The ultimate question

Discussion in 'Trading' started by nitro, Feb 16, 2010.

Is 1:1 leverage a hedge fund killer?

  1. No. As long as they are allowed to trade leveraged instruments.

    3 vote(s)
  2. Yes. Hedge funds are nothing more than masters of using leverage until they blow out.

    1 vote(s)
  3. No but only for the star hedge funds like Rentec, D.E. Shaw etc.

    0 vote(s)
  4. I don't have enough information to make an informed decision

    2 vote(s)
  5. I don't know

    1 vote(s)
  6. I don't care

    5 vote(s)
  1. nitro


    Today I had a big debate with two traders. Here is the long and short of it.

    Minus perhaps the super amazing ones like Rentec, their claim is that most hedge funds out-sized returns is almost all due to aggressive use of leverage. Note this does not mean using leveraged instruments like options or futures, it means using more than 1:1 leverage on their account. They portend that if these hedge funds used 1:1 leverage, that they would do about the same as the long term average of the SP500, or about 7%, and perhaps a little more alpha, something along 12% returns for a total of 10% over the risk free rate. They claim that the hedge fund industry would implode if leverage was not allowed.

    I claim that this is preposterous, and that even using 1:1 leverage, as long as you are allowed to trade leveraged instruments, that 100% returns would not be that uncommon.

    In essence, they are basically saying that skilled use of the Kelly Criterion is of no value, and that their returns are gotten by using huge leverage to skin tiny amounts from the markets. Nickels and dimes in front of a bulldozer. When they blow out because this enormous leverage one day bites you in the ass big, like LTCM etc, they get bailed out.

    So who is right?
  2. this question is absurd...

    you cant differentiate a company borrowing as operating leverage vs a hedge fund using margin to trade.

    >leverage IS the reality
  3. l2tradr


    ??? Are you implying that buying options outright for example isn't using leverage?
  4. nitro


    For this example that is correct. Leveraged instruments are ok, just not leverage on your account.
  5. l2tradr


    Got it. In that case, I agree with your assessment.
  6. yes
  7. Daal


    He is right when referring to the HF industry as a whole, their nice returns are the result of leverage, you cant have alpha for everyone. When talking about specific HFs, sure one can make massive returns without leverage but not everyone at the same time