An Overview of ERX
Direxion launched the bull and bear lines of the Daily Energy Shares 2X ETF in November 2008. The bull, Direxion Daily Energy Bull 2X (ERX), aims to reproduce 200% of the daily returns of the S&P Energy Select Sector Index. In other words, for every 1% gain in the underlying index, ERX attempts to produce a corresponding 2% gain. Prior to March 31, 2020, ERX attempted to produce a corresponding 3% gain.
Until March 31, 2020, ERX previously sought returns of 300% of the performance of the Energy Select Sector Index.
The Energy Select Sector Index, provided by Standard & Poor's, is heavily weighted towards oil, gas, and consumable fuels. Other holdings include companies from the energy equipment and services sector. Each component of the index must be a constituent company of the S&P 500. The composition and weighting of the index are calculated through a hybrid market capitalization methodology.
Energy sector plays have performed very well in the 21st century, although the global surge in oil and natural gas production between 2013 and 2015 bucked that trend to some degree. As a triple-leveraged ETF, ERX is particularly sensitive to increases and decreases in the market price of energy commodities.
More than 99% of the stocks in the underlying index belong to companies in the United States and Canada; small remaining portions are usually from companies in Europe. The average turnover in the category is high, and assets tend to be highly concentrated in the top five or 10 holdings. As of Sept. 2020, the top 10 holdings in the ERX portfolio accounted for more than 51% of total assets, including big players such as Exxon Mobil, Chevron, Energy Select Sector, EOG Resources Inc., and ConocoPhillips.
Direxion ETF Characteristics
ERX is an open-ended investment company offered through the Direxion Funds family and advised by Rafferty Asset Management, LLC. Like most double-leveraged ETFs, Direxion is actively managed and can come with high costs. Fortunately for the shareholders of ERX, Rafferty Asset Management entered into an operating expense limitation agreement with Direxion to cap the management fees at 0.95%.
An expense ratio of 1.06% is slightly higher but relatively in line with the industry average for a leveraged and indexed ETF. Fund expense ratios do not include brokerage fees or other trading expenses.
To achieve its correct leverage, ERX also invests in financial instruments not found in the IXE portfolio. These instruments can include futures contracts, forward contracts, options on securities, equity caps, floors and collars, swaps, short selling, reverse repurchases, and other ETFs.
Suitability and Recommendations
All investments come with risk, but leveraged ETFs can be particularly risky. Any shareholder of ERX or ERY has exposure to a degree of market risk and volatility that greatly exceeds that of most equities. Due to its heavy weighting in the energy sector, the performance of ERX is highly dependent on oil and gas prices. Investors should closely monitor the price of energy commodities and energy commodities futures.
Direxion is a renowned provider of leveraged and inversely leveraged ETFs, particularly in the double-leveraged space. Its expense limitation arrangement with Rafferty Asset Management extends to all of its fund offerings, which is particularly suitable for investors who prefer actively managed and high-turnover instruments.
The Bottom Line
In general, a 2X ETF is only meant for investors who have exposure to leveraged instruments and are comfortable monitoring their own portfolios with consistency. ERX is not a buy-and-hold play and is not suitable for fixed-income investors. It has a large bid/ask spread and does not have a consistent yield.
ERX has a track record of large upswings and downswings.
This fund has average to below-average modern portfolio theory (MPT) indicators. Its beta is at 4.64. This could serve as a nice satellite holding for competent investors, but it should never make up the core of a balanced portfolio.