Leverage: not without risk
Leverage, often referred to in investing as a ‘double-edged sword’, is another word for borrowing money to own more of an asset.
Much like a mortgage on a house, it enables you to own a higher value of an asset that you’d otherwise be unable to own. Sounds great in theory but you run the risk of the value falling, resulting in you owing more than you own (coined ‘negative equity’ in the housing world). This is never a good place to be.
At CPW we take an approach that means investments are owned, without inherent borrowing within the funds themselves.
Of course, we do believe debt is a powerful tool that governments and companies can use to raise capital to fund future growth and the importance of borrowing in capital markets, but we don’t generally believe that this is a risk worth taking at the fund or portfolio level.
Markets can be scary enough at times like Q1 2020, without magnifying the downside further through leverage!
The potential upside of a highly leveraged investment strategy is increased returns – something that can be very tempting for investors!
It can be a losing game
You might have spotted in the press that the family office Archegos Capital Management has recently unwound all of their leveraged bets leaving some banks, which provided the capital to Archegos, nursing heavy multi-billion pound losses.
Unfortunately, many investors learn painful and costly lessons by chasing returns instead of assessing their need for risk in their portfolio.
This links back to our six guiding principles of investing – otherwise known as PortfolioScience. Principles 1, ‘Accept the stock market is tough to beat’ and 2, ‘Understand risk and return are related’ are particularly important here. Click below to refresh yourself of what they mean to investors like you…
We take a risk-focused approach to portfolio construction and our Investment Committee regularly reviews the risk exposures of our portfolios to avoid those that are unwanted or typically go unrewarded. In general, leverage is one of those.
If you have any questions about your approach to risk or leverage in your portfolio, get in touch.