What are leveraged funds?
Leveraged funds are mutual funds that use financial leverage techniques to gain maximum returns from an investment. Financial leverage includes option trading, short selling, buying assets on margin, etc. These funds deliver multiples of the benchmark/ index that it tracks. Leveraged funds often use derivatives such as futures, options and swaps in order to enhance performance.
How does it work?
Leverage funds operate through regular brokerage accounts, by using margins. Investors can borrow money from brokerages to buy additional stocks so as to double the benefits earned. Example: Investor A has bought mutual funds worth Rs. 50,000 and he can borrow an additional Rs. 50,000 to invest, so that the exposure level is doubled. When the value of the mutual fund rises, the returns would be twice the initial investment. However, there is high risk involved since in case of a dip in value of mutual fund price, the loss would also be high. The investment would depend on the risk tolerance of the investor. Typically, leveraged mutual funds have higher operating expenses than other funds and the management expense ratio can range between 3% - 5% each year. For non-leveraged funds, the management expense ratio for a year would be around 1.3% - 1.5% only.
Benefits of Leveraged Funds
Index can be tracked easily– Leverage mutual funds track the specific underlying index thoroughly. Therefore, the investor can plan his/her investment strategy based on this data than on a specific type of mutual fund. This ensures that the investment has lower exposure to risk and will perform well. No per-trade transaction expenses– One of the advantages of going for leveraged mutual funds, is that there per-trade costs are not applicable. The investor can therefore partake in short-term swing trades. Good returns regardless of investment– All investors will receive good returns on their investment regardless of the account size. There is no huge disparity in returns gained by investors who invested more for a short tenure and investors who invested comparatively lesser for a longer tenure. Diversification– Leveraged mutual funds offer investors a diversified asset portfolio within the capital market. This can be attained even with a smaller investment. A diversified portfolio ensures that the exposure to risk is balanced and there is higher probability for better returns. Cost Efficiency– While buying and selling leveraged funds, there are not additional costs incurred. Since there are no per-trade costs and performance fees attached to the same, investors can invest a small amount over time than wait to invest a lump sum amount.
Types of Leveraged Mutual Funds
Leveraged Mutual Funds can be classified into the following types:
- Money Market Funds – Money Market Funds invest in a combination of government securities. Example: Short term securities such as Treasury Bills or long term securities such as Government bonds.
- Index Funds – Index funds invest in fixed income securities and equities that follow a particular index, such as NSE-Nifty or BSE-Sensex, etc.
- Equity Funds – Equity funds invest in the leading categories such as: healthcare, consumer, industrials, financials, information technology, utilities, telecommunications and materials.
- Bond Funds – Bond Funds invest in fixed income generating assets. This includes debentures, treasury bills, bonds and mortgages.
- Specialty Funds – Specialty funds are leveraged funds that invest only in particular assets such as real estate, sector funds, currencies, commodities and other special funds like Funds of Funds (FoF).
- Balanced Funds – Balanced leveraged funds invest in a combination of bond securities and equities.
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