I've been thinking (mostly before subprime) about using for lack of a better description (I know of) say tiered leverage.
Lets say you start with 200k and used a margin loan to increase that to 670k (70%). If you were to invest that directly in to a managed fund like Macquarie Small Companies that returns 80% you would generate ~530k.
Now, because this is a crazy idea I thought, what would happen if you took out some $1,000,000 100% interest only loans. MBL has one at 8.75% prepaid. So, we're talking about $87k interest only per year. In theory, you could maintain 6 of those 1,000,000 loans for a market exposure of 6,000,000. Again with small caps returning 80% you would now get $4.8m return over a single year.
Of course this could continue until you own the world, so, there is a flaw in my idea. Obviously the creditors wouldn't lend you the money, even if you were conservative and assume you would only make 40%, you just add more layers and still make a killing.
Why would this never work? Why ask? I have a mate who does this on the property side with positive gearing, though with lower returns his returns arn't as steep as above.
Whats the catch to this silly idea?