Leverage

Definition

Leverage increases investment exposure beyond the equity capital invested by using borrowing, derivatives, or financing structures. It can improve returns when assets perform well but also amplifies losses, liquidity risk, and the likelihood of forced selling during stress. Leverage risk depends on terms: duration, covenants, margin requirements, and the liquidity of underlying assets. Allocator Context Allocators view leverage through a governance lens. Some mandates prohibit or cap leverage; others allow it within strict risk limits. In private equity, leverage appears at portfolio company level; in hedge funds, leverage may be embedded through derivatives or financing. Understanding where leverage sits is important: fund-level leverage, asset-level leverage, or operating leverage. Decision Authority Leverage often triggers additional risk review and committee oversight. Funds using leverage may face stricter diligence, reporting requirements, and sizing limits. Exceptions to leverage constraints commonly require explicit approval. Why It Matters for Fundraising Managers should describe leverage transparently: where it is used, why it is required, and how downside is controlled. Under-explained leverage is a common cause of allocator rejection, especially for strategies marketed as “low risk.” Key Takeaways Leverage amplifies outcomes and liquidity risk Terms and structure matter more than headline ratios Often constrained by mandates and policy Transparency improves approval probability