NEW YORK, Dec 5 (Reuters): Hedge funds are using near-record levels of leverage to trade equities and betting on debt-backed strategies in efforts to juice returns, making the most of markets buoyed by a boom in artificial intelligence.
Over the past few years, debt-fuelled strategies have surged as funds have become larger and more complex. That trend is starting to raise concerns about whether the higher use of leverage could expose them and the broader market to steeper losses in the event of a correction.
"We are seeing leverage around historical highs on our books," said John Schlegel, head of positioning intelligence at JPMorgan. "When you look at the amount of exposure relative to liquidity in the markets, markets have gone up pretty materially from pre-COVID to now - much faster than the hedge fund AUM (assets under management) has."
Data compiled by Goldman Sachs, JPMorgan, and Morgan Stanley, the largest global prime brokerages, shows that leverage used to bolster returns for traditional hedge funds that go long or short on stocks is close to an all-time high and continues to rise, depending on the bank.
These reports were sent in recent weeks to a restricted group of clients and seen by Reuters.
Goldman's prime brokerage data showed that in November, U.S. gross and net leverage for hedge funds across the board increased. Hedge funds' gross leverage globally, which includes investor money and trading positions, sits at nearly three times their books, or 285.2%, up about 12.4 percentage points this year to date, which is close to an all-time record, according to Goldman's data. That data means that for every $100 of capital from investors, hedge funds on average had roughly $300 in long and short positions.
US hedge fund stock pickers' leverage stood at a three-year high, Goldman's data showed.
JPMorgan's November-end data showed that gross leverage levels have reached 297.9%, the highest point in the last five years and close to an all-time high. Quantitative and multi-strategy funds' leverage at the end of last month averaged 645.3% and 444.3%, respectively, the bank's report said.
Morgan Stanley's note, compiled by its prime brokerage team and sent to clients on Dec. 1, shows gross leverage for U.S. hedge funds at more than two times, adding that levels were higher only 1% of the time when tracked in the last 15 years.
Goldman and Morgan Stanley declined to comment beyond what was contained in the reports.
Three hedge fund managers and one prime brokerage executive told Reuters that when hedge funds offset buy and sell trades, leverage offered by banks ranged higher. The hedge fund sources said they received leverage levels of at least 10 times, which is near a historical high.
