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Smarter Money: Don't Be a Leverage Junky

Jim Cramer

Leverage attracts junkies. They can't stay away from it. Even in the mutual fund world.

People should learn to kick the habit. We rarely use leverage at Cramer Berkowitz because we know its hazards: Mainly, it puts a gun to your head and makes for some awful investment decisions. We don't like to think that we can always get it so right that we should be attempting to double our returns through leverage every day.

Periodically, when we have a great feel or a great call, we will deploy borrowed capital or put money in puts or calls that could lead to an outsized investment -- if it goes right.

For the most part, though, we shun the fancy tricks that allow you to bolster returns beyond the normal rates that markets can give you. If you ever wanted to see the hazards of what can go wrong using financial instruments to augment performance radically, just take a look at two funds with the same objective, the (UOPIX)ProFunds UltraOTC Fund and the (USPIX)ProFunds UltraShort OTC. These are open-ended funds that seek twice the return of the Nasdaq in either direction.

The ProFunds UltraOTC seeks to provide 200% of the performance of the Nasdaq 100 index. It is down 25% this year.

The ProFunds UltraShort seeks to provide investment returns that are twice the inverse of the performance of the Nasdaq 100. It's down 38% for the year.

That's right, a crummy year in the Nasdaq 100 has been magnified by both funds, even though you would expect that the short fund, at least, should be beating the market handily.

I think the reason for this massive underperformance is the difficulty of trying to juice returns in a difficult environment. The short fund, which invests in futures, options and short sales, has simply been unable to time its use of leverage correctly. In other words, the market has been too hard.

Before you give money to a manager who has, as his mantra, the desire to be twice as good as anyone through financial instrumentation, may I suggest you consider the performance of these funds. It is eye opening and serves as a warning: The markets sometimes are too difficult to play with the money you have.

Don't seek to double the gain. You will more likely to end up compounding your losses.

An event you won't want to miss: James J. Cramer -- Live in New York City on Aug. 7, 2000.
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