 |
Scott Wehl,
Head, Banking Products
International |
Risk factors
Three things all investors should consider before leveraging
their portfolio.
- Interest rate risk: The risk loan costs rise if your loan
duration is different from that of your investment.
- Market risk: Decline in the value of the investments
resulting in insufficient collateral value.
- Currency risk: Borrowing in a different currency to your
investment runs a forex risk.
|
Leverage has long been used as a way of
enhancing returns. An existing portfolio
can be used as collateral against which
you can borrow funds for reinvestment
into suitable instruments—boosting return
on equity in the process.
Leverage is particularly attractive at present due to the low
cost of borrowing from well-capitalized institutions such as
UBS, and the limited alternatives for a high return of equity
in a low-yield environment. The UBS Lombard offering,
which includes fixed-term advances, guarantees and
mortgages, enables investors to access this opportunity.
Leverage in action: A possible case study
Whatever your risk appetite, a stable income stream can be
enhanced by applying leverage.
Conservative investors could use borrowed money to invest
in fixed income instruments or bonds. The strategy typically
generates a positive carry of 3–5% per annum net of the
borrowing cost, depending on the underlying credit
and duration.
Investors with higher risk appetite can go for equities,
creating a high-dividend stock basket and enhance the
payout by using borrowed funds. Investors should look for
an enhanced dividend payout, plus any stock upside in the
long run. Borrowing to enhance income can increase risk
and the potential for capital loss. Increased volatility can be
mitigated somewhat by adopting prudent borrowing levels.
For example, only borrow 50% of the total amount available
in order to safeguard against market stress.
Leverage: Risk and advantages
Before leveraging a portfolio to enhance returns, it is
important to understand the risks involved and determine
whether this is a suitable strategy. In my opinion, investors
are naturally very keen to pursue a proven method to
enhance their returns, especially during this period of
stock market uncertainty. However before any leverage is
applied the investor must thoroughly consider all the risk
factors involved.
At UBS, lending specialists work with client advisors
and clients to ensure that risk factors are taken into
consideration before proposing any leveraged investment.
UBS will consider an investor’s overall risk tolerance,
experience of leverage and their performance objectives.
To help mitigate risks, the portfolio of investments being
used as collateral should be well diversified and investors
should always avoid borrowing the maximum amount, as
determined by a portfolio’s collateral value.
Investors with a moderate risk tolerance should not look
to borrow more than 50% of the available collateral
value, so as to maintain a comfortable buffer against
market volatility.
Leverage is not for every investor, but for those with the
right risk profile and performance objectives, it can be a
very effective way of potentially enhancing investment
returns in this market environment.
|
