While Buffett warns against the use of leverage, Wall Street and the banking system decided that leveraging up into high return, low risk assets (like real estate...) was a great idea.
Mutual funds that use leverage - primarily closed end funds but also newfangled 130/30 funds, had a crummy 2008.
In recent years, more mutual funds have used borrowed money to juice returns and lure investors. Now, they are discovering the downside of leverage, and some are cutting back.
Early last year, Wall Street was heavily promoting several new types of funds that rely on borrowing money. These include so-called 130/30 funds that aim to amplify market returns by betting against some stocks, as well as "leveraged index" funds, which promise to double the return of a market index or double its inverse.
At the same time, closed-end funds, many of which have used leverage for decades, were growing rapidly until 2007.
While borrowing money can improve returns in good times, it also widens losses in bad times, and that is what happened in 2008. Some of these funds ended the year with even greater losses than the market as a whole. For instance, of the 15 mutual funds that apply the 130/30 strategy for U.S. stocks, only a third beat the Standard & Poor's 500-stock index in 2008, according to Morningstar Inc. Some of the laggards fell behind the index by five percentage points.
We remain amused by the mutual fund industrial complex's ability to generate new ideas to sell shortly before the market takes a long trip south.
While Buffett warns against the use of leverage, Wall Street and the banking system decided that leveraging up into high return, low risk assets (like real estate...) was a great idea.
Mutual funds that use leverage - primarily closed end funds but also newfangled 130/30 funds, had a crummy 2008.
In recent years, more mutual funds have used borrowed money to juice returns and lure investors. Now, they are discovering the downside of leverage, and some are cutting back.
Early last year, Wall Street was heavily promoting several new types of funds that rely on borrowing money. These include so-called 130/30 funds that aim to amplify market returns by betting against some stocks, as well as "leveraged index" funds, which promise to double the return of a market index or double its inverse.
At the same time, closed-end funds, many of which have used leverage for decades, were growing rapidly until 2007.
While borrowing money can improve returns in good times, it also widens losses in bad times, and that is what happened in 2008. Some of these funds ended the year with even greater losses than the market as a whole. For instance, of the 15 mutual funds that apply the 130/30 strategy for U.S. stocks, only a third beat the Standard & Poor's 500-stock index in 2008, according to Morningstar Inc. Some of the laggards fell behind the index by five percentage points.
We remain amused by the mutual fund industrial complex's ability to generate new ideas to sell shortly before the market takes a long trip south.
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