Despite what many investors seem to believe today, leverage isn’t a monster hiding under their beds, according to an expert panel of portfolio managers who focus on fixed-income.
The Alternative Investment Management Association (AIMA) Wednesday hosted a panel discussion in Toronto on generating yield in today’s market environment.
“Post-2008, leverage and derivatives, particularly in the media, became dirty words,” said Andrew Torres, founding partner and chief investment officer of Toronto-based Lawrence Park Capital Corp. However, that is a misconception because there are different kinds of leverage and not all of it is dangerous.
While many investors may be uncomfortable with the idea of leverage, it is a necessary investment strategy if they want to find sufficient yield in fixed-income, according to the panel. For example, due to persistently low interest rates, said Torres, an un-leveraged investment in a high-grade bond will not generate any yield.
When investors avoid a leveraged investment out of fear, they are missing the bigger picture. “The notion of leverage or derivatives being a “boogie man” of the financial markets for the last little while is focusing on the wrong idea,” said Kevin Dribnenki, a portfolio manager for the Ontario Teacher’s Pension. “For me, I look more at the infrastructure in place to manage risk.”
As well, when it comes to hedge funds, current market conditions mean that the amount of leverage used for an investment strategy is far less than in previous years. “Six, seven years ago,” said Torres, “the leverage you would find in a relatively small hedge fund was astronomical.” The level of leverage in funds has decreased due to a higher degree of volatility risk and an increase in cost.
Of course, there are times when using leverage is not a good idea. Leverage can be dangerous if it is not constant and isn’t monitored appropriately, said Dribenki. In order to manage the risk, he said, it’s important that investors are able to track the leverage used in a fund.