Exploring the impact of debt and leverage on survivability, emphasizing optimization over maximization. Discussing how leverage can amplify gains and losses in investments, cautioning against underestimating risks. Highlighting the importance of balancing borrowed capital for long-term success and prudent leverage strategies for sustained investment prosperity.
16:05
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Quick takeaways
Proper debt levels should align with enterprise size to navigate volatility effectively.
Leverage balances gains with potential ruin, emphasizing moderation to avoid catastrophic losses.
Deep dives
The Impact of Debt on Longevity
Debt plays a crucial role in the survival of businesses over centuries as evidenced by Japanese businesses that endured numerous challenges for over 500 years. The concept highlights the importance of avoiding excessive debt, as companies with significant cash holdings and no debt tend to withstand calamities better. Practical wisdom suggests that proper debt levels should align with enterprise size and potential profit fluctuations to navigate volatility effectively.
Portfolios, Leverage, and Volatility
Leverage, used to enhance capital efficiency, amplifies both gains and losses in investment portfolios. The use of debt enables owning more assets and potentially increased profits, but also magnifies losses during market downturns. It emphasizes the crucial balance between leveraging for gains and the risk of ruin under extreme circumstances, encouraging cautious assumptions when employing leverage to safeguard financial stability.
Cycles in the Use of Leverage
The cyclical nature of attitudes towards risk influences the market's acceptance or rejection of leverage. Positive market conditions often lead to increased leverage as investors chase higher returns, while negative events reverse this trend, penalizing excessive leverage. It underscores the importance of moderation in leveraging to avoid catastrophic losses and emphasizes the need to prioritize survival through prudent asset management.
In his latest memo, Howard Marks examines the relationship between leverage and survivability, taking inspiration from a recent Collaborative Fund post by Morgan Housel. Howard explains why determining the appropriate amount of leverage should be about optimization, not maximization.
You can read the memo here (https://www.oaktreecapital.com/insights/memo/the-impact-of-debt).
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