One of the main reasons why all of my strategies need to stand on their own, without leverage...

Saturday, 15 March 2008 05:00

One of the main reasons why all of my strategies need to stand on their own, without leverage...

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...and why the muni market may be more treacherous than many presume. With all of this instant supply, it will get a lot more expensive for the comparatively weaker credits to borrow when they need it most.

From WSJ.com :

"The resulting blow to confidence threatens to further weaken lending, borrowing, spending and investment in the U.S. economy. "Hedge fund blowups have so far been one-off situations. One worry is that we'll cross some line and there'll be a systemic wave of fund failures. It's a reason why the market is so nervous," says John Tierney, credit derivatives strategist at Deutsche Bank.

Banks also are increasing the collateral they demand when they lend to hedge funds that hold municipal bonds. One hedge fund manager described what appears to be a coordinated effort by big investment banks to reduce their risk as they faced quarter-end pressures to cleanse their balance sheets. Lenders declared "by fiat," he said, that municipal-bond-fund managers needed to post more collateral to back their borrowings.

As a result, funds run by Blue River Asset Management, 1861 Capital Management and others circulated lists of assets to raise cash. The sell-off flooded the market with municipal bonds, making it more expensive for municipalities to borrow and upending the traditional relationship between tax-exempt municipal bonds and taxable U.S. Treasury bonds. For the first time in memory, yields on tax-exempt municipal bonds jumped above yields on taxable U.S. Treasury debt.

Now, many hedge fund managers say, access to borrowed money, essential for many of their investment strategies to work, has become virtually impossible.

Mohamed El-Erian, co-chief executive officer of Allianz SE's Pacific Investment Management Co., says the hedge-fund community is unwinding its leverage. "This will push more of them into 'survival mode,' further accentuating distressed sales and nervousness among the prime brokers," he wrote to his colleagues Thursday morning. "In such a world, the quality of the assets matters less than whether you can finance them [or] how liquid they are."

Last modified on Saturday, 15 March 2008 05:00