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Leverage: Difference between revisions
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Positive “[[alpha]]” is extremely hard — some would say impossible, over an extended period — to generate. It requires the skill of a {{strike|Meriwether,|}} {{strike|Scholes,|}} {{strike|Fuld,|}}{{strike|Skilling,|}} {{strike|Huang,|}} Soros or Buffett. [[Vega]], on the other hand, is really easy to generate, as long as you have someone credulous to borrow from. | Positive “[[alpha]]” is extremely hard — some would say impossible, over an extended period — to generate. It requires the skill of a {{strike|Meriwether,|}} {{strike|Scholes,|}} {{strike|Fuld,|}}{{strike|Skilling,|}} {{strike|Huang,|}} Soros or Buffett. [[Vega]], on the other hand, is really easy to generate, as long as you have someone credulous to borrow from. | ||
From a distance it is easy — and, when the portfolio is doing well, ''tempting'' — to confuse [[alpha]] and [[vega]], and many [[hedge fund]] managers do. There is a [[Survivorship bias|survivor bias]] problem here of course, because hedge fund managers do not often get the opportunity to talk about their negative alpha performance, because by the time it happens, the fund has | From a distance it is easy — and, when the portfolio is doing well, ''tempting'' — to confuse [[alpha]] and [[vega]], and many [[hedge fund]] managers do. There is a [[Survivorship bias|survivor bias]] problem here of course, because hedge fund managers do not often get the opportunity to talk about their negative alpha performance, because by the time it happens, the fund has imploded taking the hedge fund manager, its shirt and all its credibility with it. | ||
It was leverage | It was leverage — not anything more difficult to understand than that — that caused the implosion of [[Long-Term Capital Management|LTCM]], the [[global financial crisis]], and the [[Archegos]] affair. | ||
Quite how such an ugly {{tag|metaphor}} shape-shifted into an all-purpose business {{tag|verb}} is anyone’s guess, but it is time it was sent back where it came from. With leverage. | Quite how such an ugly {{tag|metaphor}} shape-shifted into an all-purpose business {{tag|verb}} is anyone’s guess, but it is time it was sent back where it came from. With leverage. | ||
===One times leverage?=== | ===One times leverage?=== | ||
Leverage means the “amplification of an original force”. It doesn’t mean “borrowing” (any more than it means “use” or “fill out”), although people frequently misuse it that way. As a result, it is a metaphor that doesn’t bear close examination. A lever that produces “no leverage” would stop at | Leverage means the “amplification of an original force”. It doesn’t mean “borrowing” (any more than it means “use” or “fill out”), although people frequently misuse it that way. As a result, it is a metaphor that doesn’t bear close examination. A lever that produces “no leverage” would stop at its fulcrum. It wouldn’t lift anything. It would be worse than not using a lever at all. | ||
To — er — ''leverage'' the metaphor, let’s say picking up a brick, without using a lever, takes one unit of force. Now, apply a lever which generates “one times” leverage: for every unit of force you push down on the lever, you get one unit of force up on the other side of the fulcrum. The force you apply is still just your own investment. You haven’t borrowed anything. You’ve just used a lever to do what you could have done without one. Get your kicks — | To — er — ''leverage'' the metaphor, let’s say picking up a brick, without using a lever, takes one unit of force. Now, apply a lever which generates “one times” leverage: for every unit of force you push down on the lever, you get one unit of force up on the other side of the fulcrum. The force you apply is still just your own investment. You haven’t borrowed anything. You’ve just used a lever to do what you could have done without one. Get your kicks — | ||