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LONDON (Reuters) – Hedge and private equity funds say they are slowly increasing their use of leverage, after cutting it to almost zero during the credit crisis when banks slashed lending to rein in credit risk.

Deals

While banks are more prepared to lend than last year, lending levels are far lower than in the heady days before the Lehman collapse, fund executives told the Reuters Private Equity and Hedge Funds Summit in London.

Funds too are limiting borrowing to manageable levels.

“Levels of leverage have fallen dramatically on all our strategies, for example our convertible strategies are running with no leverage,” said Chris Goekjian, chief investment officer of private equity firm Cheyne Capital.

“Even if you want leverage now, your prime broker won’t (always) give it to you,” said Goekjian, whose company is looking to launch an EU-regulated fund to invest in merger arbitrage.

The reduced level of leverage means funds are less likely to be hit by bank margin calls and to be forced to sell off positions if the market moves against them, keeping a lid on market volatility.

“Leverage has returned and it is well priced, diversified and well risk-managed,” said Oliver Dobbs, chief investment officer of $6.7 billion hedge fund company CQS.

ROCK BOTTOM

Dobbs said before the market dislocations of 2008 large funds paid just 20 basis points over London Interbank Offered Rate (LIBOR) for leverage.

It is now priced at a more reasonable LIBOR plus 60 bp, having become almost unavailable following the Lehman collapse, when many funds were forced to sell assets at rock bottom prices to pay off or reduce borrowing.

Limits on leverage will prevent funds from reporting spectacular, leverage-fueled returns, although it will have little effect on risk-adjusted returns, some managers say.

“The cost of leverage has gone up and the quantity has gone down relative to the peak (of the market). The impact is significant but not dramatic on IRR (internal rate of return),” said Charlie Bott, head of private equity firm BC Partners.

Private equity companies are also limiting the use of leverage when buying and are delevering companies before trying to sell them on.

“Deals being done now are being done with a lot less debt than at the height of the bubble. When you take a company public you have to have a lower level of gearing than a couple of years ago,” said Bott.

Better Capital founder John Moulton said he sees flickers of life back in the leveraged loan market, but he doesn’t see it returning to anywhere near peak levels in the immediate future.

“It is fair to assume leverage will be a much lower component of returns than it has been,” Moulton said.

However, for funds buying into troubled companies, debt levels of those companies meant there was already enough inherent leverage. “Most of our deals… are more than adequately ready-levered,” he said.

(Editing by David Holmes)