Sustainable Leverage: Sizing the Book for Long-Term Viability

Leverage is the only dial a fundamental equity PM can turn to bridge the gap between her intrinsic Sharpe ratio and the return target her investors expect. Set leverage too low and the fund is commercially unviable; set it too high and a single bad year triggers the stop-loss, destroying the fund before the edge has time to compound. The sustainable leverage interval — the range of leverage ratios compatible with both the return target and the maximum-loss constraint — is a derived quantity, not a negotiable assumption. When the interval is empty (the lower bound exceeds the upper bound), no leverage setting makes the fund viable, which is the most precise statement of why so many hedge funds fail.

1. Assumptions and setup
2. Portfolio volatility and the leverage formula
3. The lower bound on leverage (minimum return constraint)
4. The upper bound on leverage (maximum drawdown constraint)
5. The leverage interval: combining the two bounds
6. The IR formulation: linking %idiovar to leverage
7. Practical implications for different fund types