Unstructured Finance

Hedge funds love affair with leverage still on hiatus, for now

By Katya Wachtel

Last year was a sorry one for the $2 trillion hedge fund industry, when funds lost 5 percent on average. This year managers are doing better, up more than 5 percent for the year, according to the latest tracking data.

But those returns are a far cry from the 16.4 percent rise achieved by the S&P 500 this year, so what will hedge fund managers – who are supposed to be the smartest, savviest market players on the Street – do to juice returns?

For now at least, they’re not levering up in the hunt for yield. Certainly, they’re not ratcheting up portfolios to the levels seen pre-Lehman implosion, when returns were bountiful, and hedge fund managers reported leverage of 3.4, on average.

While funds are indeed sniffing around for and  investing in more highly-levered products like CDOs and CLOs – as we reported in a recent story on managers eyeing riskier exotic assets - prime brokers and traders say the demand for leverage in the form of borrowed cash from Wall Street lenders has not been high, despite the fact investors are starved for yield.

Data from Citi Prime Finance shows that gross leverage* across all strategies for hedge funds on its Prime Brokerage platform was at 1.74 at the end of August, up slightly from 1.73 in July, after falling for several months from a peak of 1.99 in February.  Overall leverage levels have remained pretty stable, according to the Citi data, between January 2011 and August 2012 – never falling below 1.67 and never going higher than 1.99. Over that 20 month period, the funds on Citi’s platform have averaged leverage of 1.8.