Why would hedge fund leverages be different across strategies?

krystle920 · February 15th, 2007, 11:19 pm

Fitch report on Hedge Funds leverageOn page 4 of this report, it shows the differences in leverage across various hedge fund strategies. Why would these leverages be significantly different for each strategy?

jomni · February 16th, 2007, 12:35 am

Depends on two factors:1) potential return - low risk low return strategies justify increased leverage to attain return targets2) potential risk - high risk high return strategies should warant moderate leverage levelsBe warry if your fund utilizes a high risk strategy with high leverage.

ppauper · February 16th, 2007, 1:35 pm

there may also be regulatory aspects at play, specifically margin requirementslong-short equity is the least levered in that table at 2.0

bskilton81 · February 16th, 2007, 8:36 pm

I would also make sure the report is calculating leverage consistently. There is no standardized definition of leverage for operational purposes, but some leverage calculations are better than others.Suppose two HF's have identical strategies, buying options (no hedging). One measures leverage as total notional/NAV. Another measures it as the sum of option deltas x notionals/NAV. Obviously the second will always be lower, and probably more realistic. But I believe both versions are used.

Aaron · February 17th, 2007, 3:10 pm

In addition to the excellent answers you have received so far, it might help to think about VaR margining. Not every fund uses VaR margining, and few funds go to the limit of their leverage. But it's still a handy way to quantify leverage. Funds can borrow until the standard deviation of their returns reaches a defined fraction of their equity capital. In that case, you would expect leverage to be inversely proportional to standard deviation of return, as jonmi suggests, rather than constant.

Trevor · February 19th, 2007, 1:51 am

I'm stretching a bit here, as most of the obvious has been stated, but from a marketing stand-point, some funds may seek to maximize their Sharpe ratio as it an important metric when marketing funds. So market-neutral funds, who presume that their StDev won't scale in relation to an increase in leverage, may seek to boost their returns by increasing leverage. Just a thought, but I think most of the obvious ones have been mentioned. /shrug.T