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By Eric Dutram

Thanks to today’s shaky economy, which could either surge or falter in 2012, many investors are keeping a close eye on volatility as a barometer of fear in the market. Many investors, as well as historical performance, point to higher periods of volatility as indicative of bear markets or worse, suggesting that more analysis of a portfolio is needed when markets are oscillating wildly. In order to combat this with ETFs, some investors may be cheering the launch of three funds from Direxion which look to help investors sail through volatile markets a little easier.

With these three ETFs, which are all based on broad, popular indexes, investors have exposure to a dynamic benchmark which shifts depending on the level of volatility in the underlying index. In practice, this means that when the underlying index is seeing volatility of 15, the product is 100% invested in the index. Then, when the volatility level falls below 15, the product increases its exposure to equities, up to the point of 150% in the underlying equity benchmark (see Three Low Beta Sector ETFs).

When volatility is rising, however, the product takes a different approach as it cycles out of the equities and into low risk T-Bills in order to protect principal against the rising possibility of a bear market. In fact, as volatility rises past 40, just 40% of the fund is in the underlying equity index while when volatility rises above 85, the products have less than 20% of their assets in equities with the rest in ultra safe fixed income. For a more detailed explanation of how this is done, investors should see the Direxion page on the products or the chart highlighted below from their site:

In essence, this strategy looks to exploit the trend of higher stock prices when volatility is low and to decrease risk when volatility is surging or is at elevated levels. This could be ideal for those who are uncertain about the future of the economy but want broad exposure to the market and are looking for a hedge at the same time (read Does Your Portfolio Need A Hedge Fund ETF?). Yet, while these products could see lower betas when compared to their non-hedged counterparts, they could also experience lower overall performance as well, especially if markets rise in the face of heightened volatility levels. So for investors who are intrigued by this idea, we have highlighted some of the key points—and competition that results-- from the launch below:

Direxion S&P 500 RC Volatility Response Shares (NYSEARCA:VSPY)

For investors seeking a broad market play with a hedge, VSPY could be an interesting choice. The fund follows the S&P 500 Dynamic Rebalancing Risk Control Index which gives investors dynamic access to both T-bills and the S&P 500. This product looks to compete with several entrenched competitors in the space which combine to hold close to $125 billion in assets. These three funds -- SPY, IVV, and VOO -- all have expenses that are a fraction of VSPY’s 45 basis points, but they do not employ the same dynamic methodology in terms of exposure (see Five ETFs To Buy In 2012).

Direxion S&P 1500 RC Volatility Response Shares (VSPR)

For a broader look at the markets with a hedge, VSPR is probably the way to go. This fund tracks the S&P Composite 1500 Dynamic Rebalancing Risk Control Index which gives investors exposure to both T-Bills and the S&P 1500 with assets divided based on levels of volatility. Competition in this space is less direct than in either of the other two funds that launched, but there are a number of close rivals nonetheless. Arguably the biggest in terms of AUM will be the Vanguard Total Stock Market ETF (NYSEARCA:VTI) or the iShares Russell 3000 Index Fund (NYSEARCA:IWV). Beyond these two, the iShares S&P 1500 Index Fund (ISI) is also likely to be a big competitor but once again, VSPR’s 45 basis point expense ratio is more than double the main challengers (read Ten Best New ETFs Of 2011).

Direxion S&P Latin America 40 RC Volatility Response Shares (VLAT)

If investors are seeking a lower risk play in the often volatile Latin American market, VLAT could be an intriguing pick. The fund tracks the S&P Latin America 40 Dynamic Rebalancing Risk Control Index which gives access to both the Latin America 40 Index as well as T-Bills, depending on levels of volatility.

The main competitor to VLAT is likely to be the iShares Latin America 40 Index Fund (NYSEARCA:ILF). This product tracks the S&P Latin America 40 Index and charges investors 50 basis points a year in fees. ILF is one of the more popular Latin America ETFs on the market today as the fund has amassed close to $1.8 billion in AUM since its inception over a decade ago. However, despite this lead in AUM, VLAT actually has the advantage in terms of fees, suggesting that this Direxion fund could pose a formidable opponent for the iShares product in this slice of the market.

Source: Understanding The 3 New Direxion Volatility Response ETFs