Can Mutual Funds Use Leverage?

Must read

2 min read

Traditionally, mutual funds have not been considered leveraged financial products. However, a number of new products have emerged that seek to reap the benefits of leveraged hedge funds in mutual fund packages. Because of the liquidity requirements governing all mutual funds, there are still strict rules regarding the degree of leverage a mutual fund may use. Nevertheless, the promise of accelerated earnings made possible by the use of debt to increase a fund’s position has drawn many investors to leveraged mutual funds.

What Is Leverage?

In its simplest form, leverage is debt. To use leverage means to use borrowed funds to reap a greater gain than is otherwise possible. When a company or an investment uses leverage, it means it takes on debt to achieve a goal faster than it is able to with equity capital alone.

Leveraged investments use debt to increase their gains in a short period. By increasing the amount of money invested, they increase their potential profits. Conversely, they are liable to creditors if investments fail. For this reason, leverage is inherently very risky; however, risk and volatility provide the opportunity for huge gains or crushing losses.

How Do Leveraged Mutual Funds Work?

Mutual funds are strictly limited with regard to the amounts of their portfolios that can be funded by borrowed money.1 This is because mutual funds are by definition highly liquid and the greater the proportion of debt to equity used in a fund’s portfolio, the less liquid the fund becomes.

What Kinds of Mutual Funds Use Leverage?

Most leveraged mutual funds fall into the leveraged index fund category, which simply means they attempt to return a certain multiple of the returns generated by an index.6 For example, a 2X S&P 500 fund is specifically managed to return twice the returns generated by the S&P 500.

Conversely, some leveraged funds, called inverse funds, attempt to return an inverse multiple of an index’s returns.3 If a fund manager believes the S&P 500 will lose value in the coming year, for example, her fund may be aimed at generating a profit that is twice the amount of the index’s loss. A 10% drop for the S&P means a 20% profit for shareholders if everything goes to plan.

Other leveraged mutual funds employ a 130/30 strategy, where they borrow $30 for each $100 of portfolio value and use it to short some stocks while going long on others to beat a given benchmark. Other funds are less aggressive, employing a 120/20 strategy instead.

Some stocks while going long on others to beat a given benchmark. Other funds are less aggressive, employing a 120/20 strategy instead.



Please enter your comment!
Please enter your name here

Latest article

5th March

History Of The Day – 5th March

INDIA 1931: Mahatma Gandhi And British Viceroy Lord Irwin Signed The Gandhi – Irwin Pact On This Day. It Was...
Anushka Sharma

Mrs. Anushka Virat Kohli Announces Her New Netflix Original ‘Mai’ Hailing Her Producer’s Hat!

Anushka Sharma announces her new production venture after the success of Paatal Lok and Bulbbul. She will again produce a Netflix...
Shreya Ghoshal

Shreya Ghoshal And Shiladitya Are Expecting – Love And Blessings For The New Phase...

The year 2020 was the year of bad news, and nothing extraordinary was happening to refer. However, on the...
4th March

History Of The Day – 4th March

INDIA 1788: First Copy Of The Kolkata Gadget Was Launched In Kolkata, West Bengal. 1879: Bethune’ College, founded in 1849 by...
Dooming Relationship

4 Warning Signs You Should Know That Will Tell You If Your Relationship Is...

Everything feels like a fairytale initially, and the sparks fly whenever the two of you are together. However, as...