Many short-term traders focus on the Federal Reserve's interest rate decisions. If the Fed cuts its benchmark rates, bond yields will fall, the financial conditions will ease, and more investors will take on debt and rotate back toward riskier investments. Those conditions could broadly lift the financial sector, which thrives on increased investments, trading, and loans.
If you expect Kevin Warsh, the Trump Administration's nominee for the next Fed chair, to aggressively cut rates upon succeeding Jerome Powell this May, then it might be a good time to get bullish on financial stocks. Let's take a look at a popular ETF that aims to triple daily returns in the financial sector -- and whether it's a safe long-term play on lower interest rates.
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What does Direxion's Daily Financial Bull 3x Shares ETF do?
Direxion's Daily Financial Bull 3x Shares (FAS 4.52%) is a leveraged ETF that aims to triple the daily performance of the S&P Financial Select Sector Index, which includes 76 of the top financial stocks from the S&P 500. The index's top holdings -- including Berkshire Hathaway, JPMorgan, Visa, Mastercard, Bank of America, and Wells Fargo -- drive most of its growth.
There are plenty of ETFs that also track the S&P Financial Select Sector Index, but Direxion uses total swap returns with banks to triple the index's daily return.
So instead of directly investing $100 million in the index, Direxion finds a bank that agrees to invest $300 million on its behalf. The bank agrees to pay Direxion triple the index's return daily, while Direxion agrees to pay the bank interest until the swap contract expires. For FAS, Direxion charges a high expense ratio of 0.89% to cover those interest payments.
Moreover, leveraged ETFs magnify the gains and losses of the underlying index or stock. If the S&P Financial Select Sector Index rallies 1%, FAS will rise 3%. But if it declines 1%, FAS will drop 3%. That makes them risky long-term plays -- especially since their returns are reset daily.
NYSEMKT: FAS
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Should you invest in Direxion's Daily Financial Bull 3x Shares ETF?
FAS might spike abruptly if the Fed adopts a dovish stance under its new chair. However, it's still a short-term trading tool instead of a reliable long-term investment. Warren Buffett famously told investors to be "fearful when others are greedy" -- and leveraged ETFs like FAS are clearly designed for greedy investors instead of patient ones.
