Albertus Rigter, Partner , Astra Asset Management

Investment Chief, Vincent Mortier brings up a really interesting point on hidden leverage in the financial system today. The recent volatility in Gilts and the Liability Driven Investments (LDI) caused margin calls for pension funds when gilts started falling in value. Away from the crisis at hand, the article talks about leverage in the private markets.

Investment Chief, Vincent Mortier brings up a really interesting point on hidden leverage in the financial system today.¹ The recent volatility in Gilts and the Liability Driven Investments (LDI) caused margin calls for pension funds when gilts started falling in value. Away from the crisis at hand, the article talks about leverage in the private markets. Beyond the more visible leverage on buyout transactions, the question is how much hidden leverage is there and moreover how vulnerable is this?

Optimizing rate of returns has become the name of the game for so many private equity and private debt fund managers. Some of that is done through various forms of leverage such as commitment financing. For those less familiar, managers will first invest using a credit line and call capital only later. Naturally, if the investment performs positively, it creates a higher return on drawn capital. Lower in the food chain, the allocators to those private funds may also use leverage lines. They over-commit, counting on the fact that managers do not call 100% of the committed capital but in case they do, they will need to borrow. They might also just want to enhance returns.

It is hard to assess how much this “hidden” leverage really represents, but possibly every private manager has some sort of leverage facility available. On a 4.5 trillion private equity industry, and a multi trillion-dollar private debt industry, any percentage number will be significant in notional terms and be material enough to have an impact if it fails. Let’s just hope that in a more challenging environment there will be no hiccups in the leverage food chain because, if there are… snowballs might be rolling, and winter will arrive early.

References

1. Agnew, H., and Cumbo, J. (2022) Amundi warns on hidden leverage in the financial system, The Financial Times. Page Title. Available at: www.ft.com/content/4dfd546b-bff6-4dfa-a858-06b855001faa (Accessed: 02/11/2022).

This article has been prepared by Astra Asset Management UK Limited (Astra). Astra is authorised and regulated by the UK Financial Conduct Authority and is registered as an Investment Adviser with the US Securities Exchange Commission, solely in relation to US persons. The information published here does not comprise investment advice or a recommendation and is for general information and discussion purposes only. Any future-looking statements may comprise hypothetical information, and you should carefully consider the risks inherent to such information when considering this article. Astra provides services only to qualified institutional and professional investors. Before making any investment decision you should take such professional advice as you feel necessary. Astra is not acting as your fiduciary or adviser. Capital is at risk. This article was published on 02/11/2022 and reflects the publisher’s opinion as at that date.