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As leverage was withdrawn, the hedge fund industry suffered over $100 billion in redemptions in the first quarter of 2009 alone, according to Hedge Fund Research, Inc, a Chicago-based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)"