Uday Maitra's  Instablog

The ETF product offering doesn't quite make sense. Macro is a very different strategy compared to Emerging markets, not just in terms of concept but also in terms of statistics.

Macro is mostly long/short futures driven by some technical analysis (e.g. CTA) and some by fundamental analysis (e.g. many Global Macro based trading yield curves etc). Emerging market is primarily long only Emerging Markets, and shorting is rarely possible. At best, many Emerging market hedge funds reduce their gross exposure, but in 2008 they haven't done a decent job of that either.

It is strange that the both are combined together.

Macro did well in 2008, while Emerging markets did quite poorly. Emerging markets are doing well in 2009, while Macro has suffered in so far, although not that much. Combining these two strategies seems ironical and most likely either strategy can cancel out the benefits of the other.

In addition, most Macro hedge funds during stable times have much lower volatility than Emerging market hedge funds. Combining the two, might just make the combination behave more like a Emerging market hedge fund, i.e. up if the Emerging markets is up and vice versa. Not surprisingly, 40.4% of the weights are to emerging market ETFs: EEM and VWO. Another 48.4% of the weights are to either to short term fixed income instruments or investment grade corporate bonds. The only thing that resembles anything like what a global macro fund would have done is a 5.4% weight to carry trade (DBV) and 3.5% weight to short real estate (SRS).

Where are the commodity exposures? Gold? Oil?

It might have made much more sense to offer a pure play on Macro. We already have a lot of ETFs on Emerging markets and the Emerging market hedge funds have very high correlations with emerging market ETFs.

Disclosure: not holding any of the ETFs mentioned here

By now, the behavior of levered ETFs have been very widely document, commented and studied. A common property of the levered ETFs is that they will tend to lose money over time due to a drag on the volatilty. Specifically, if the arithmatic returns (e.g. daily) is ra, and the volatility is v, then the longer term realized geometric returns (e.g. monthly, quarterly etc) rg will be governed by rg = ra – ½ v². Hence, leverage products with higher volatility underlyings will bleed a lot more than leverage products on lower volatility underlyings.

To see some examples of this effect, consider the Since-Inception returns (from the Direxion website) as of April 20th 2009 of a few of the more volatile products:

In the table above, both the Bull and the Bear 3x products are down since inception (SI). It is quite likely that this will also be the eventual fate of their other products as well.

In the long run, it is not difficult to imagine that, if not all, the Direxion products will trade in pennies. Unless, timely reverse splits are carried out.  

All of us appreciate the nature and popularity of these products as trading instruments. However, many traders (e.g. myself) operate in environments where they may be mandated to trade instruments that have a price above certain limits such as $5. In addition, if the price is above a certain level, it is possible that shorting might be easier. Additionally, the option market makers might be able to give finer spreads because it is easier to give finer spreads on an underlying trading at $10, than if the underlying is trading at $1 (because of lot size of 100 and other considerations etc).

Disclosure: Not currently holding any Direxion ETFs.

REM, the Mortgage REIT Index ETF from iShares seems quite undervalued.

The price did fall a lot last year along with fall in the prices of other financials with exposures to credit. Mortgage REITs had also taken a hit both on earnings as well as questions were asked on the validity of some of their book values.

However, at present the Price/Book Value of the index is 0.9. The index (or the stocks in the index) seem to be up for grabs for less than the Book Value. In addition, the Price/Sales is at 1.9 and Price/Cash Flow is at 5.47.

Most of these companies have already declared their 2008 with the corresponding reduction in earnings and other accounting parameters. No doubt, the business of mortgage REITs looks weak with house prices looking week. However, at the present valuations and the Dividend Yield of 11.5% (30-day SEC Yield of 11.7% as per iShares' website), this index does look like a steal.

Lastly, it could be possible (depending on how you look at it), that the recent up swings in the equity markets have brought about a trendline break in the ETF. On a logarithmic scale, here is how the chart looks like:

Note apart from the "possibility" of having broken a trendline, the index could have possibly made at least two (or more) double bottoms.

The only worrying part about this ETF is that it had always had low volumes, with occasional spikes.

Disclosure: long REM