How To Invest With Leverage


Managing The Risks Associated With Leverage

Investing With Leverage (Borrowing to Invest, Leveraged ETFs)

Leveraging a CEF introduces additional risks. While historically leverage has often increased returns, optimal results depend on a fund managers ability to use tools and strategies that can increase the funds likelihood of success.

Nuveens integrated leverage management processes are designed to mitigate risks and build a foundation for potential long-term success of the leveraged fund. These include:

  • Leveraging funds that invest in asset classes or strategies Nuveen believes offer the greatest potential to benefit from leverage over the long term.
  • Setting internal operating guidelines that are monitored daily, including leverage target levels and internal minimum and maximum levels that are well within regulatory and rating agency requirements.
  • Managing leverage costs via swaps and hedges as needed, seeking to minimize potential volatility in future fund earnings.
  • Creating new forms of leverage and expanding the set of partners who provide debt or purchase preferred shares, with a goal of reducing leverage costs.

When applied with proven investment principles and managed consistently, we believe leverage is a sound strategy that is additive to the performance of many closed-end funds.

Can You Beat The Market

Yes and no. Technically, yes of course its possible. Perhaps the most famous example is Warren Buffett. But youre not him. Moreover, for the most part, his investing style provided excess exposure to the Value and Quality factor premia historically, nearly fully explaining his above-market returns.

For most investors, the answer to the question above is an emphatic no. It is well known that the vast majority of investors even professional fund managers fail to beat the market, even in bear markets. If youve arrived on this page, you likely already know that fact. I wont delve into the details and the data too much, but Ill provide a brief overview to set the context for the discussion below on how to beat the market.

Institutional investing, which is responsible for the majority of invested assets, is largely a zero sum game, as skilled managers are competing with each other in a global market. Fund managers underperformance for their clients is then exacerbated by fees.

Active management and stock picking also introduces additional uncompensated risk in the form of excess exposure to single companies, and decreases reliability of outcome. As John Bogle, considered the founder and father of index investing, said, buy the whole haystack instead of trying to find the needle. Even Buffett himself advises retail investors to buy a plain ol S& P 500 index fund with low fees, which is where hes instructed most of his wifes inheritance to go.

How To Leverage For Maximum Net Worth With Real Estate Investing

Ive meandered long enough. Lets actually talk about how to leverage your money.

As of the time of this writing, Kate and I have now bought three investment properties and our net worth has been climbing faster than we realized was possible.

I consider 10% ROI to be the bar for investing.

Over long periods of time, money in the stock market approaches 10% return on investment. You may do a little better or a little worse, but thats been about the historical average.

With that in mind, heres the power of real estate investing:

Recommended Reading: Columbia Business School Value Investing

The Potential Benefits And Risks Of A Leveraged Investment Portfolio

Just as a lever allows you to increase your potential force, leveraged investing through the use of borrowed funds can increase your potential gains. If you’re confident about an investment, leverage allows you to invest more than you otherwise could and potentially enhance your profits.

In addition, some investors may choose a leveraged approach to assist with their cash flow management. For example, rather than contributing the entire upfront investment amount from their own funds, investors can borrow to invest and only contribute a small portion of their own funds to meet the borrowing costs. This means that the investor may be able to use their remaining capital to make other investments and diversify their portfolio. For example, if an investor wanted $10,000 worth of exposure to one particular share, the investor could borrow $10,000 and only pay the interest expense of, for example, $1,000. The investor could then use their remaining capital to manage overall portfolio risk by diversifying their investment portfolio.

Some investors may choose a leveraged approach to improve their cash flow management

The costs of borrowing may also be offset partly or entirely with income, such as share dividends, generated by the assets in which you’ve invested.

What How & When In Practice

What Is Leverage In Forex? How To Calculate Leverage ...

Its one thing to mentally model investing as collateral, leverage, and volatility. Its another to put it to practice. While sounding abstract, this seemingly has been done for ages, purposely or not.

Scaling investment exposures by volatility is hardly a new idea. Value at risk models are cornerstones in risk management. Strategies like risk parity and vol targeting have been around for decades. In fact, even the classic 60-40 portfolio balances collateral, a bond position, with leverage, i.e. equities.

While these techniques all use volatility in a particular way, we need not follow suit. To me, a more logical goal is to coordinate ones use of leverage with expected changes in volatility regimes. For example, if your maximum leverage coincides with a fall in volatility, you should profit from the narrowing of possible price ranges . Conversely, carrying less leverage when price uncertainty explodes minimizes the cost of error and best positions you to act in the more uncertain environment.

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Borrow Money To Make Money

Today well explore a common question I get asked all the time: What is my thought process behind leverage? The short answer is simple. I want to make high returns without being exposed to high risk. Normally the two go hand-in-hand. But leverage allows me to separate them. For example, a speculative marijuana stock may grow 20% to 50% a year. But it could just as easily lose half its value. The potential reward is tempting. But the high risk is not worth it.

Instead, Im looking for a lower return, lower risk investment such as an established oil/gas pipeline company known for its predictable earnings, dividend growth, large economic moat, and low stock volatility. Using historical data and fundamental analysis I may determine that there is a very high probability this stock will appreciate 4% to 10% a year. I can then apply a leverage multiplier of 5 times on this investment which means my actual expected rate of return is 20% to 50% before subtracting the cost of borrowing.

In other words, I do not subject myself to the high risk that is typically associated with juicy returns. But I still get those juicy returns! Awww yeah.

Thats pretty much it. The long answer requires some further explanation. Lets start with the 3 criteria I look for before I borrow to invest.

Why Invest With Nuveen

A trusted closed-end fund provider for more than thirty years, Nuveen offers advisors and investors dedicated client service with a legacy of integrity and innovation.

  • : A pioneer in long-term income and cash flow solutions
  • Focused expertise: Active management from Nuveen and its independent investment affiliates
  • Deep commitment: Pursuing long term, lasting value for advisors and investors

Also Check: What’s The Best Way To Invest In The Stock Market

Why Can Cefs Use Leverage

Because of their closed-end structure, CEFs are allowed by law to use leverage. Specifically, according to the Investment Company Act of 1940which provides the framework for CEFs, mutual funds, and ETFsCEFs are allowed to issue:

  • Debt in an amount up to 50% of net assets
  • Preferred shares in an amount up to 100% of net assets

In practice, the average leveraged CEF carries 33% total leverage. For every $1 of net assets, they have another $0.33 in leveraged capital.

What Are The Things We Should Look At For Leverage

Should You BORROW to INVEST? | How Investment Loan Works? (Leverage Loan)

We have all heard stories about investors using leverage only to end up having their accounts wiped clean. That is an expected outcome for anyone who blindly and blatantly applies leverage, particularly, on high-risk strategies in the pursuit of returns. But despite all its shortcomings, leverage is a useful tool if we use it conservatively on the right candidate.

For me personally, the right amount of leverage depends on multiple factors including the long-term average return of your strategy, its volatility, tail risks, your own risk tolerance, and target returns. To get answers, we need to be able to model or backtest the strategy over a period covering a full market cycle or more, so that we can observe its behavior and performance under different market conditions.

1. CAGR should be decent.

You dont need eye-popping returns here, but you do need a decent return. What do I mean by decent return? It means your strategy should have a long term CAGR with a sufficient margin above your financing costs. If you cant even beat that, then dont bother. Neither does it make a lot of sense eking out only an additional measly 1% or so while doubling or tripling your leverage. Because the risk-reward just isnt appealing. And note that in the examples I shown earlier, I am using USD ON LIBOR + 0.5% which are lower than what most people would be paying. On top of that, higher leverage means your tail risks just got larger. We will touch on that in a while.

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What Is A Leverage Ratio

Leverage ratio is a measurement of your trades total exposure compared to its margin requirement. Your leverage ratio will vary, depending on the market you are trading, who you are trading it with, and the size of your position. Using the example from earlier, a 10% margin would provide the same exposure as a $1000 investment with just $100 margin. This gives a leverage ratio of 10:1. Often the more volatile or less liquid an underlying market, the lower the leverage on offer in order to protect your position from rapid price movements. On the other hand, extremely liquid markets, such as forex, can have particularly high leverage ratios. Heres how different degrees of leverage affect your exposure for an initial investment of $1000:

What Is Leverage In Real Estate

Leverage in real estate is using borrowed money to buy a property. When leveraging a property, you borrow funds from a lender to be able to purchase an investment property instead of having to cover the entire purchase price yourself. Being able to leverage your investment is one of the reasons real estate investing is so attractive.

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An Explanation Of Leverage Trading And The Risks Involved

The vast majority of everyday investors trade stocks and other securities using the cash they have. If they want to buy a stock, they need to have enough money in their account to pay for those shares.

One of the drawbacks of investing only with cash is that your gains are limited by your financial resources. Even if you find an amazing investment opportunity that returns 100%, if you only have $500 to invest, youll only earn a $500 profit.

Many professional traders borrow money to invest or employ strategies that allow them to invest more cash than they have on hand. This is called investing with leverage, or leverage trading. This lets them greatly increase their buying power and potential returns, as well as their risk.

Learn how traders use leverage safely and how trading with leverage carries the same amount of risk as trading with cash.

Stock And Index Futures

What Is Leverage In Forex? How To Calculate Leverage ...

A futures contract is a financial instrument used to purchase a specific investment for a certain price at a later date. Financing costs are included in the price of the future, which makes the transaction equivalent to a short-term loan.

Futures are often associated with currencies, commodities, and interest-earning instruments, rather than equities. However, stocks have been coming on strong in recent years. 2019 saw a 10-year-record in the number of equity derivatives contracts traded globallyâabout 16 billion, almost half of the 32.89 billion contracts overall. Of those, 1.69 billion were single stock futures.

There’s also been an explosion in equity options trading, especially in the U.S. Equity options traded on American securities exchanges jumped 52.4% to 7.47 billion contracts in 2020. Overall, futures and options on equity indices, the largest category of the listed derivatives markets in terms of volume, reached 18.61 billion contracts traded in 2020, an increase of 6.15 billion or 49.3% from 2019. Futures and options on individual equities reached 9.9 billion in 2020, an increase of 3.8 billion or 62.3% from the previous year.

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How Does A Cef Leverage Itself

To create leverage, a CEF raises capital by borrowing at short-term rates, then uses the proceeds to make additional investments for its portfolio. The fund may also leverage itself by issuing senior securities that pay variable or fixed dividends at short-term rates. Holding certain investments within the portfolio portfolio leverage is another leverage strategy.

The primary costs associated with leverage are ongoing dividend and interest expenses, but there may also be expenses for issuing or administering leverage. A funds leverage strategy is successful when, after considering the associated costs, common shareholders obtain higher distributions or total return than they would have without leverage.

While leverage may help increase distributions and return potential for the fund, it also increases the volatility of the funds net asset value , and potentially increases volatility of its distributions and market price as well.

Scenario #1 Reasonable Leverage Risk

A doctor making $300K is one year out of residency, owes $300K in student loans at 4% and $500K in mortgage debt at 4.5% on a $550K house. She has $30K saved for retirement.

That’s a ratio of / = 138%. But I think few people would argue that this doc is dramatically overleveraged. If her plan is to rid herself of student loans in 4 years and her mortgage in 15 years, I think it is okay for her to invest in stocks or real estate in a taxable account instead of directing additional money at the debt. If she needs $3 Million to retire, running some leverage risk in order to get there a little faster seems very reasonable. It is simply a matter of weighing the leverage risk against the other financial risks in her life, both personal and the shallow and deep risks we all face.

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For The Same Level Of Risk Is It Better To Be 100% In Stocks Or Add Leverage To A Balanced Portfolio

Whats the definition of risk? In finance, that usually refers to how much volatility there is in the portfolio.

There are two ways to add risk to a portfolio:

  • Increasing stock allocation
  • Increasing leverage

When investors have an aggressive risk profile, the common thinking is to invest in a portfolio with a larger allocation to stocks. Its less common to consider the possibility of using leverage on a balanced portfolio, which is another way to add risk.

So lets compare the following:

  • 100% Stock Portfolio WITHOUT leverage
  • 60% Stock/40% Bond Portfolio WITH leverage

Would the benefits of diversification outweigh the cost of borrowing? In the following sections, we compare the two based on:

  • risk-adjusted returns
  • worst sell-off and subsequent recovery time
  • Comparing Risk-Adjusted Returns

    We wanted to see to compare the risk-adjusted returns of a Stock Portfolio with that of a Balanced Portfolio + Leverage.

    In the table below, rational investors should desire portfolios with

    • the same or higher returns
    • but with lower volatility

    For the period between 2001 to 2020, the Balanced Portfolio + 20-35% Leverage had a clearly better risk-adjusted return than the Stock Portfolio.

    Comparing Worst Drawdowns & Subsequent Recovery Time

    We wanted to see to compare the worst sell-offs and the recovery time of a Stock Portfolio with that of a Balanced Portfolio + Leverage.

    Rational investors should desire portfolios with:

  • smaller portfolio declines during the worst sell-offs
  • Online Guide To Leverage

    Investing With Leverage (Should You Borrow Money To Invest)

    Leveraging is a popular concept promoted by the financial industry. Its common to hear financial advisors or other so called experts highlighting the benefits of leveraging. To put it in simplest terms, leveraging is simply using someone elses money to make money.

    Most of us have leveraged in our lifetime, for example buying a house. You can put down 5%, 10%, 25% and the bank lends the rest of the value of the house to you. It is your responsibility to pay back the loan in the form of a mortgage.

    Investment leverage is where you borrow money and use that money to invest in stocks, bonds, mutual funds or other types on investments.

    Because I get a lot of people asking me if leverage is a good way to invest, I thought I would put together this resource to help people make the decision to leverage or not

    Recommended Reading: The Calvert Principles For Responsible Investment

    Plan For Every Contingency

    Its great to have a plan based on things working out the way that you would like them to, but its crucial to have plans in place in case things dont work out as planned. Make sure that you give yourself plenty of wiggle room to ensure that you are protected in case of unexpected expenses from property renovations or prolonged vacancies in investment properties.

    Investors can benefit from leveraging strategies, but its important to carefully consider all the potential downsides before making a decision about how to approach this kind of investment strategy. After taking the time to fully consider all the benefits, disadvantages and considerations that come along with leveraging for investment, talk to a professional about financing options to access your homes equity. With enough planning and a strategic approach, leveraging home value for investments can offer very high rates of return.


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