Extreme Leverage

[fourth]

I've been thinking (mostly before subprime) about using for lack of a better description (I know of) say tiered leverage.

Lets say you start with 200k and used a margin loan to increase that to 670k (70%). If you were to invest that directly in to a managed fund like Macquarie Small Companies that returns 80% you would generate ~530k.

Now, because this is a crazy idea I thought, what would happen if you took out some $1,000,000 100% interest only loans. MBL has one at 8.75% prepaid. So, we're talking about $87k interest only per year. In theory, you could maintain 6 of those 1,000,000 loans for a market exposure of 6,000,000. Again with small caps returning 80% you would now get $4.8m return over a single year.

Of course this could continue until you own the world, so, there is a flaw in my idea. Obviously the creditors wouldn't lend you the money, even if you were conservative and assume you would only make 40%, you just add more layers and still make a killing.

Why would this never work? Why ask? I have a mate who does this on the property side with positive gearing, though with lower returns his returns arn't as steep as above.

Whats the catch to this silly idea?

 

[resourcesman]

As you said, cant get that much on small caps... secondly u have to be able to meet the margin calls.... if you leverage to your nose, its likely that you will get a margin call which you wont be able to pay because you wont have the spare money.... that means you will need to sell some of your shares at the temporarily low price, and you end up losing money, not making it

 

[nioka]

I've been thinking (mostly before subprime) about using for lack of a better description (I know of) say tiered leverage.

Lets say you start with 200k and used a margin loan to increase that to 670k (70%). If you were to invest that directly in to a managed fund like Macquarie Small Companies that returns 80% you would generate ~530k.

Now, because this is a crazy idea I thought, what would happen if you took out some $1,000,000 100% interest only loans. MBL has one at 8.75% prepaid. So, we're talking about $87k interest only per year. In theory, you could maintain 6 of those 1,000,000 loans for a market exposure of 6,000,000. Again with small caps returning 80% you would now get $4.8m return over a single year.

Of course this could continue until you own the world, so, there is a flaw in my idea. Obviously the creditors wouldn't lend you the money, even if you were conservative and assume you would only make 40%, you just add more layers and still make a killing.

Why would this never work? Why ask? I have a mate who does this on the property side with positive gearing, though with lower returns his returns arn't as steep as above.

Whats the catch to this silly idea?

The catch is knowing which "small caps" return 80%. Look at a lot of them, shares issued at 20c and most selling now for a fraction of that and having new issues to remain afloat. Check out the comp month by month. Then try and get a margin loan on any of them.

 

[nomore4s]

Also even if you did get the leverage approved, managed to get a large position on those small caps without inflating the price while you're doing it (try buying a $1,000,000 worth of stock like RMI or CUL and see what happens to the price).

What happens when the market tanks like it has in the last few weeks? You're in big trouble is what happens. Like Resourcesman said there would be a margin call and how do you pay that? Alot of those small caps that return 80% pa (if you're on the right one) also get hit the hardest in times like this.

Using that much leverage is asking for trouble imo, only need 1 unforeseen event to happen and you're in trouble. Leverage magnifies your gains but also magnifies your losses.

Being consistently profitable is about managing your risk imo

 

[fourth]

Sorry, guys I was referring to Small Caps funds, in particular "Macquarie Master - Small Companies Fund". It returned 85% over the last year, 49% of the past few years. It was performing at over 20% over the 2000-2002 period.

What happens when the market tanks like it has in the last few weeks?

I would imagine that unless the market tanks right after you entered the position, at 85% returns you are looking a nice fat buffer after only a few months.

I was looking at some charts of the fund today (my super is in it) and according to the unit price it hasn't actually dropped, which amazed me. It's just mocing sideways.

So I looked up the PDS and found out what they were invested in and check out the charts of those companies and of what I saw was some were still growing with most moving sideways and almost nothing had dropped.

The reason I had this idea was sheer greed. Turning $200k in to $4.8m in 1 year IS certainly interesting, but being a pessimist I'm assuming it simply wouldn't work. Though I don't know why yet. (Apart from the currently tanked market )

 

[fourth]

According to Morning star the collection of funds I'm referring to has about 3-400mil in them.

6 Mon, % 1 Yr % 3Yr %pa 5Yr %pa 7Yr
%pa
Macquarie - Small Companies Fund 31 Jul 07 25.42 85.66 50.03 37.60 23.99

This is not the only fund performing like this, there are another 8 funds above 66%. I just found that MBL's Small companies has the longest proven track record.

The main thing that bothers me about funds is that you can't set stop losses. The benefit is that margin lenders will lend you 70% against these small companies that often are not even on the leverage list...

This is not my plan to riches btw... I just had this idea on the bus last week and I can't seem to break it.

 

[noirua]