Turmoil in 2007 hammers hedge funds - study

NEW YORK, June 23 (Reuters) - Hedge funds around the world became more cautious, reducing the amount of debt they took on to buy assets by the end of last year as returns took a beating from turmoil in global credit markets, according to a study released on Monday by Greenwich Associates.

Leverage is the lifeblood of many hedge funds, which seek to outperform more conventional investment strategies through the use of debt and derivatives. Its decline shows even top-flight hedge fund managers have become skittish.

Hedge fund leverage ratios declined to about 2.1 at the end of 2007 from 2.3 a year earlier, the Greenwich Associates/Global Custodian study showed.

The global credit crisis has taken an especially heavy toll on hedge funds focused on fixed income, consistent with its origins in the U.S. mortgage lending market.

As short-term funding was cut off, it forced waves of deleveraging that have amplified sell-offs during the credit crisis.

Overall gross leverage ratios for fixed income-oriented funds declined to an average of approximately 3.0 at the end of 2007 from 3.4 the year before.

Leverage ratios measure the amount of debt compared to assets, which in turn may be leveraged.

The study showed the share of hedge managers reporting returns of more than 10 percent dropped to 52 percent in 2007 from 62 percent in calendar year 2006.

Those with negative returns jumped to 9 percent from 5 percent in 2006. Those with returns of 5-10 percent increased to 23 percent from 21 percent. Sub-5 percent returns rose to 15 percent from 12 percent.

About two-thirds of funds investing at least half of their assets in fixed income-related strategies generated returns above 10 percent in 2006. In 2007, that number plunged to 43 percent.

Eight percent of these funds reported negative returns for 2007, up from just 2 percent for 2006.

The share of equity-focused funds reporting returns in excess of 10 percent dropped to 55 percent from 63 percent.

European hedge fund managers experiencing net redemptions increased to just over a quarter, compared with 21 percent in 2006. Among U.S. hedge funds, that share was unchanged at slightly more than 25 percent. In Asia, net annual redemptions actually fell to 15 percent in 2007 from 22 percent.

The study said the hedge funds participating in this year's study reported holding 15 percent of their total assets under management in cash at the beginning of 2008. It did not have comparative figures for the year-ago period.

Global Custodian, in conjunction with Greenwich Associates, conducted the study between December 2007 and January 2008. The results are based on Internet interviews with 1,688 hedge funds in North America, Europe and Asia. (Reporting by Burton Frierson; Editing by Dick Satran and Jonathan Oatis)