [correlation]. Or I may want to take advantage of the fact that [the difference] over shorter time periods is on average 15 percent. That is a massive difference.”

Mazza noted that the 150/50 relative weight strategy, which can be accomplished using a suite of recently launched ETFs by the company, are ideally meant for an investor who is neither focused on short-term profits nor focused on decades-long savings. Instead, the strategy offers an opportunity for informed investors with an intermediate time frame of more than a year to better capture returns on cyclical market patterns.

Summing up the design of company’s ETF that track this strategy, Mazza described the products as building blocks within a portfolio. Investors won’t see the benefit of their structure unless they are working alongside a broader strategy of medium- to long-term asset holdings.

“These tools are not intended to be used in tactical trading.” said Mazza. “They're different than the majority of other products. They're not leveraged products or the like, but they really can help an investor make decisions for that intermediate time horizon