Mortgages – risk bomb or turbo in the portfolio?
Many private investors equate leverage with higher risk. But the truth is more nuanced. Leverage in itself is neither good nor bad – it is a tool. Used incorrectly, it can become a risk bomb, used correctly, it can strengthen an already robust strategy and increase long-term returns.
To illustrate what I mean, let's look at a real-world example. It's not an advanced hedge fund model, but a simple strategy that anyone can understand. Yet it shows why leverage doesn't have to be dangerous. On the contrary, it can be one of the most powerful pieces of the portfolio puzzle.
Example of an active asset allocation strategy
This example invests in stocks, government bonds, and gold and uses a simple trend-following rule (12-month moving average). Depending on the prevailing trend, the portfolio will sometimes be fully invested and during certain periods will have cash. No transaction costs are included.
Backtesting since 1985:
- Sharpe ratio: 1.1 (stock exchange: 0.5)
- Volatility: 5.1% (stock market: 17.9%)
- Maximum decline: -10.0% (stock market: -56.8%)
- CAGR: 5.7% (stock market: 8.9%)
The strategy does not outperform the stock market in absolute returns, but offers a higher risk-adjusted return, a significantly smoother journey and a risk profile that enables controlled leverage. Anyone who only looks at absolute returns is thus missing the most important thing.
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