Do you use margin with value investing? How do you quantify the risk?
Hi,
I have been picking value stocks for the past four years and have had reasonably good results. That said, almost everyone has benefited from a strong market over much of that period, and I’m not convinced that my unleveraged stock picking has consistently outperformed the S&P 500 on a risk-adjusted basis.
What I have been experimenting with instead is using moderate margin leverage alongside a value-oriented portfolio. My reasoning is that if I am buying companies with a substantial margin of safety and avoiding extremely expensive or highly speculative stocks, the downside distribution may be somewhat more favorable than for a more aggressive growth portfolio. Of course, value stocks can still fall dramatically, so I don’t consider this protection in itself.
The main problem is how to quantify the additional risk created by leverage. So far, I’ve been estimating the probability of reaching a margin-call threshold using historical price movements of the underlying positions. I don’t treat this as a guarantee or forecast, but rather as a way to measure how vulnerable the current portfolio is. If the estimated risk becomes too high, I would consider deleveraging.
Does anyone here use a similar approach? If you use margin with a long-term value portfolio, how do you decide how much leverage is reasonable ?
