Should Investors Worry When An ETF Reverse Splits? (ERY, DRV, TZA, TYP)

“From purely a monetary standpoint, splits — in either direction — are neutral. Many companies use splits in place of routine dividends, doling out small fractional shares, so that you effectively have reinvested dividends into the stock instead of pocketing cash; thus, your dividend effectively is a 1.1-to-1 split, giving you 11 shares for every 10 you held before the payout. Still, many investors see a regular split as a good sign, expecting a little pop after a high-priced stock becomes much cheaper again. Conversely, any stock that has to go through the reverse process is stained by the imagery of trouble that typically surrounds such a move. Funds, however, are not stocks. Share-price points are mostly arbitrary; some firms always open new funds at $10 per share, others start at $20, but management can effectively pick any point it likes. Moreover, the fund’s share price movements reflects fluctuations in its underlying holdings, rather than the sentiment investors feel towards the fund, thus there is no post-split pop or decline,” Chuck Jaffe Reports From MarketWatch.

Jaffe goes on to say, “The pricing on an ETF also reflects the point where management started things, but it can wind up making a big difference, thus the need for the reverse splits. ETFs trade like stocks — moment-by-moment rather than being priced once a day — but they are funds, an investment pool run to reach the common objective of the shareholders. Some ETFs are leveraged to move several times the market — up or down — every day. The leverage increases the volatility, and send the fund down in a hurry. If share prices get low enough, it can increase the fund’s daily “tracking error,” meaning it’s harder to reach the daily goal of moving several times what the index moved.”

“Furthermore, some technical issues in how ETFs work could result in low-priced volatile funds sometimes trading at a net asset value that is different from its actual share price; that’s an invitation for traders trying to game the system. Low share prices also allow the smallest fast-money traders to get in and out with very little skin in the game. That’s why Direxion Daily Energy Bear 3x Shares ETF (NYSE:ERY) , Daily Real Estate Bear 3x Shares ETF (NYSE:DRV) , Daily Small Cap Bear 3x Shares ETF (NYSE:TZA) , and Daily Technology Bear 3x Shares ETF (NYSE:TYP) announced the 1-for-5 reverse split effective in July. A year ago, the firm made similar moves to some of its other leveraged issues,” Jaffe Reports.

“A reverse split in an ETF often is the responsible thing for the ETF provider to do,” said Tom Lydon, editor of the ETF Trends newsletter. “It doesn’t mean the ETF hasn’t been successful in meeting its daily mission. A fund that was priced at $40 two years ago and that is priced at $5 today was inverse a market that was working against it, and that happens sometimes.” Added Michael Johnston, senior analyst for ETF Database: “You don’t have to worry — as you might with a stock — that the fund is going bankrupt or closing its doors and you’re going to lose everything. It’s an adjustment in the fund that protects shareholders. You might wonder whether these funds are right for you, but you shouldn’t worry just because they have a reverse split that something has gone horribly wrong.”

Here are some more details on the ETFs going through the reverse split below:

Direxion Daily Energy Bear 3x Shares (NYSE:ERY)  Visit Our ERY Category: HERE

The investment seeks to replicate, net of expenses, 300% of the inverse daily performance of the Russell 1000 Energy Index The fund will invest at least 80% of assets in securities that comprise the index. It will also utilize financial instruments that, in combination, provide leveraged and unleveraged exposure to the index. The fund is nondiversified.

Chart forDirexion Daily Energy Bear 3X Shares (ERY)

Direxion Daily Real Estate Bear 3x Shares (NYSE:DRV)  Visit Our DRV Category: HERE

The fund seeks daily investment results, before fees and expenses, of 300% of the inverse (or opposite) of the price performance of the MSCI US REIT index. The fund normally creates short positions by investing at least 80% of net assets in financial instruments that, in combination, provide leveraged and unleveraged exposure to the index. It is nondiversified.

Chart forDirexion Daily Real Estate Bear 3X Shrs (DRV)

Direxion Daily Small Cap Bear 3x Shares (NYSE:TZA)  Visit Our TZA  Category: HERE

The investment seeks to replicate, net of expenses, 300% of the inverse daily performance of the Russell 2000 Index The fund will invest at least 80% of assets in securities that comprise the index. It will also utilize financial instruments that, in combination, provide leveraged and unleveraged exposure to the index. The fund is nondiversified.

Chart forDirexion Daily Small Cap Bear 3X Shares (TZA)

Direxion Daily Technology Bear 3x Shares (NYSE:TYP)  Visit Our TYP Category: HERE

The investment seeks to replicate, net of expenses, 300% of the inverse daily performance of the Russell 1000 Technology Index The fund will invest at least 80% of assets in securities that comprise the index. It will also utilize financial instruments that, in combination, provide leveraged and unleveraged exposure to the index. The fund is nondiversified.

Chart forDirexion Daily Technology Bear 3X Shares (TYP)

The CUSIPs for the four ETFs will change as follows:

       
ETF Old CUSIP New CUSIP  
Direxion Daily Energy Bear 3x Shares (NYSE:ERY) 25459W870 25459W 342  
Direxion Daily Real Estate Bear 3x Shares (NYSE:DRV) 25459W748 25459W 334  
Direxion Daily Small Cap Bear 3x Shares (NYSE:TZA) 25459W839 25459W 326  
Direxion Daily Technology Bear 3x Shares (NYSE:TYP) 25459W201 25459W 318  
       
     

Shareholders of record of the above ETFs on July 7, 2010 will participate in the reverse splits. The Depository Trust Company (“DTC”), the registered owner of all ETF shares, has been notified of the reverse splits and has been instructed to adjust each shareholder’s investment accordingly.

As a result of the reverse splits, every five shares of each ETF will be exchanged for one share of the applicable ETF. The number of each ETF’s issued and outstanding shares will decrease by approximately 80%, and the ETF’s per share NAV will increase 5-fold at the opening of the markets on July 8, 2010.

The shares of each ETF will be offered on a split-adjusted basis on July 8, 2010. The total market value of the shares outstanding will not be affected as a result of this reverse split, except with respect to the redemption of fractional shares, as discussed below.

Hypothetical Example of 1-for-5 reverse split:

1-for-5 Reverse Split  
Period # of Shares Owned Hypothetical Market Price Total Share Value  
Pre-Split 100 $5 $500  
Post-Split 20 $25 $500
 

Redemption of Fractional Shares and Tax Consequences for each Reverse Split

As a result of the reverse splits, a shareholder of each ETF could potentially hold a fractional share. However, fractional shares cannot trade on NYSE Arca. Thus, each ETF will redeem for cash a shareholder’s fractional shares at the Fund’s split-adjusted NAV as of July 7, 2010. Such redemptions could cause a shareholder to realize a gain or loss. Otherwise, the reverse split will not result in a taxable transaction for holders of ETF shares. No transaction fee will be imposed on shareholders for such redemption.

“Odd Lot” Unit

As a result of the reverse split, the ETFs will have outstanding one aggregation of less than 50,000 shares to make a creation unit, or an “odd lot unit.” Thus, each ETF will provide one authorized participant with a one-time opportunity to redeem the respective odd lot unit at its split-adjusted NAV, or at the NAV on such date the authorized participant seeks to redeem the odd lot unit.

To speak to a member of the Direxion team, or request more information, please contact Katrine Winther-Olesen at (973) 400-1341 or [email protected]

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