Go light on leverage

Financial services group MLC has today urged investors to avoid excessive leverage, claiming that investor ignorance of leverage has exacerbated recent financial market volatility.

Speaking at the Australian Superfunds Summit, MLC investment management division general manager Michael Clancy said current market volatility is the result of a complex tapestry of forces that have been at play for many years and that one of the main forces is the issue of excessive leverage.

“Leverage is the use of various financial instruments or borrowed capital to increase the potential return of an investment, which sounds great, but when the investment decision goes wrong, it also magnifies losses,” he said.

Leverage can be a powerful tool for wealth creation if used responsibly, according to Clancy, but it only takes a small number of strategic errors to push a viable institution into insolvency, he said.

“Some banks and credit unions have failed — most spectacularly Bear Stearns and Northern Rock.

“Bear Stearns had a leverage ratio of around 30:1,” he said.

While the world is now going through the de-leveraging processes, a key issue going forward, Clancy claimed, is how Australians approach leverage in the future.

“We [need to] avoid a repeat of the build up of excessive leverage in the future,” he said.