LABU: A 3X Leveraged ETF Best Avoided (NYSEARCA:LABU)

Direxion Daily S&P Biotech Bull 3X Shares (NYSEARCA:LABU) is an exchange traded fund (ETF) launched by Direxion Investments on May 28, 2015, and is managed by Rafferty Asset Management, LLC. LABU invests in derivatives (such as futures, options, swaps) of companies operating primarily in the biotechnology and life sciences sectors. LABU’s performance is determined by daily performance of the benchmark index – S&P Biotechnology Select Industry Index (SPSIBITR). Here LABU’s investment moves 3x upwards or downwards with respect to the SPSIBITR.

Direxion Daily S&P Biotech Bull 3X Shares is much riskier than unleveraged ETFs, because it seeks daily goals. These leveraged ETFs “should not be expected to track the underlying index over periods longer than one day. They are not suitable for all investors and should be utilized only by investors who understand leverage risk and who actively manage their investments”. In addition, LABU also undertakes the risk of 3x investments (over the composition of benchmark index) in derivatives of stocks in the underlying index. This way a 3X leveraged fund like LABU tries to gain three times the daily or monthly return of their respective underlying indices. If the investments in SPSIBITR goes up by 5 percent, the 3x investments will enhance LABU’s value by 15 percent. Similarly, if the investments in SPSIBITR goes down by 10 percent, the LABU fund will go down by 30 percent.

SPSIBITR is provided by S&P Dow Jones Indices LLC and includes US biotechnology companies. SPSIBITR’s major holdings are in small-cap and mid-cap biotechnology firms. The index had a poor price performance in 2021, and it’s still continuing to perform poorly. Last year it fell by more than 20 percent. However, the index had a positive growth of 16 percent between 2019 & 2021; and 14 percent between 2017 & 2021.

As the benchmark index witnessed a poor performance, Direxion Daily S&P Biotech Bull 3X Shares performed much worse. Because LABU is 3 times leveraged, the degree of negative return is also much higher than the benchmark index. LABU recorded a negative return of approximately 65 percent during 2021. LABU’s price also dropped by 15 percent and 61 percent over the past one and three months respectively. However, as the underlying index recorded a growth in the medium term, LABU also was expected to grow, and grow by more than 3 times that of the index. But, unfortunately, LABU recorded huge losses of 35 percent and 20 percent over the past 3 years and 5 years respectively. Since its inception, LABU has lost 28 percent of its initial value, whereas the underlying index grew by almost 6 percent.

This exposes the inherent weakness of 3X leveraged ETFs like Direxion Daily S&P Biotech Bull 3X Shares. As explained earlier, this 3x leveraged fund only tracks daily performance. Now if the underlying index suffers losses in more number of days than it has made gains, the 3x positive returns on certain days will fail to compensate for the 3x losses incurred in other days. 3X leveraged funds also have a high expense ratio due to investing in three times the volume of the underlying index. LABU has an expense ratio of 0.96 percent, which also is a reason behind such poor performance over the medium and long term. And because these ETFs invest in derivatives, these become further risky. One more demotivating factor for investing in this 3x ETF is that LABU doesn’t pay dividends on a regular basis. It paid quarterly dividends in 2018 and 2019, but again the yield was extremely low, almost negligible.

I also compared the performance of Direxion Daily S&P Biotech Bull 3X Shares with some other 3x ETFs of Direxion – Daily S&P Biotech Bear 3X Shares (LABD), Daily Semiconductor Bull 3X Shares (SOXL), Daily Small Cap Bull 3X Shares (TNA), and Daily Small Cap Bear 3X Shares (TZA). None of these 3x leveraged funds is able to instill confidence in me, so that I can treat it as a lucrative or obvious investment instrument in order to seek growth for my portfolio of investments. Overall I find all these 3x derivative ETFs to be extremely volatile and risky. I agree with the view expressed in the policy statements of Direxion that “Leveraged ETFs are not suitable for all investors and should be utilized only by investors who understand the risks associated with seeking daily leveraged and inverse investment results, and intend to actively monitor and manage their investments. Due to the daily nature of the leveraged and inverse investment strategies employed, there is no guarantee of long-term inverse returns”.

Direxion was the first company to offer ETFs with 3X leverage during November 2008. This move was followed by its competitors ProShares and Rydex Investments a few months later. Since then, the market has seen the introduction of a significant number of 3X leveraged ETFs. However, I’ll always advise growth seeking investors to stay away from 3x leveraged ETFs due to their high risk, extreme volatility, and higher expense ratio. As these ETFs invest 3 times the number of units, they incur higher fees that can result in significant losses over a long term horizon. As discussed earlier, high leverage can also cause huge losses during volatile markets. And because these ETFs invest in derivatives, these become further risky.

In addition to all these, Direxion Daily S&P Biotech Bull 3X Shares is a bull market 3x leveraged ETF that benchmarks itself against a very poorly performing underlying index. As a biotechnology sector focused index, SPSIBITR had performed poorly in the short and medium term. As the underlying index suffered losses in more days than it had made gains, LABU’s 3X investments failed miserably. I don’t assume that this scenario will change. Biotechnology sector will stay volatile due to its inherent nature of being impacted by unfavorable policies, product launches, testing, and approvals, etc. And above all these, an average negative growth between 20 percent to 60 percent for the past 16 years, makes Direxion Daily S&P Biotech Bull 3X Shares severely unattractive for a long term investor like me.

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