DRN: Portfolio Composition Of This 3X Leveraged Fund Fails To Generate Optimism

~ by Snehasish Chaudhuri, MBA (Finance)

In my last coverage almost a year back, I discussed the high-growth and low-growth segments within the real estate investment trusts (REITs). I mentioned that one of the biggest beneficiaries of the growth of e-commerce was industrial REITs. At the same time, office & commercial REITs and healthcare REITs were expected to perform poorly. Post Covid-19 pandemic, remote work became a permanent feature. Traditional landlords were facing real struggle due to lack of occupancy. Companies with older office buildings were suffering the most, as their rents were going down and expenses were going up. The inflation and looming recession was adding more pain to them.

Direxion Daily Real Estate Bull 3x Shares ETF (NYSEARCA:DRN) invests heavily in office REITs, Retail & Hospitality REITs, Residential REITs and Healthcare REITs. These segments were not expected to perform well. However, DRN’s investments in industrial REITs and infrastructure REITs were expected to deliver high growth. As a 3x leveraged fund, this growth would have been thrice the unleveraged REITs. Although I was not optimistic about DRN a year back, the fund requires a relook due to the changing economic scenario and considering that the fear of rescission to be almost over during this period.

I Was Not Very Optimistic About This 3X Leveraged Bull Fund One Year Back

Direxion Daily Real Estate Bull 3x Shares ETF seeks daily investment results, of three times that of the performance of the Real Estate Select Sector Index. Real Estate Select Sector Index is an index provided by S&P Dow Jones. The fund invests in derivatives in stocks of companies operating across all major types of REITs - Residential REITs, Office REITs, Healthcare REITs, Retail & Hospitality REITs, Infrastructure REITs, and Industrial REITs. DRN has been in operation for almost 14 years and is domiciled in the United States. As a 3x leveraged ETF, the fund by default has a high expense ratio of 0.96 percent.

During my last coverage, I found that DRN’s underlying index performed poorly, and due to the fund’s 3X investment in derivatives of the component stocks, the loss got compounded. Almost 75 percent of the index’s investments recorded loss on a yearly basis. Uncontrollable factors like Covid-19 pandemic, inflation, and looming recession negatively impacted funds having similar composition to that of Direxion Daily Real Estate Bull 3x Shares ETF. Only the industrial REITs were able to generate positive growth between June 2021 and May 2022, and in case there is a rescission, only these REITs were expected to grow. Going by the trend, I was not at all optimistic that as a 3X leveraged bull fund concentrated more on other types of REITs (besides industrial REITs), DRN will be able to generate huge positive growth in the short run.

DRN’s Investments in Industrial REITs Failed to Generate Positive Returns

DRN’s top 30 investments covers almost 80 percent of its entire portfolio. So, an analysis of these 30 REITs will provide a clear picture of the direction and growth potential of Direxion Daily Real Estate Bull 3X ETF. 20 percent of its investments were in five industrial REITs primarily engaged in the business of logistics & warehousing. These companies were Prologis Inc. (PLD), Public Storage (PSA), Weyerhaeuser Company (WY), Extra Space Storage Inc. (EXR), and Iron Mountain Incorporated (IRM). During my last coverage, these REITs were the only growth generating REITs with an average one-year return (calculated during June 2022) of almost 9 percent. Unfortunately, this time, these REITs are a big disappointment, with only IRM generating a positive price growth (that also only 4 percent) over the past one year.

Returns From DRN’s Investments in Other REITs Were Further Disappointing

DRN invested another 15 percent of its fund in three big communication infrastructure REITs, namely American Tower Corporation (AMT), Crown Castle International Corp. (CCI), and SBA Communications Corporation (SBAC). CCI fell by almost 37 percent, and SBAC fell by almost 32.5 percent, while AMT suffered a price loss of 23.5 percent. Residential REITs such as AvalonBay Communities, Inc. (AVB), Equity Residential (EQR), Mid-America Apartment Communities, Inc. (MAA), Essex Property Trust, Inc. (ESS), Camden Property Trust (CPT), Invitation Homes Inc. (INVH) and UDR, Inc. (UDR) posted a negative price growth between 8 to 25 percent, during the past 12 months.

Retail & hospitality REITs like Realty Income Corporation (O), Simon Property Group, Inc. (SPG), Kimco Realty Corporation (KIM), Regency Centers Corporation (REG), Federal Realty Investment Trust (FRT) and Host Hotels & Resorts, Inc. (HST), also generated negative growth between 8 to 20 percent over the same period. Only VICI Properties Inc. (VICI) registered a price growth of 5.4 percent. Healthcare and data center REITs also suffered setbacks over the past 12 months. Ventas, Inc. (VTR) fell by 20 percent, Healthpeak Properties, Inc. (PEAK) lost more than 27 percent, Digital Realty Trust (DLR) fell by 20 percent, and Welltower (WELL) recorded a price loss of 12.6 percent.

Unattractive Yield and High Negative Price Growth Makes DRN Unattractive

Office & commercial REITs were the worst of the lot. CBRE Group, Inc. (CBRE) lost 5.8 percent, Alexandria Real Estate, Inc. (ARE) lost 28.5 percent, Boston Properties, Inc. (BXP) lost 52 percent. The only bright spot was a 12.85 percent return generated by Equinix, Inc. (EQIX). Quite expectedly, Direxion Daily Real Estate Bull 3X ETF suffered huge losses over the past one year (53.5 percent). And in the absence of any significant dividend yield, its total return was equally pathetic at negative 52.5 percent. During the same period, S&P 500 generated a total return of almost 5 percent, which grew to 10.75 percent during 2023. Unfortunately, DRN failed to generate any positive return during 2023, too, and doesn’t seem to be in a position to deliver in the near future.

REITs generally have properties that can generate steady returns in an adverse economic scenario. In the short run, bull leveraged REIT exchange traded funds can be a good investment strategy provided that those funds invest in the right kind of REITs, that not only are performing under current economic conditions, but also are most likely to generate positive price growth in the near future. Unfortunately, most of the REITs included in DRN’s portfolio serve neither. These REITs don't have strong fund flow from operations either. Direxion Daily Real Estate Bull 3X ETF doesn't offer any decent yield and is designed to hone in on real estate asset values as a leveraged speculative tool. I feel that this is not the exposure that investors are actually looking for.

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