Leveraged Funds

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

1. 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.
2. 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.
3. 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.
4. 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.
5. 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.