Bearish China ETF fades in a year

Traders work on the floor of the New York Stock Exchange on Aug 23. New York-based company Direxion lnvestments last year launched an exchange-traded fund or ETF that profited by shortselling Chinese stocks. [Photo/Agencies]

As growth outlook brightens, assets of Direxion shrink to $90m from $403m in August 2015

A year ago, an exchange-traded fund called Direxion was designed to profit from declines in Chinese stocks. It proved to be a standout when it was created. Now, however, Direxion is languishing. For, China's growth outlook has improved.

Total assets in the ETF surged 101 times to $403 million from June to August 2015 as traders piled in to take advantage of a market selloff.

Now, Direxion's assets have shrunk to less than $90 million as the leveraged fund's shares trade near a record low.

The Direxion Daily CSI 300 China A Share Bear 1X Shares fund, the fastest-growing new ETF when it was started last year, has dropped 24 percent from this year's high in February.

Better-than-expected economic data and government efforts to enhance market transparency have helped drive a rebound in mainland-traded stocks from the lowest levels in two years.

"When it comes to a leveraged fund, one day you can be the best-performing product when the market is cooperating, and the next day you are crashed," Mohit Bajaj, a director of ETF trading solutions at WallachBeth Capital in New York, said. "We may see the fund rally again once the sentiment on China sours, but it's easy to make a mistake and lose a lot of money."

Bajaj should know. He has been covering exchange-traded funds for more than 10 years.

The quick success of the Direxion ETF, the first designed to use leverage to amplify returns from falling Chinese mainland shares, was partly because of the right timing. It started just prior to a market crash spurred by a surprise yuan depreciation. For some bears, it was easier to buy the fund than use the two other main options available at the time－the futures market or short-selling the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF.

A year ago, when the China market rout was at its worst, the Direxion fund's assets swelled at the fastest pace among the almost 200 US-traded ETFs that started in the prior eight months, according to data compiled by Bloomberg.

After about $5 trillion of equity value was wiped out in the rout last year, China has moved to improve access to markets and stabilize a slowdown in economic growth. The nation's economic expansion held at 6.7 percent in the second quarter from a year earlier, beating the 6.6 percent growth forecast in a Bloomberg survey.

"If we see a pullback in China, I would expect that the assets in the bear fund would creep back up again," Sylvia Jablonski, managing director at Direxion Investments, said. "We never recommend holding our ETFs for a long period of time, at least not without actively managing and reviewing your position on a daily basis."

Leveraged ETFs use swaps or derivatives to try to amplify daily index returns, delivering the multiple on a one-day return. This ultimately can produce higher-than-expected gains if the index moves in one direction over the long term. Market reversals will lead to worse-than-anticipated returns.

Laurence Fink, who oversees the world's biggest suite of ETFs as chairman of BlackRock Inc, has sharply criticized the leveraged structure, saying such funds could "blow up the market". Regulators are paying close attention, particularly after finding ETFs were partly responsible for a bout of market mayhem last year.

For the brave of heart, leveraged funds could bring some hefty returns. Four of the top five US ETF performers this year are leveraged funds. The best-performing fund this year, Direxion Daily Junior Gold Miners Index Bull 3x Shares, has rallied 920 percent this year through Aug 18.

Some exchange-traded fund analysts remain cautious.

"The level of risk that the leveraged funds have is too much for some of the traditional ETF investors to put up with," Todd Rosenbluth, a New York-based director of ETF research at S&P Global Market Intelligence, said. "Leveraged funds are for some highly sophisticated traders, but even so the risk is too high you can lose all you got."

Bloomberg