LABD - LABD: 3X Leveraged Inverse Fund In Biotechnology Sector Is Best Avoided

2023-07-21 15:03:27 ET

Summary

• Direxion Daily S&P Biotech Bear 3X Shares ETF failed to generate decent yield & price growth over the past 90 months. I don’t foresee this fund generating positive growth in the near future, either.
• LABD has a high expense ratio, and its investments in derivatives enhance the chances of default. Its drift is also at its worst since the fund’s inception.
• LABD is a short-term trading tool for seasoned traders who have a strategy with clear entry and exit signals, and have a strong understanding of leverage.

~ by Snehasish Chaudhuri, MBA (Finance).

Direxion Daily S&P Biotech Bear 3X Shares ETF ( LABD ) invests in derivatives of companies operating primarily in the biotechnology and life sciences sectors. This 3x leveraged exchange-traded fund, or ETF, invests 3 times (of its composition in the underlying index) in derivative instruments such as futures, options, or swaps. LABD had a poor price performance over the past 90 months. This fund made gains on some days, or over a month, but over the longer term, LABD failed to generate positive price growth. LABD has been inconsistent with its quarterly payouts and paid dividends only four times in the past 16 quarters. Annual average yield since its inception on May 28, 2015, has been less than 2 percent. In my opinion, there is hardly any incentive for either income-seeking investors or long-term growth-seeking investors to buy or hold this fund.

A Healthy Growth In Prices Of Biotechnology Stocks Is Detrimental For LABD

Direxion Daily S&P Biotech Bear 3x Shares ETF seeks to track 3 times the daily performance of the S&P Biotechnology Select Industry Index, which mostly include small-cap and mid-cap biotechnology firms. Although equity markets had gone through bad times since the outbreak of covid-19 pandemic, the stocks from biotechnology sector has performed comparatively better than other sectors. The S&P 500 biotechnology index grew by 8.63 percent, 12.13 percent and 15.64 percent over the past three calendar years, respectively. As an 3x inverse fund, LABD had to incur price loss, and that also by a much higher margin than the index increases.

While the S&P 500 biotechnology index invests over the entire spectrum of biotechnology stocks, S&P Biotechnology Select Industry Index primarily includes small-cap and mid-cap biotechnology stocks, Its top 10 holdings are Catalyst Pharmaceuticals, Inc. ( CPRX ), BridgeBio Pharma, Inc. ( BBIO ), Exact Sciences Corporation ( EXAS ), Blueprint Medicines Corporation ( BPMC ), Halozyme Therapeutics, Inc. ( HALO ), Vertex Pharmaceuticals Incorporated ( VRTX ), Revolution Medicines, Inc. ( RVMD ), Horizon Therapeutics Public Limited Company ( HZNP ), IVERIC bio, Inc. ( ISEE ), and Incyte Corporation ( INCY ). During my last coverage almost a year ago, HALO and ISEE were the only two stocks that were among the top 10 holdings of the same index.

A 3X Leveraged Inverse Fund Aims To Gain 3 Times The Daily Return Of Its Underlying

Inverse funds are composed of various derivative products with an objective of making profit out of a decline in the value of the respective underlying stocks. We know how the short position works, where an investor sells certain stocks after borrowing it from an investment firm and hopes to buy it back at a lower price on a later date. By this method, an investor can gain without even owning the stock. Inverse ETFs hold a series of short positions on the stocks that constitute an ETF. Inverse ETFs can also be leveraged like Direxion Daily S&P Biotech Bear 3x Shares ETF, which invests 3 times (of its composition in underlying index) in derivative instruments such as futures, options or swaps.

3X Leveraged Funds Are More Volatile and Riskier Than The Unleveraged ETFs

Thus, 3X leveraged funds are in a position to gain three times the daily return of their respective underlying indexes. The objective of 3x ETFs is to make higher utilization of day-to-day price movements. However, it is more volatile and riskier than other leveraged ETFs and unleveraged ETFs. LABD is a 3X leverage fund, which is benchmarked on the S&P Biotechnology Select Industry Index (SPSIBI). For obvious reasons, the percentage change in the value of this leveraged ETF will be much higher than the percentage change in SPSIBI or any unlevered fund with a similar kind of portfolio composition.

Moreover, beta-slippage will bring down the value of 3x leveraged funds. A rise of 25 percent on the first day and a fall of 20 percent the next day will mean that the value of an unlevered fund or index like SPSIBI will remain the same as it was initially. But, a 3x leveraged inverse ETF like LABD will go down by 75 percent the first day and gain by 60 percent the next day. Due to its 3x leverage, Direxion Daily S&P Biotech Bear 3x Shares ETF will become 40 percent of its original value. SPSIBI's price return was 12.13 percent during the 12 months ending June 2023. During the same period, LABD’s return was negative 62.3 percent, which implies a drift of negative 2.71 percent. This drift is something long-term investors should be aware of while investing in LABD.

Over the Past 90 months, LABD Failed Miserably and This Trend Seems to Continue

It's obvious that positive price growth for biotech stocks will be detrimental for investors of Direxion Daily S&P Biotech Bear 3x Shares ETF. However, even in the years when the biotechnology index had negative growth, LABD failed to generate positive price growth. In every completed year over the past 90 months, it has failed miserably. This is because LABD is in a position to make huge gains on a daily basis, but when the time duration is longer, there lies every possibility of losing on more days than the number of days it is gaining.

Over the past 6 months, 12 months, 3 years and 5 years, the market price of Direxion Daily S&P Biotech Bear 3x Shares ETF fell by 17 percent, 49 percent, 77 percent and 97 percent respectively. I don’t foresee it to generate positive growth in the near future, either, as the top holdings in the underlying index are posting strong positive price growth. For reference, 8 out of the top 10 stocks (barring HALO and INCY) recorded price growth over the past 12 months; and barring BPMC, all other stocks had positive growth over the past one month.

Investment Thesis

Direxion Daily S&P Biotech Bear 3X Shares ETF is a short-term trading tool for seasoned traders who have a strategy with clear entry and exit signals, and who understand well the fund’s behavior behind the leverage factor. In my opinion, investing in 3X leveraged funds in the biotechnology sector is not a wise option from the viewpoint of long-term investing. Biotechnology itself is a volatile industry, with powerful rallies and frequent rollercoaster corrections.

Also, as Direxion Daily S&P Biotech Bear 3x Shares ETF invests three times the number of units, they incur higher fees that can result in significant losses over a long-term horizon. High leverage also causes huge losses when the markets are volatile. And because LABD invests in futures, options and swaps it becomes further more risky. LABD’s drift is also at its worst level within the last 90 months. It has failed to perform over the past 90 months and I don’t foresee it to generate positive growth in the near future either. If investors are seeking long-term growth, I’d suggest they do away with their holdings.

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