Finadium Research Report

Hedge Funds and Leverage 2009

December 2008

This report looks at the complex impacts of leverage for the hedge fund business and for financial markets. Drawing from 25 interviews with hedge funds, funds of funds, institutional investors and prime brokers, the report analyzes where leverage has been and where it is going. We conclude with a framework for a new long/short model with broad application across hedge funds and traditional asset managers.

Hedge fund deleveraging has driven change across multiple business models. Equity markets have seen valuations plunge; our data indicate the amount of leverage that has driven these markets and give an indication of what the next phase of equity market growth looks like. Prime brokers have seen revenues fall precipitously in the short term, though medium and long term their business models look stable though with lower margins. Hedge funds themselves are hard pressed to argue for high fees when less risk is being employed and returns are low or negative.

Based on our interviews and data collection, we believe that a new long/short model is emerging that will become the new investment standard. We are not prepared to call this scenario a 130/30 strategy, though it may bear some resemblance. Rather, we see a low cost long/short strategy becoming commonplace that uses much less leverage than today’s hedge funds, though is free to short by whatever amounts managers see fit in order to maintain a risk-balanced portfolio.

This report is 28 pages with 15 exhibits.

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■ Executive Summary
– Key Point Summary

■ Deleveraging and Underfunding
– Methodology

■ Measuring the Reduction in Leverage
– Tracking Historical Hedge Fund Leverage
– Product Leverage versus Brokerage Leverage

■ The Hedge Fund Perspective
– Inflows and Outflows
– Access to Margin and Securities Loans

■ The Hedge Fund/Prime Brokerage Relationship
– Growing Talent

■ A New Long/Short as the New Investment Standard
– Less Leverage Means New Business Models
– Service Provider Revenue Opportunities in the
New Long/Short Model

■ About the Author

■ About Finadium LLC


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