I was actually levered to 110% of the value of equities, so 10% levered in 1998, as I purchased more securities during the Asian crisis. I was very lucky, because everything worked out for me and I made a little bit more return as a result. Since then, the fund has never been leveraged for a very good reason. Most of the people that you and I know, the readership of your fine publication, will be in trades that will make them money provided they can play out their hands.
We know that leverage can prevent you from playing out your hand because exactly the time when markets go into crisis is when your credit gets called. I am aware of funds that had their credit lines pulled at the most inconvenient times and suffered catastrophic losses which would not have been suffered had their credit not been pulled.
It is worth saying that except in the case of a very large fund that can arrange for some kind of long-term loan from their broker, the loans tend to be overnight. You get money overnight and the trades can usually be liquidated within a very short period of time. Good investment ideas usually take months, if not years, to play out. I would argue that levering up an investment portfolio, even if it is composed of liquid securities, is a profound mismatch of assets and liabilities.
I think that the experience of Bear Stearns and Lehman Brothers exemplifies this case. They were borrowing money short-term and the investments they were making were liquid, so from the perspective of the lender they were not bothered because they knew they could force the brokerage firm to liquidate in order to pay their short-term funding. The reality was that the bets that they were making needed time to play out and to the extent that those firms didn’t have the time to let those bets play out, they suffered insolvency, and that is not something that I am about to do for my investors.
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