Driving in the wrong gear

The leverage employed by hedge funds is often seen as a key risk measure by investors and regulators. But focusing too closely on measures of leverage in risk analysis is a big mistake, argues Barry Schachter

Leverage is a centrepiece of risk discussions among hedge fund stakeholders, including regulators. Unfortunately, this focus on leverage does not substantively aid risk assessment or risk management. The extent to which it may be useful to focus on leverage in risk assessment depends heavily on the context. Even where leverage might be a relevant indication of risk, an unbridgeable chasm separates the idea of leverage and how we measure it in practice.

On a purely conceptual level, leverage is