At its most basic level, leverage is the concept of using borrowed money to increase the rate of return on an investment. Leverage can be used in a variety of different instances—alternative investing being one of them. Let’s take a quick look at the concept of leverage, how it works, and how it’s relevant to Yieldstreet investments.
In terms of debt (or fixed-income) investing, a Lender may use borrowed money or debt (leverage) to finance a loan to a Borrower. Though using leverage can increase return, it does, however, also increase the Lender’s risk.
To fully understand how leverage works, let’s first take a look at the participants of a debt-related investment that could be offered on the Yieldstreet platform:
Borrower: An individual or entity looking to take out a loan. A borrower signs a contract to repay the amount of the loan with an agreed-upon rate of interest.
Lender: An individual or entity that provides funds to a borrower under the stipulation that these funds will be paid back with interest.
Leverage Provider: An individual or entity that provides funds to a lender. This money, along with money from the Lender is provided to the Borrower.
Now that you understand the players in a potential case of leverage, let’s take a look at how it works in terms of a hypothetical Yieldstreet offering. In this scenario, Yieldstreet is working as the Lender:
In this scenario, the use of leverage allows Yieldstreet to increase the return on investment for our investors by 4.5%. Another word to describe the increased return is “Levered Return” and the synonym for the original 8% return on investment is “Unlevered Return.” But remember, in increasing this return on investment, the Lender is also increasing their risk.
Though Yieldstreet in this scenario is increasing our investors’ return, we are increasing our risk by taking on a more junior position in the capital stack. The Leverage Provider is always paid back first due to their senior position in the capital stack. This means is that if the Borrower is not able to make payments, the Leverage Provider (who has a more senior position on the capital stack) is paid back first. Then, only after the Leverage Provider is fully paid, will our investors be paid. However, in a healthy investment, the Borrower is expected to be able to make all payments and return the loan with interest.
Taking on additional risk shouldn’t be seen as either good or bad. It all comes down to whether the reward justifies the risk. At Yieldstreet, we recognize that each individual is different and with that, so is their risk profile.
To help further meet the needs and risk profiles of all our investors, Yieldstreet is now offering a wider selection of investments—some of which take advantage of leverage—that sit in different positions within the capital stack. For additional information related to leverage, check out our article on What is the capital stack?
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.