Some hedge funds are using leverage to boost returns. They’re doing it with bonds. With bond yields so low, it’s one way to meet the demands of their clients. But I wonder whether their clients understand the risk that they’re taking. After all, a lot of the beneficiaries are retired teachers who can’t afford to lose money to reckless investment decisions.
I read one strategy that uses two-to-one leverage with the bond side of the portfolio. That’s great when interest rates go down. Remember, bond prices move in the opposite direction from interest rates. But it will be ugly when interest rates go up. I know, I know—the Federal Reserve is going to keep them low for the next couple of years, so it’s not a problem. Really?
It’s easy to forget that bonds trade on the open market, much as stocks do. Their price is set by the market, not by some guy down in Washington. When investors demand more yield for the risk they’re taking, bond prices will fall. It will be devastating for those who have ventured too far out on the yield curve, never mind those who have levered up their portfolio. Now would be a good time to do your homework and determine whether your pension is levered up and what you can do about it.