Leverage
Leverage is the use of borrowed capital, derivatives, or structural financing to increase exposure beyond the invested equity.
Allocator relevance: A key driver of both returns and tail risk—leverage can amplify drawdowns and create liquidity stress when markets move fast.
Expanded Definition
Leverage magnifies outcomes. It can improve efficiency when used prudently (e.g., short-term facilities, modest portfolio-level borrowing), but it can also create forced selling, covenant breaches, and rapid loss spirals if asset values fall. Leverage shows up in many forms: fund-level borrowing, portfolio company debt, subscription lines, margin, derivatives, and structured products.
Allocators evaluate leverage not just by level, but by terms: duration, covenants, refinancing risk, and whether the leverage is matched to asset liquidity.
How It Works in Practice
Managers may use leverage to enhance returns, smooth deployment, or bridge capital calls. Allocators diligence leverage policy, stress test scenarios, and monitor leverage drift over time.
Decision Authority and Governance
Governance defines leverage limits, approval requirements, and reporting standards. Strong governance requires transparency on both explicit leverage and embedded leverage (e.g., derivatives exposures).
Common Misconceptions
- Leverage is always bad (it can be appropriate in some strategies).
- Leverage is fully visible in headline metrics.
- Leverage risk only matters in downturns (it also matters in volatility spikes).
Key Takeaways
- Leverage amplifies returns and losses.
- Terms and liquidity matching determine real risk.
- Transparency and limits are non-negotiable for allocator trust.