U.S. corporate bond rally unfazed by lack of leverage

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.