Hedge funds respectively lowered their “leverage” to avoid market storms

Hedge funds all over the world have respectively reduced their leverage this year with a more cautious view of the market, thereby putting more selling pressure on both stocks and bonds.

Net leverage — a measure of risk in the hedge fund industry, in terms of long and short positions — fell nearly 20 percentage points to 66 percent, the lowest level in 1 year, according to data from Goldman Sachs. Another metric from Morgan Stanley showed net leverage falling to 41%, a level rarely seen in the past 10 years.

Goldman Sachs and Morgan Stanley are two big players in the field of providing services to institutions and hedge funds. Each of these investment banks is serving about 5,000 hedge funds, according to data from Convergence.

Goldman Sachs and Morgan Stanley executives said the deleveraging came from a more cautious view from hedge funds as interest rates continued to rise and markets plunged.

Hedge funds “want to make sure they don’t get pushed so close to being forced to sell,” said Charles Lemonides, chief investment officer at New York-based hedge fund Valueworks.

“Further market declines can put stress on hedge funds at some point. As the Fed tightens policy, you have to face the reality that a sell-off is possible,” he said.

According to a hedge fund manager who has more than $500 million and has reduced leverage this year, the biggest risks today are high-interest rates, prolonged inflation and geopolitical uncertainty.

Austerity

The decline in leverage can also come from austerity by investment banks, as interest rates rise and the global economic outlook is more gloomy.

During a meeting to discuss Q3 results, Morgan Stanley CEO James Gorman said they had reduced their margin balances over the past 12 months. “We looked at all the data on the prime brokerage platform and we decided to pull back a little bit with certain clients.”

Morgan Stanley is among the investment banks affected by the collapse of Archegos Capital Management in 2021 – which stemmed from the abuse of highly leveraged derivatives. After this incident, banks also raised their vigilance and tightened supervision.

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