Commodity Watch: Leverage Cuts Both Ways

<div class="grid grid--33-66-col"><div class="col"><img loading="lazy" src="/getContentAsset/061c994a-a452-418f-bfa0-f2cf3cf5c577/cb87803a-320c-480f-ab75-7b9029eaaf79/Ahmad-Al-Sati-new.png?language=en" alt="Ahmad Al Sati - insights" title="Ahmad Al Sati - insights" style="width: 180px" class="fr-fic fr-dii"></div><span style="font-size: 12px"><div class="col"><strong>AHMAD AL-SATI<br></strong>PORTFOLIO MANAGER<br><br><p>Ahmad is the President and Portfolio Manager for Gemcorp Capital Advisors LLC, based in New York.&nbsp;<br><br>Ahmad has spent most of his career in the global credit markets. Prior to Gemcorp, Ahmad was President of Pandion Mine Finance and RiverMet Resource Capital, LP - a fund focused on investing in precious metals, where he was responsible for managing the investments and the day-to-day operations of the registered investment adviser.&nbsp;</p></div></span></div><hr><p>Optimism, economic prosperity, increased productivity, technological innovation and leverage.&nbsp;</p><p>For a decade in the 1920s the US went through changes that were mostly accretive. That abruptly came to a halt when the stock market crashed. I am not saying that we are headed to a 1929-like crash (that’s a tired analogy). But that period can be instructive. Heavy borrowing throughout the decade ultimately aggravated market downturns and increased volatility. The Dow was down 3% on days with forced selling. It was up 0.5% on days without. Per Walter Schloss, “Be careful of leverage. It can go against you.”</p><p>Today, the proliferation of direct loans to corporates by non-banks has increased leverage throughout the system. Private Credit (PC) is now 8 times larger than it was in 2010. PC increased as it found middle market businesses and increasingly expensive Leveraged Buyouts (LBOs). Fund level loans added to overall leverage. Bank loans to PC funds (including Business Development Companies) went from $8 billion in 2013 to $94 billion in 2024 as funds borrowed to juice their returns (Fed data). Lending accelerated by 19.5% per annum between 2019 and 2024 (by comparison bank loans to corporates grew by 2.7% per annum during the same period).</p><p>Leverage cuts both ways.&nbsp;</p><p>It enhances returns and accelerates downtrends (see Archegos and the UK Gilt market). Banks manage that leverage by tightening availability when conditions get worse (real or perceived). At some point, fund liquidity is exhausted (typically two quarters for funds) and borrowers (PC funds) sell loans to payback lenders, exacerbating the downward trend and increasing the likelihood of redemptions. The NAV keeps getting lower and the cycle continues. The cycle can be broken through cash injections from a new investor (think CalPERS and BREIT). Though almost all PC funds borrowed, not all will be able to secure the requisite new money. That will adversely impact lenders, borrowers and investors.</p><p>Lenders are concerned. JPM is now tightening its credit exposure to private funds. This tightening is occurring as asset level leverage remains elevated (think SaaS company leverage), private credit defaults are increasing (9.2% in 2025 per Fitch) and recoveries for PC loans remain lower than those of High Yield bonds (39% vs. 52%). Will these conditions act as kindling for fire sales? We shall see.</p><p>Not all headline returns are created equal.&nbsp;</p><p>Leverage may yield an extra point or two, but it also amplifies the downside. Evaluating a fund’s overall leverage is thus key. Other factors also differentiate headline returns, especially in credit, and may help to weatherproof portfolios that seek diversification in the current environment. But you already know what I am going to say: SHIELD (Short duration, Hard asset, Income, Enduring demand, Low LTV and Debt).</p><p><br></p>