Lessons from Jim Leitner - Part 2 of 3


Here is Part 2 on the wonderfully insightful interview in Steve Drobny's book The Invisible Hands with Jim Leitner, who runs Falcon Investment Management, and was previously a member of Yale Endowment's Investment Committee. Leitner is an investor who has spent considerable time contemplating the science and art of investing, making money opportunistically across all asset classes, unconstrained, focused on finding the right price and structure, not losing money...and remaining humble (an increasingly rare quality in our industry).

His very clearly articulated thoughts about hedging, risk management, cash, and a number of other topics are profound. Below is Part 2 of a summary of those thoughts (please also see Part 1 and Part 3). I would highly recommend the reading of the actual chapter in its entirety.

Hedging, Leverage, Creativity

Summarized below is a wonderful example of Jim’s differentiated and creative thought process.

Conventional wisdom cautions investors to avoid leverage because it is considered more “risky.” This is generally true if you’re employing leverage to purchase additional positions that have similar correlation/volatility profiles to existing positions.

But what if you used leverage “to purchase only those assets which, at least historically, have had negative correlations” to the existing portfolio holdings? Theoretically, this additional leverage should not increase the “riskiness” of the total portfolio because in the event of a market drawdown, the asset purchased on leverage will increase in value thus avoiding the margin call and downward spiral generally associated with leveraged portfolios in bear markets.

One example Jim gives is a levered (via the repo market) position long government bonds, an asset class that tends to rally when equity markets hiccup.

Usually, hedges and insurance protection cost money to purchase which in turn causes number of problematic issues (for more on this topic, please see a whitepaper published by AQR). But what if we could find a hedge that pays us instead? Although rare, it’s possible. In the example above, “bonds can be repo’d at the cash rate and have a risk premium over cash, over time the cost of such insurance should actually be a positive to the fund.” In other words, the interest received from the bonds purchased is greater than the interest paid on cash borrowed to purchase those bonds.