OSC Alerts Investors About Risk of Leveraged Investing

The recent issue of OSC Investor News cautions investors about the risks of leveraged investing.  While we are pleased to see the OSC recognizing issues relating to leverage, we have some concerns about some statements in this Investor News piece.

It rightfully warns investors that borrowing money to purchase investments increases risk and provides a mathematical example to demonstrate how losses are magnified if the investment goes down in value.  It also correctly points out that leveraged investing can result in much greater losses than investing using one’s own cash.  FAIR Canada is, however, concerned that leverage is described by the OSC, as a “common investing practice.” FAIR Canada does not view its “some things to think about” bulleted items to be sufficient to draw attention to the risks.  In addition, we do not believe that the statement: “The risk of leverage declines as the time horizon grows, so you should be investing for the long term” to be accurate. Instead, regulators should encourage investors to pause and consider whether:

  1. they truly understand the risks;
  2. they have a high risk tolerance;
  3. they have the necessary net income to service the interest and principal repayments along with any possible margin calls;
  4. they are approaching retirement or some other milestone which will have an impact on their investing time horizon; and
  5. they have the ability to withstand the loss.

FAIR Canada is of the view that leveraged investing is not suitable for most investors and that there should be a presumption of unsuitability.  FAIR Canada urges CSA members to focus on the systemic issues which encourage registrants to  push investors to borrow to invest.  While attempting to caution investors is a laudable effort, FAIR Canada calls on regulators to issue notices to registrants cautioning them: (1) on the use of leverage and the need for proper supervision of leveraged investments; and (2) that any advertising and marketing must be fair and balanced, and fully disclose the risks, including the statement that leveraged investing in mutual funds and similar products is only suitable for investors with a high risk tolerance.

Please see our letter to the CSA for further details on our recommendations.

Click here to read Rob Carrick’s recent article Leveraging: Where math and emotion are a bad mix in the Globe and Mail.

January 26, 2012