Hedge funds using more leverage, says Greenwich

Almost one third of 36 hedge funds surveyed by research company Greenwich Associates increased their use of leverage in the past year.

Nine of the hedge funds said their prime brokers are extending more credit now than they were six months ago, and 20% said their prime brokers have decreased haircut requirements in the same period, said Greenwich. It added that these developments could play an important role in a widely expected regulatory review that could begin as early as this summer, with a US Securities and Exchange Commission plan to require hedge funds to be registered.

“None of these developments – a flood of pension capital, increasing leverage, declining haircut requirements or easier credit – would, on its own, be a cause for immediate concern,” said Greenwich consultant Peter D’Amario. “In aggregate, however, these trends bear serious consideration on the part of hedge fund investors, not only as possible indicators of an ‘overheated’ market, but also as potential harbingers of intervention by regulators in the US and Europe.”

Greenwich said the recent flood of pension fund money has led to a proliferation of new hedge funds and has stoked competition among prime brokers. This competition is forcing prime brokers to extend more credit and reduce haircut requirements, the company warned.

“Without a doubt, the ability of hedge fund managers flush with capital, including pension capital, to shop from multiple prime brokers’ offerings is contributing to the overall growth of the hedge fund industry,” said Tim Sangston, another Greenwich consultant. “The question is whether the industry is growing too fast. Has it become too easy to set up a hedge fund? Has it become too easy to get capital? Has it become too easy to leverage?”

Greenwich believes the hedge fund industry will come under greater regulatory scrutiny in the coming months, resulting in tighter rules being put into place in the UK and US. “While we do not necessarily favour increased regulation of hedge funds, the data from our research does not contradict the concerns the regulators are voicing,” said Sangston.