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

As it turns out, it was the big regulated entities, the banks and investment banks, that were the problem, not the unregulated hedge funds

TO BE NOTED: From the NY Times:

Talking Business

Hedge Fund Manager’s Farewell

By JOE NOCERA

Two weeks from now, a seven-year-old hedge fund called Alson Capital Partners will return around $800 million to its investors, and shut its doors for good.

The fund was founded and managed by Neil Barsky, 51, a former Wall Street Journal reporter-turned-Morgan Stanley analyst, who started his first hedge fund in 1998, just as the “hedge fund decade” was gaining steam. He was an old-fashioned stock picker who ran Alson Capital as a classic “long-short” stock fund, meaning that he bought companies he thought had good long-term prospects, while shorting companies he thought were likely to fall off the cliff. At its peak, Alson Capital had $3.5 billion under management, charged a 1.5 percent management fee, took 20 percent of the profits, and, when you include Mr. Barsky’s predecessor fund, produced compounded annualized returns of 12.11 percent a year. It’s fair to say he’s made a pretty penny.

Mr. Barsky is also a source of mine. In the decade or so that I’ve known him, I was able to quote him by name only once. As he explained to me recently, hedge fund managers who become too visible can make their investors wonder, “Why are you spending all your time on TV when you should be managing my money?” But he was one of the people I turned to when I wanted to learn what was really going on in the market. He is blunt, sardonic, funny and passionate, an insider who never lost his outsider’s perspective.

So when I read that he was quitting, I went to see him. I was hoping he would be willing to reflect on his life and times as a hedge fund manager, on the record this time. Happily, he was.

•

A bit of context first. For all the talk these last few years about the risks to investors of “secretive, unregulated” hedge funds, they certainly haven’t turned out to be the big problem, have they? Like most hedge funds, Alson Capital had a rough year in 2008, down more than 20 percent. Indeed, thousands of hedge funds lost, in the aggregate, hundreds of billions of dollars last year, and hundreds have shut down. But nobody in government is calling for a hedge fund bailout because hedge funds losses, however painful to investors, don’t create systemic risks to the nation’s financial apparatus. As it turns out, it was the big regulated entities, the banks and investment banks, that were the problem, not the unregulated hedge funds.

Why did all the fear about hedge funds turn out to be unjustified? One reason is that most hedge funds didn’t have the kind of 30-1 leverage ratios that the big banks had. Mr. Barsky’s fund, for instance, didn’t need much leverage to carry out his long-short strategy. But even if he had wanted to “lever up,” as they say, his prime broker — that is, the investment bank that did his back-office work — probably wouldn’t have let him.

In a wonderful irony, the banks and investment banks that were themselves drowning in debt were fearful of allowing their hedge fund clients to carry too much debt. They still remembered Long Term Capital Management, a hedge fund that a decade earlier had, indeed, brought the financial system to the brink because of its extreme leverage.

The second reason is that, while hedge fund managers could make extraordinary sums, they had far fewer incentives than Wall Street traders to take truly insane risks. “Ninety percent of my net worth was in the fund,” said Mr. Barsky, and that is true of most hedge fund managers. Wall Street traders got rich by making deals that brought short-term profits, even if they “blew up” later. Hedge fund managers who blew up hurt not only their investors but themselves. “As long as the hedge fund manager has his own capital in the fund, the risk equation is different,” Mr. Barsky said.

Although his fund lost money in 2008, it did not blow up; as he put it, the 20 percent loss was “not a disaster but not good.” Although he was forced to make redemptions to investors who bailed out, enough remained that he could have stayed in business. What really caused him to exit the hedge fund business is that he felt ground down by the relentlessness of the job.

“When you manage a hedge fund,” Mr. Barsky said, “the cost is the incredible stress you endure. You can never escape it. You are never free. The thing that is different about running a hedge fund is that your investors own you.”

The goal of a hedge fund manager is not to beat an index, as it is for a mutual fund manager, but to generate positive returns no matter what the market is doing. Failure to do so would invariably mean redemptions, and could often mean the end of the business. “Hedge funds are fragile,” Mr. Barsky said. Over the years, I could always tell when Mr. Barsky was feeling especially stressed; he did not hide it well.

He was also tired of the ways the business had changed. “When I first started in 1998, we used to send out quarterly numbers. Now investors want weekly numbers. Professor Louis Lowenstein” — the iconoclastic and recently deceased Columbia University business law professor — “has a great line in one of his books: ‘You manage what you measure.’ ”

Mr. Barsky shrugged, as if to say: don’t feel sorry for me. “That’s life,” he said. “None of us should ever lose sight of the fact that we were in one of the most profitable industries ever. I’m just saying it became a little less fun. And last year was no fun at all.”

•

Finally, though, Mr. Barsky felt that staying in business would mean having to operate in an investing environment that he no longer quite understood. Making macro bets about the economy was suddenly more important than individual stock picking. And that wasn’t his strength. Besides, at 51, he felt he had another act left in him, and he wanted to find out where life might take him if he were no longer in the business of running money, particularly in the arena of public policy, which fascinates him. “So,” he concluded, “giving people their money back was the best course for everyone.”

Although Mr. Barsky has clearly gotten rich, he was surprisingly clear-eyed about the societal imbalances of hedge fund mania. The industry, he told me, “was part of this huge trend towards the celebration of wealth. Hedge fund managers overearned. It just became too easy. There has been a massive misallocation of human resources. I have so many smart guys here who were making seven figures. And I think it is a fair question to ask: what would they have been doing in 1948 — going into the foreign service? If Obama does anything, the best thing he could do is change a generation’s values.”

He continued: “I have a friend whose son is a senior at Princeton. She said all his friends want to work for Goldman Sachs.” He added, “We have an overground railroad to finance. It is not the best way for a society to be run.”

One of the things that struck him when he first started working on Wall Street, he said, was “how compensation-oriented Wall Street is. When I was a journalist, I could get rewarded in 100 ways, including being on Page 1. Wall Street is the other extreme. There is a singular focus on compensation that is simple, it is clean, but ultimately it is unhealthy.” He thought the outcry over the Merrill bonuses was helping the rest of the country see Wall Street’s skewed priorities more clearly.

Earlier in his career, while still at Morgan Stanley, Mr. Barsky helped edit “Buffett: The Making of an American Capitalist,” written by his good friend, the writer Roger Lowenstein (who is also Louis Lowenstein’s son). As he talked about that experience, I asked him if he had modeled his own investing style on Warren Buffett. He let out a small chuckle.

Then he stood up and walked over to his desk, where he showed me two framed letters, one he had sent to Mr. Buffett, and the Oracle of Omaha’s reply. They were written in the fall of 2000, shortly after Viacom had spun off its Blockbuster unit. Mr. Barsky had bought the stock — and then had written to Mr. Buffett suggesting that he buy the company.

Mr. Buffett sent back a one-sentence reply: “I’ve thought about the business a lot but have never been able to come up with a conviction as to where the industry will be in 10 years.”

“Ten years!” Mr. Barsky said. “I think of myself as a long-term investor and I have a two- or three-year horizon.” He shook his head. “In addition to an outsize intellect, Buffett has something that very few investors have. He has a temperament that makes him suitable to being a great long-term investor.”

“I don’t feel a sense of defeat,” Mr. Barsky said, as I was preparing to leave. “We have done well by investors and by our employees. We comported ourselves ethically. Three months ago,” he added, “I started to read books on Buddhism. What I learned is how much of what we do is ego-driven. Why do I feel I have to be the best hedge fund manager? I started to have perspective. You probably want your hedge fund manager to eat raw meat. But as we unwind, I’m pretty comfortable with my mind-set.”

Sounds like he’s getting out just in time."

Investors' bets that have fueled the recent rally in corporate bonds and other riskier markets have been made mostly without the excessive borrowing

TO BE NOTED: From Reuters:

"U.S. corporate bond rally unfazed by lack of leverage

Wed May 13, 2009 6:48pm EDT

By Tom Ryan and John Parry - Analysis

NEW YORK (Reuters) - Investors' bets that have fueled the recent rally in corporate bonds and other riskier markets have been made mostly without the excessive borrowing of the boom years that preceded the Panic of 2008.

The huge amounts of leverage provided to "hot money" investors, or hedge funds, in the bull market heyday has been unwound and the recent rally in corporate bonds marks a return of more traditional investors, analysts say.

De-leveraging of trillions of dollars in borrowed money lies at the heart of the global credit crisis. But corporate bonds' recovery, courtesy of more traditional investors like pension funds and insurers, is an early sign that securities markets can function without hefty amounts of borrowed money.

Hedge funds "were primarily credit driven and the more you listen to the shrinkage of the hedge fund community, the more you realize there is less and less leverage being used," said Tom Sowanick, chief investment officer at Clearbrook Financial LLC in Princeton, New Jersey.

The decimation of hedge funds is one reflection of the heavy price that investors who borrowed excessive amounts had to pay when the global financial crisis cut a swathe through riskier asset markets.

Such speculative investors' exposure was magnified by hefty borrowing, or "leverage." For example, before the global credit crisis erupted in summer 2007, some speculative investors borrowed about $30 for every $1 bet.

When those bets went badly awry in everything from mortgage-backed securities to other complex financial structures, that "leverage" had to be quickly paid back.

During the third quarter of 2008, when Lehman Brothers collapsed, the financial system went into cardiac arrest and leverage -- the lifeblood of hedge funds -- dried up.

As leverage was withdrawn, the hedge fund industry suffered over $100 billion in redemptions in the first quarter of 2009 alone, according to Hedge Fund Research, Inc, a Chicago-based research firm. That was on top of the quarterly record $152 billion in redemptions during the fourth quarter of 2008 and a huge acceleration from negligible redemptions in the previous three quarters.

Traditional buyers such as pension funds and insurers, who are restrained by regulators from borrowing large amounts to make market bets, have propelled corporate bonds to a stellar rally so far this year.

Since late March, U.S. investment-grade corporate bond yield spreads over comparable Treasuries have rallied 158 basis points tighter to 442 basis points, according to Merrill Lynch data as of Tuesday.

While hedge funds will always have a presence in the corporate bond market, they won't reach the same level they did before the financial meltdown, said Sabur Moini, high yield portfolio manager at asset management firm Payden & Rygel in Los Angeles.

"They were the marginal buyers that were being provided tremendous and cheap leverage by the Street" and "all that has been washed out of the system," he said.

"The world going forward is going to be different; we're just not going to have the sort of leverage and cheap financing" seen prior to the financial meltdown, Moini said.

With the once-championed Wall Street broker-dealer model extinct and stricter oversight on the remaining depository institutions, it is hard to see how the huge amounts of leverage once offered to hedge funds could ever return, analysts say.

"In the same vein, the prime brokers aren't extending the same amount of credit and there are fewer of them" than before the global financial crisis started, Clearbrook Financial's Sowanick said.

"Where the big change comes from is the brokers, who were (leveraged) between 30 and 40 times. But because brokers are now banks, their leverage has been cut significantly," to about 10 times, he said.

One example is Merrill Lynch, which had been leveraged at between 30 and 35 times. Its leverage is likely about 10 times since Bank of America bought it in late September, Sowanick said.

(Reporting by Tom Ryan and John Parry; Editing by Dan Grebler)"

"one of the biggest flights to safety the industry has seen."

The Aversion To Risk and Accompanying Flight To Safety have been something to behold. All because of an Avalanche Of Foreclosures followed by a Calling Run. Here's proof from the FT:

"Flight to safety hits mutual funds with $320bn outflow

By Deborah Brewster in New York

Published: January 1 2009 23:28 | Last updated: January 1 2009 23:28

Investors pulled a net $320bn from mutual funds in 2008, a record in both dollar terms and as a percentage of assets, in one of the biggest flights to safety the industry has seen.

The move out of what were previously regarded( NO GOVERNMENT GUARANTEES ) as safe and stable investments followed a record year of investor inflows in 2007.

EDITOR’S CHOICE

Money flows out of hedge funds at record rate - Dec-30

Sigh of relief for fund managers - Dec-26

However, it appears that outflows stabilised and even reversed in the final weeks of the year( WE HAVE BEGUN TO SEE SIGNS OF THE DIMINUTION ). Investors put a net $23bn into equity funds during December and withdrew only $3.5bn from bond funds, less than in earlier months.

Equity funds had outflows of $233.5bn in the year to December 29, with bond funds seeing outflows of $58.2bn and balanced funds – which include both securities – having outflows of $28bn, according to Emerging Portfolio Funds Research, which tracks fund flows in most of the world.

The data include both retail and institutional investors. The total outflow of $320bn does not include money market funds.

Almost every money manager has seen a drop in long-term assets this year as a result of net outflows and a decline in performance.

Much of the cash withdrawn went into money market funds, which saw inflows of $422bn during the year, lifting their total assets to a record $3,720bn.

Bank deposits( FDIC INSURED ) also saw increases during the year.

More than 4 per cent of equity fund assets were withdrawn during the year, a record since EPFR began keeping records in 1995.

This is greater than the percentage of assets investors pulled from hedge funds during the year, although hedge fund outflows have been partly halted by managers’ suspending or limiting redemptions. This is not an option available to mutual fund managers, who market their funds as offering daily liquidity.

The main, if not the only, growth for money managers this year has been in money market funds, but these have generated several problems of their own. Earlier in the year many ran into trouble because of exposure to subprime securities.

One fund, the Reserve, “broke the buck”, with the value of assets falling below the level investors paid in.

More recently, as interest rates fell to near zero, the funds have been able to eke out only tiny yields which offer little return to investors and provide no profit to the firms running them."