Leverage and the Limits of the Possible

Abstract

Leverage is rarely, if ever, explicitly taken into account in investment policy decisions for both practical and economic reasons, although investors can borrow and lend among asset classes to achieve blends of exposures not otherwise available in traditional portfolios. But even with the most judicious use of leverage, how much is it possible to improve overall performance of the policy portfolio? Leveraging individual asset classes provides no additional benefits over simply leveraging the highest Sharpe ratio portfolio, regardless of asset class assumptions. Further, investors are unlikely to achieve any net benefit from leverage for policy purposes, unless the investor can express an informed and confident view about expected market returns that differs materially from the consensus.

TOPICS: Portfolio construction, portfolio theory