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 individuals to own a higher-value asset than they would otherwise be able to afford. However, there is the risk that the value may fall such that the investor ends up owing more than they own (coined ‘negative equity’ in the housing world). This is never a good place to be.

At WealthFlow, our investment philosophy is centred around long-term focus and an absence of borrowing or levering. This means that the investments are owned without inherent borrowing within the funds themselves. Of course, we do believe debt is a powerful tool that corporate finance departments and governments can use to raise capital to fund future growth and we recognise the importance of borrowing in capital markets, but we don’t generally believe that this is a risk worth taking at a fund or portfolio level. Markets can be worrying enough, Q1 of 2020 being a recent example, without further magnifying the downside through leverage.

Although the potential upside of highly leveraged strategies can be extremely favourable returns, hence the initial attraction of doing so, the downside can be 100% or more. A recent example that illustrates the dangers of leveraging is the family office Archegos Capital Management. [1] They took large risks in a bid to reap huge returns, but the recent unwinding of their leveraged bets has left some banks, which provided the capital to Archegos, nursing multi-billion pound losses as well as the family itself.

This is a prime example of poor risk management. By only considering the short-term and borrowing money to try and achieve quick returns, it was not so much investment but rather gambling. WealthFlow instead looks to achieve unleveraged, long-term, consistent growth which still produces favourable returns without squandering large sums of money, Our risk-focused approach to portfolio construction means that we regularly review the risk exposures of portfolios and seek to mitigate or avoid those that are unwanted. Generally speaking, leverage is one of those risks.

[1] Economist, April 3rd 2021. “Margin call of the wild: Archegos, a family office, brings Nomura and Credit Suisse big losses”. Also, for a good insight into the backstory: https://www.bloomberg.com/news/features/2021-04-08/how-bill-hwang-of-archegos-capital-lost-20-billion-in-two-days

Duncan R Glassey
Managing Director – WealthFlow
duncan.glassey@wealthflow.com

This article is distributed for educational purposes and should not be considered investment advice or an offer of any product for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed. Past performance is not indicative of future results and no representation is made that the stated results will be replicated. Errors and omissions excepted.

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WealthFlow Group Ltd. Registered in Scotland No SC635011. Registered Office: 10 Charlotte Square, Edinburgh EH2 4DR.

Head Office & Consulting Rooms: 10 Charlotte Square, Edinburgh EH2 4DR.

Mail correspondence to our Central Scotland Admin Hub: WealthFlow Group Limited, PO Box 14947, Grangemouth FK3 3AU.

WealthFlow Group Ltd is authorised and regulated by the Financial Conduct Authority.

The guidance/advice contained in this website is subject to the UK regulatory regime and is therefore restricted to consumers based in the UK.

For your protection, unresolved complaints can be referred to the Financial Ombudsman Service.

To contact the Financial Ombudsman Service, please visit www.financial-ombudsman.org.uk.

WealthFlow Group Ltd. Registered in Scotland No SC635011. Registered Office: 10 Charlotte Square, Edinburgh EH2 4DR.