Why hedge fund managers shouldn’t lever up

By Felix Salmon
April 5, 2009

Howard Marks of Oaktree Capital, whatever his merits as a hedge-fund manager, is a spectacularly good memo-writer. And his latest makes a particularly germane point:

Once you decide to lever a fund, “risk management” becomes more important than “portfolio management.” Many more people know how to pick securities than know how to restrict a levered fund’s risk to the amount that can be withstood. And the ability to pick securities for an unlevered fund isn’t nearly as critical as the ability to manage risk in a levered fund.

Leverage should, by rights, be orthogonal to fund-manager selection. Investors should choose the asset-pickers they want, and then, if they want leverage, invest borrowed money in the fund. As Marks says, embedding leverage in the fund only serves to make the fund manager’s life massively more difficult, for little obvious benefit. You want your fund manager out there finding the best possible investments, not faffing around with margin agreements.

(HT: Manham)

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