Direxion Funds, which was one of last year's big success stories in exchange-traded funds in attracting investment dollars, has filed to offer 40 new inverse and leveraged funds. 

In the request, dated Feb. 26, Direxion is proposing a new wrinkle to its existing lineup of ETFs. While the fund provider proposes to still offer 200% and 300% leverage to different major indexes, it's moving to expand the time each new portfolio compounds returns.

The company's previous ETFs have used daily returns to calculate a fund's performance. By contrast, the new ETFs would track monthly prices of their underlying benchmarks. 

Representatives of the company's Direxion Shares group declined to comment on Wednesday, although they did confirm that they're seeking to come out with the new ETFs based on monthly returns.  

In theory, being able to track a longer return period should make the new Direxion ETFs better-suited for longer investing periods. That assumes, of course, investors hold the proposed ETFs at the beginning—rather than later—in any given month. 

Still, rebalancing techniques used by Direxion aren't likely to completely smooth short-term differences between benchmark and fund returns. That has been an issue raised by some advisers with the firm's leveraged and inverse ETFs that use daily returns. Even Direxion is warning investors that daily deviations will take place. 

In fact, it has started to send investors a pamphlet that clearly spells out the role of compounding in leveraged index-based funds. An example it gives is between Jan. 15-21 earlier this year. During that week, the Direxion Financial Bull 3x Shares (NYSE: FAS) and the Direxion Financial Bear 3x Shares (NYSE: FAZ) both wavered substantially from the Russell 1000 Financial Services Index. 

The funds, which seek to provide 300% exposure both ways to the benchmark, in that period lost 9.04%, according to Direxion.  

"If you were to assume that based on this cumulative return of the index, the bull fund would have experienced a 27% loss and the bear fund would've experienced a 27% gain, you would unfortunately be incorrect," wrote the company in the document. "In fact, for that time frame, the bull and bear funds returned -34.46% and 6.32%, respectively."

Skewered Returns

Since the funds have to rebalance daily to maintain their expressed levels of exposure to their underlying benchmarks, sharp market shift or increased volatility over several days can cause a skewing in returns. 

Anthony Welch, a Sarasota, Fla.-based adviser and portfolio manager who uses leveraged and inverse ETFs, says that such short-term differences point to a need for investors to use such funds strictly as trading vehicles.  

"These new ETFs are a very good idea," said Welch. "But they won't replace the ones tied to daily returns. Those are designed for shorter-term trades on a daily basis or a week or two. But with leverage available on a monthly basis, someone could make longer-term calls more easily on the market."

He added: "These are going to behave differently than the dailies in terms of performance. In fact, you could hold the monthlies and trade the dailies around those. So these new ETFs should be a nice complement."

Direxion is planning to provide four different funds for a range of indexes. Two will offer 200% exposure (one leveraged, the other inverse). Another set will do the same, yet with 300% exposure. 

The indexes being proposed by Direxion for monthly 200% and 300% exposure include:

• Four broad-based Russell benchmarks (Russell 3000, Russell 2000, Russell 1000 and the Russell MidCap)

• Two MSCI indexes (MSCI EAFE and MSCI Emerging Markets)

• Two Bank of New York indexes, one for China and another for BRIC markets

• One from Indus covering just India

• Three S&P benchmarks which will separately provide exposure to Latin America, homebuilders and clean energy firms around the globe

• A trio of other Russell indexes covering sectors for Financial Services, Tech and Energy

• A Dow Jones Wilshire REIT index

• Several Merrill Lynch Treasury indexes, with exposures ranging from two-year terms to 30-year terms

The complete filing can be found here.