Advanced Portfolio Management

Chapter 10Set Your Leverage Ratio for a Sustainable Business

• What will you learn here: What leverage to set for your fund.
• Why do you need it: If you are starting a fund, this is perhaps the most important decision you take. It will determine whether the fund can meet its return and risk goals.
• When will you need this: You will need this chapter only when you decide to start a fund, and when your fund undergoes structural changes, like an increase in the number of PMs, geographical coverage, breadth, or investment style.

Leverage Decisions are usually not under the control of a portfolio manager, the exception being when the portfolio manager is also the principal of the firm. Therefore, it is unlikely that this section will be relevant to you, the exception being that it may be the most relevant section to you in the entire book, in which case I recommend plodding through the math. Although I am going to analyze this problem only from a risk perspective, I would like to point out that there are additional dimensions to it. On the one side, the Treasury department would look at funding adequacy and set an upper limit to leverage based on its counterparty agreements, a detailed simulation of margin rules and worst-case scenarios. On the other side, the strategic positioning of a firm compared to its peers is essential to its success. The value proposition of the firm determines ...