LABU: This 3X Leveraged Bull ETF Fails To Raise Any Optimism

I covered the Direxion Daily S&P Biotech Bull 3X Shares (NYSEARCA:LABU) at the end of Q1 2022. On 30th March, the stock was trading around $18 (with day’s high recorded at $18.2). The stock has been on a free fall since then, and has come down to a level of $5 (with day’s low recorded at $4.55) on 17th June, 2022. That’s a fall of exactly 75 percent within a span of 12 weeks. Moreover, LABU is a non-dividend paying stock. This makes investments in LABU highly risky.

LABU’s investment moves 3x upwards or downwards with respect to the S&P benchmark index – Biotechnology Select Industry Index (SPSIBITR), an index which is composed of companies operating primarily in the biotechnology and life sciences sectors. LABU invests in derivatives (such as futures, options, swaps) of those companies that are listed in SPSIBITR, but the volume of investment is 3 times that of the underlying index.

In 2021, SPSIBITR fell by more than 20 percent, and correspondingly LABU fell by 65 percent. I expected LABU to fall further, and it did so. During the past 6 months, it recorded a negative growth of 86 percent. I was very critical of this stock at that time because, despite positive growth recorded by the underlying index, LABU failed to record positive growth over the medium and long run. This happened because the underlying index suffered losses in more numbers of days than it made gains.

The biotechnology sector is going through a bearish phase and the trend is likely to continue for the foreseeable future. Biotechnology sector in general is quite volatile due to its inherent nature of being impacted by unfavorable policies, product launches, testing, and approvals, etc. Biotechnology and pharmaceutical sectors are yet to overcome uncertainties surrounding the probable drug pricing reform which was an integral part of president Biden’s ‘Build Back Better’ campaign.

According to a report published in the Wall Street Journal, “A lobbyist representing large healthcare providers estimates the chance of a bill passing at 50%.” The report also mentions concerns raised by some renowned analysts. “Brian Abrahams, an analyst at RBC Capital, thinks the risk of “drug pricing legislation making a comeback is highly underappreciated on the Street.” “A group of Morgan Stanley analysts, including Matthew Harrison and Terrence Flynn, noted that with ‘midterm elections nearing, Democrats appear ready to take one more serious shot’ at lowering prescription drug prices”.

Analysts believe that drug pricing reform will have a huge impact on the share prices of large-cap stocks from these sectors. “Any progress in negotiations this summer could put some pressure on sector stocks – especially those with the most exposure to the bill, such as big biotechs Regeneron (REGN) and Amgen (AMGN). Direct Medicare negotiations for Regeneron’s Eylea could trim the company’s revenue by 5% to 15%, according to Morgan Stanley estimates”. In addition to all these, the current economic scenario that involves geopolitical turmoil, high inflation, series of interest rate hikes, rising unemployment, and looming recession, will aggravate the pains of biotechnology stocks.

I believe that over the medium or longer term, leveraged bull funds can only be suitable in less volatile sectors, and the sectors which are in demand at a given point of time. Considering the current economic situation, a 3x bull ETF on the energy and commodity sector will be a good option for investors, provided the component stocks make gains in more numbers of days than they make losses. Energy and commodity stocks are much more stable, and are safer bets during a scenario of high inflation, rescission and economic uncertainty.

The Direxion Daily S&P Oil & Gas Exploration & Production Bull 2X Shares (GUSH) delivered a return of 80 percent in 2022. The MicroSectors U.S. Big Oil Index 3X Leveraged ETN (NRGU) grew by 157 percent during the same period. At the same time, bull leveraged funds from other more volatile sectors with poor future outlook made huge losses. LABU made a loss of 84 percent. Daily Semiconductor Bull 3X Shares (SOXL) and Daily Small Cap Bull 3X Shares (TNA) generated a loss of 81 percent and 62 percent, respectively.

When it comes to the biotechnology sector or other volatile sectors which are expected to perform poorly, the bear leveraged funds deserve a look. The inverse funds stand to make considerable gains, as the biotechnology stocks (or similar stocks) make losses or are expected to fall in the future. In 2022, bear leveraged funds such as Daily S&P Biotech Bear 3X Shares (LABD), and Daily Small Cap Bear 3X Shares (TZA) generated a positive growth of 86 percent and 90 percent, respectively.

Another critical point is that all the leveraged funds have a very high expense ratio. 3X funds will have the highest expense ratio, as these funds need to invest 3 times the volume. The expense ratio of the above-mentioned leveraged funds are as follows: LABU – 0.96 percent, GUSH – 1.01 percent, NRGU – 0.95 percent, SOXL – 0.9 percent, TNA – 1.05 percent, LABD – 1 percent, and TZA – 1 percent. As these funds incur higher fees, expense ratio can result in significant losses over a long term horizon. Moreover, due to the extreme level of volatility, these 3X funds are generally not suited to offer dividends.

Mr. Warren Buffett once said “A rising tide lifts all boats. In bull markets, investors who take on more risk by using leverage will look like geniuses. When sentiment changes and a recession occurs, these leveraged portfolios will not look so smart.” Being a non dividend paying biotechnology sector 3x leveraged bull ETF with high expense ratio, LABU is an extremely risky investment. The probable drug pricing reform will cause further pain to it.

As the recession is knocking on the door, nothing seems to be favorable for Direxion Daily S&P Biotech Bull 3X Shares at present. Moreover, investing in order to make quick short term gains is risky; just recall what Buffett told us: “If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value.”