Thesis (Ph. D.)--University of Rochester. William E. Simon Graduate School of Business Administration, 2018.
Using a hand-collected data set of mutual fund leverage, I examine how mutual funds use
leverage for their portfolio management. I show that funds with higher leverage tilt their
portfolios toward lower-beta stocks, which is consistent with the prediction of the CAPM
under leverage constraints. This negative relation between fund leverage and equity beta is
especially strong when the overall leverage constraint in the market is tightened, whereas
the negative relation is weaker if the funds have access to indirect leverage channels such as
equity derivatives trading. By decomposing equity beta into equity leverage and asset beta,
I also show that the negative relation between fund leverage and equity beta is driven by the
negative relation between fund leverage and asset beta rather than by the relation between
fund leverage and equity leverage. Managers of levered funds seem to implement their
beta-tilting strategy by relying on the asset beta of stocks rather than on the equity leverage
of stocks due to the better predictability of asset beta for equity beta, the instability of
equity leverage, and the high tracking error volatility associated with equity leverage.