| Hedge funds alter structure of credit markets |
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| 24/06/2007 | |
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Credit strategies, particularly those involving credit default swaps (CDS) are one of the fastest growing for hedge funds, making up about 60% of CDS trading volumes, according to a new study by Fitch Ratings. The findings are supported by an International Monetary Fund (IMF) Financial Stability Report. The IMF notes that credit-oriented hedge fund assets grew to more than $300bn in 2005, a six-fold increase from the level of five years ago. Another report from Greenwich Associates notes that hedge funds account for 58% of all CDS trading volume in structured credit products such as collateralized debt obligations (CDOs). And according to the International Settlements, the CDS market is estimated to have grown to $29 trillion at the end of 2006. "For the leveraged finance markets, trading volumes remained relatively steady at about 30%-32% for leveraged loans and 25% for high yield bonds. However, given the growth in the markets, the absolute amount of credit instruments traded by hedge funds grew appreciably. For example, leveraged loan insurance reached $612bn in 2006, up from $300bn a few years ago." Hedge funds have been active buyers of second lien leveraged loans and expanding their CDO equity exposure, notes the report. "CDO equity may be structured on the basis of reverse inquiry from hedge funds with few or any triggers at more senior levels of transaction. A shift into more speculative, less liquid investments including subordinated/equity positions, bridge financings and private equity is symptomatic of hedge funds' risk appetite in a low return environment." The findings are based on interviews conducted at the end of 2006 with a number of global prime brokerage institutions as a primary window into the activities of hedge funds. Leverage targets among the prime brokers participating in the survey appeared in line with levels reported in 2005, though there has been some modest upward pressure. The maximum allowable leverage for certain strategies (fixed-income arbitrage and mortgage-backed securities relative value) has trended upward since 2005. "Positively, most hedge funds were reported to be financing their positions at levels well below maximum leverage permitted by the prime brokers, typically 40%-60% of the maximum allowable. VB |
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