a lot of unwinding to go. But it is improving. It started to improve in late March and into early April

TO BE NOTED: From the FT:

"Leverage creeps back on to the radar

By Gillian Tett

Published: June 1 2009 20:09 | Last updated: June 1 2009 20:09

Investors and policymakers have been scouring the financial landscape looking for green shoots.

One hint of these can be found in an elegant building in London’s Knightsbridge district, which houses the CQS funds.

A few months ago, hedge funds such as CQS, one of Europe’s largest credit funds, were finding it almost impossible to get leverage, or loans from banks to trade. The shock of the Lehman Brothers collapse left banks frantically hoarding any cash they had.

Now CQS says the climate is easing – a touch.

“At the peak of the euphoria you would get 20 times leverage. It was mad,” says Michael Hintze, a former Goldman Sachs trader who co-founded CQS a decade ago.

“Then it all disappeared. You could hardly get any leverage at all last autumn.

“[But] now we can get three times leverage on many assets. Not all – you cannot get leverage on most asset backed securities [such as mortgage bonds] or many Asian assets.

“There is still a lot of unwinding to go. But it is improving. It started to improve in late March and into early April.”

Mr Hintze is keen to stress that this modest shift is not remotely similar to patterns seen in the boom.

During the peak of the bubble, average leverage across the empire of funds that CQS runs was around five times.

These days it is nearer one-and-a-half times, echoing a dramatic shrinkage across the industry (see chart). That is forcing many credit funds to rethink their strategies.

Though CQS was one of the first credit funds to appear in London, in the first seven years of this decade a plethora of other funds sprouted up around the Knightsbridge area.

In the boom, many of these earned returns by applying high levels of leverage to highly rated assets. While asset prices were rising and leverage was cheap, the strategy produced results, not least because investors were generally willing to buy products on the basis of credit ratings alone.

But once asset prices plunged and the credibility of ratings was shattered, investor money deserted these funds.

Numerous credit funds have closed, leaving Mayfair “feeling like a bombsite”, one banker says.

CQS has not avoided pain. At the peak of the bubble, its assets under management reached $9.5bn.

Now they are about $6.3bn, due to falling asset values and redemptions.

Some of its stable of funds have performed badly. A vehicle that specialises in convertible bonds declined 32 per cent last year.

A fund that invests in oil rigs had to be restructured. That has been embarrassing for Mr Hintze, who has had a relatively high profile in London, partly because he is a big donor to the Conservative party.

“What has happened with the rig fund is very, very disappointing,” says Mr Hintze, who is a “significant stakeholder” in the rig fund himself. “It gives you the idea of the dangers of leverage. We thought we were being very prudent. There were some prime brokers offering in excess of 10 times leverage on these types of [rig] assets.

“But thank God the fund didn’t leverage up more.”

Yet the fact that CQS has retained an impressive $6bn of assets under management as other funds have closed is something of an achievement.

Mr Hintze says that some of the investors who filed redemption notices to CQS are starting to cancel them as the climate improves.

Away from the highly visible oil rig embarrassment, other parts of CQS are enjoying strong results.

A CQS fund that invests in ABS, such as mortgage bonds, posted returns of 73 per cent last year, and 12 per cent so far this year.

The convertible bond fund has returned 11 per cent this year and the main CQS multi-strategy fund is up 14 per cent.

There are signs that the carnage in the credit world is starting to produce benefits for the survivors.

For one thing, there is less competition to buy assets, since so many other investment groups have imploded.

“The [bank] prop desks are really just a shadow of their former selves. The fact that they are no longer so active, that they don’t have money, has really helped us,” Mr Hintze says.

He adds that “post Lehman, the prices of many asset classes have fallen to levels where little leverage is required to make attractive returns”, meaning profits can be earned even with low levels of debt. ( NB DON )

That is pulling new competitors into the credit world, such as long-only funds, which were absent during the boom.

But it is also prompting groups such as CQS to reposition themselves to cope with the lower leverage world.

Notably, instead of trying to earn returns by using cheap debt, the new mantra at CQS, as elsewhere, is to exploit traditional credit research skills.

“There are a lot of opportunities in the asset backed securities market now, in the credit world, particularly if you take a more granular, fundamentals-based approach,” says Mr Hintze.

He says that CQS has “invested in that fundamental credit research. You ask questions like ‘What is in that portfolio? What is happening to real estate prices in downtown LA?’”

He adds: “It’s really back to basics now.( NB DON )

“I am working harder than ever before.”

gillian.tett@ft.com