DRN: An ETF To Own During Fed Policy Normalization

seekingalpha09-27

The Direxion Daily Real Estate Bull 3X Shares ETF seeks to deliver 300% of the return of the IXRE index which is heavily tilted to large-capitalization US REITs.I expect underlying IXRE constituents ...

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I estimate that the underlying holdings of DRN will produce a high-single-digit total return over the next few years. DRN's 300% leverage and 1% expense ratio will turn this into a low double-digit return for investors. As such I think the opportunities outweigh the risks and rank the DRN a buy. ETF Overview You can review all ETF information on the Direxion website here. Please note that the website contains information for the short ETF as well, the Direxion Daily Real Estate Bear 3X Shares ETF (DRV) which I do not currently recommend. Back to our bull ETF, the Direxion Daily Real Estate Bull 3X Shares ETF seeks to deliver 300% (3x) of the performance of the Real Estate Select Sector Index (IXRE). The index is well diversified across property sectors, with Telecom Tower REITs accounting for ~15.63% of the index, followed by Retail REITs at ~12.79% and Data Center REITs at ~12.27%:   IXRE breakdown between sectors (Direxion website (Accessed September 2024))Holdings and diversification The underlying IXRE index is heavily concentrated in large-capitalization US REITs such as Prologis (PLD), American Tower (AMT), and Equinix (EQIX). As such, the top ten holdings account for ~60% of the total index:   IXRE top ten holdings (Direxion website (Accessed September 2024))On the one hand, the high concentration exposes the ETF to the idiosyncratic risks of just a few companies. On the other hand, it allows investors to gain a better grasp of underlying holdings prospects and their return potential. For example, I covered Prologis in August 2024, the largest weight in the IXRE and respectively the most important single stock for DRN's returns. Prologis is representative of large US REITs, offering a high-single-digit return potential thanks to an AFFO multiple of around 20x and a market-implied cap rate in the mid-single digits (Prologis specifically is marginally more expensive due to robust net operating income growth). Expenses and distributions The DRN has a net expense ratio of 1.01% which is in line with other triple-levered ETFs. The fund pays a quarterly dividend, with the current yield at 1.90% annually. The case for buying the DRN As highlighted above, my assumption is that the underlying IXRE index will return about 8% over the next few years. This return is a result of circa 20x AFFO multiple, stable real estate cap rates, and 30% leverage employed by large US REITs. Hence the 8% return can be broken down between 5% from current cash flows and 3% from capital gains on real estate appreciation driven by 2% inflation accruing exclusively to common shareholders. As DRN will amplify this return ~3x but also cost circa 1% in fees, DRN investors are potentially looking at a low double-digit return over the next few years. The key driver behind capital gains in the real estate sector will be the remaining Fed rate cuts over the next few years before the central bank reaches its neutral rate of 2.9% by the end of 2026:   Outlook for macroeconomic indicators (Fed September 2024 summary of economic projections)Furthermore, as the economy is cyclical, at some point the US will enter a recession which will likely be marginally beneficial for large US REITs as they boast stable long-term funding. In this case, the Fed is likely to cut rates below its 2.9% neutral rate, boosting the appeal of dividends provided by REITs on a quarterly basis. Real estate was also highlighted in the September 2024 Seeking Alpha Sentiment Survey as the largest beneficiary of rate cuts, reaching 58.1% of all votes, well ahead of small-caps at 13.2%:   Sector beneficiaries from rate cuts (Seeking Alpha)Risks The key risk in the investment case is that it is based on medium-term considerations and outlook while the DRN mirrors daily performance. As such, there is no guarantee that the drip-feed of small daily gains will not be offset by a few significant daily declines. But even if markets do experience large downturns now and then, I expect US REITs to eventually recover, compensating patient investors. The other looming near-term risk are the US elections which will likely cause near-term uncertainty in US stocks. This is already visible with the Vanguard Global ex-U.S. Real Estate Index Fund ETF (VNQI) outperforming the IXRE over the past month:   VNQI vs IXRE over the past month (Seeking Alpha)In any case, I do not expect the elections to have a lasting impact on US REITs as they remain cheap relative to the broader market. Conclusion The DRN ETF has only marginally outperformed the SPY so far in 2024. I think real estate remains cheap relative to the broader US market and will be one of the key beneficiaries of Fed policy normalization. As such I anticipate the DRN to deliver a low double-digit return over the next few years, justifying its Buy rating. While risks stemming from the daily replication of DRN and the upcoming US elections are points of concern, I expect the Fed's policy normalization to prevail over the long term, rewarding investors who look through the short-term noise.  Thank you for reading.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2470084190"}