In early November 2008, Direxion Funds rolled out the first of its much-anticipated triple-exposure exchange-traded funds.

Somewhat surprisingly, the Direxion ETFs as a whole have been an instant hit. The funds launched into a market with direct and established competition, from ProShares ETFs, which has provided leveraged and inverse leveraged ETFs since 2006.

But investors have flocked to the Direxion funds. At the end of November, with less than a full month of trading behind them, the eight funds had accumulated a total of more than $510 million in assets, with the largest fund—the Direxion Large Cap Bull 3X Fund (NYSEArca: BGU)—racking up more than $195 million.

ETFs are generally considered a success if they break the $100 million mark, and there are hundreds of more-established exchange-traded products out there that have yet to achieve even $25 million in assets. To gather that much in assets in such a short period of time is surprising.

What's more interesting than assets, perhaps, are the volumes displayed by the funds. In the early weeks of December, BGU was regularly trading more than 10 million shares a day. Of the remaining seven funds, six were seeing volumes almost uniformly in the millions. To put that in perspective, the original SPDR (NYSEArca: SPY) trades hundreds of millions of shares on a daily basis, but still: A few million shares daily is well beyond respectable for your average, well-established ETF.

With the funds capable of extreme volatility, almost by definition, volume and liquidity are crucial to their success. There is a lot of risk attached to these products, and investors need to be able to get in and out of them quickly.

"When you're launching new ETFs, it's very much about liquidity and volume. It's sort of the chicken before the egg. You need the volume to be at the right level for the spreads to be at the right place for people to be interested in them and get the investment going," said Direxion Vice President and Marketing Director Andy O'Rourke.

A Useful Trading Tool ...

There are a few basic strategies for which the DirexionShares are a good fit.

That's what the heads of Ironwood Asset Management are using the funds for. Partners Gary Stringer and Derek Sinani had pulled back into cash by the end of 2007, well before the market chaos of 2008. After largely exiting the market, "we began looking for opportunities to put smaller amounts of capital at work and trying to leverage the opportunity of a volatile market," said Sinani.

"We have tried to take advantage of this volatility with a small percentage of those assets, and by utilizing some of these leveraged funds, that small amount of dollar risk can produce a large amount of return," explained Stringer. The firm had already been using Direxion's leveraged and inverse mutual funds and was quick to begin using the triple-exposure ETFs when they became available.

Anthony Welch, a partner at Sarasota Capital Strategies, says the funds are also good for quick exposure.

"[On] one of those days when the market takes off and looks like it's running away without you, instead of panicking and buying everything, you can just buy BGU and now you've got triple exposure and you can ride it up," explained Welch, who also noted that traders investing money according to set algorithms can also use the Direxion ETFs to gain appropriate exposure at roughly one-third of the money needed for other ETFs tied to the same or similar indexes.

Jerry Slusiewicz, president of Pacific Financial Planners, is currently using the funds to achieve quick, lower-cost market exposure, but believes that as the market environment changes, the Direxion ETFs will become more important as hedging tools, in particular for protecting a portfolio without creating tax consequences. In this way, the funds will fill what Slusiewicz terms an "unbelievably great void."

For example, Welch suggested that investors faced with capital gains taxes concerned about protecting their investment against an end-of-year decline could simply purchase one of the Direxion ETFs rather than selling stock and realizing the capital gains.

...Or A Dangerous Gamble?

The main thing to remember about these funds that everyone—including the folks at Direxion—agrees on is that these are not the long-term, buy-and-hold core investment vehicles that should represent the bulk of a portfolio. Direxion executives make it clear that they did not design these products for the average investor; rather, they are tools for the hands-on, sophisticated trader. As such, the beginning investor or investors who don't want to take an active approach to managing their personal portfolios should probably steer clear.

"We are very up front, transparent and straightforward about making sure people understand what these products are all about, what's in them and making sure people know how they operate. If people don't have a full understanding of what these things are, we really do recommend they don't get into them. We want people to use them if they work for their strategies, but we really don't want the more-ignorant investor—not to be too blunt—to take a stab at these when they don't have a full understanding," O'Rourke said.

Essentially, these are funds you never want to turn your back on—triple leverage means that in three days, an unattended fund that sees declines of 2% each day in its benchmark index would be down more than 20%. The compounding issue means there is no guarantee that if the market falls 20% this year, a 300% inverse fund will deliver 60% returns. It only guarantees returns on a one-day basis; after one day, the math gets funny.

The compounding effect is an issue with any product offering more than straight 100% or -100% exposure, but it becomes a particularly urgent issue when triple exposure is paired with exceptionally volatile markets.

"If you get caught on the wrong side of one of these, it's a nightmare," Welch said.

At Ironwood, both Stringer and Sinani emphasized that a triple-exposure fund should not represent a large part of an overall portfolio, and they have kept their investments in such funds to 5-10%.

Stringer notes that although the Direxion ETFs have been, as he puts it, "spectacularly effective" for his firm, "it's not for the faint of heart or for those unwilling to do their research or their due diligence."

And of course, because the Direxion ETFs primarily gain their exposure through swaps, counterparty risk is an issue to monitor as well.



Table includes first ETFs launched by Direxion in November 2008.