Second, leverage can evolve greatly over a short period of time. Third, and perhaps most importantly, there are different forms of leverage, some of which are unlikely to be captured reliably by any aggregate industry data. The most basic form of leverage pertains to financial intermediaries such as global investment banks extending credit facilities to hedge funds to allow them to invest funds in excess of their own capital base. Such credit facilities are usually at the root of industry-wide or strategy-specific estimates of leverage in the hedge fund industry. Following the collapse of LTCM, much of the regulatory discussion focused on this type of leverage by attempting to strengthen the relationship between financial intermediaries and hedge funds to improve counterparty risk management. A second, more recent form of leverage in the hedge fund industry is related to the rapidly growing fund of funds industry. A number of fund of funds managers have begun to leverage their products by either using their own balance sheet or, alternatively, borrow credit facilities from other financial firms with large balance sheets. 2:1 leverage ratios are typical. In some cases, leverage ratios can be as  BIS Review 8/2005  3  high as 4:1. This form of leverage, though probably still limited, is unlikely to be captured by any industry leverage figures. Finally, the most complex form of leverage that hedge funds employ is what I would refer to as instrument leverage. This type of leverage is embedded in the use of most kinds of derivative instruments.
Current estimates suggest that approximately 7500 hedge funds manage assets totaling close to USD 1000bn (graph 1).3 Remarkably, according to the CSFB/Tremont Hedge Fund Index, there have been only a few quarters with net outflows since 1994.4 These figures demonstrate that the hedge fund industry has matured at an extraordinary rate and today constitutes a non-negligible component of the global asset management industry.5  1  A more detailed study on hedge funds will be published in the forthcoming Quarterly Bulletin of the Swiss National Bank (March 2005). 2  Alfred Winslow Jones is credited for the creation of the first hedge fund in 1949. His strategy consisted in combining long positions in undervalued stocks and short positions in overvalued stocks, in an attempt to minimise the influence of overall stock market moves. To magnify his portfolio’s return, Jones added leverage. 3  According to Hedge Fund Research Inc., 7436 Funds managed USD 973bn of assets at the end of 2004. Other sources may come up with different figures. 4  The CSFB/Tremont Hedge Fund Index is the largest asset-weighted hedge fund index. The CSFB/Tremont Index is broadly diversified, encompassing around 400 funds across ten style-based sectors, and representative of the entire hedge fund industry. Assets included within the CSFB/Tremont Hedge Fund Index amounted to USD 615bn in September 2004. Performance is calculated net of fees.