Hedge funds pumping up leverage to buy stocks

Hedge funds are borrowing more to buy equities just as loans by New York Stock Exchange brokers reach the highest in four years, signs of increasing confidence after professional investors trailed the market since 2008.

Leverage among managers who speculate on rising and falling shares climbed to the highest level to start any year since at least 2004, according to data compiled by Morgan Stanley (MS). Margin debt at NYSE firms rose in November to the most since February 2008, data from NYSE Euronext show.

The rising use of borrowed money shows that everyone from the biggest firms to individuals is willing to take more risks after missing the rewards of the bull market that began in 2009. While leverage means bigger losses should stocks decline, investors are betting that record earnings and valuations 9.8% below the six-decade average will help push the Standard & Poor’s 500 toward the record it set in October 2007.

“Many managers are just behind their benchmarks and as a means to catch up they’re trying to utilize leverage,” Dan Veru, chief investment officer at Palisade Capital Management, said in a phone interview last week.

“You’ve got to earn your keep because you’re commanding a premium price for that underperformance,” said Mr. Veru, whose firm oversees $3.6 billion. “You’re underexposed to equities and you have to put your money to work quickly if you want to catch up.”

Gross leverage, a measure of hedge fund borrowing that shows how much their holdings exceed the cash invested by clients, was 153% in the week ended Jan. 4, up from an average of 152% in 2012 and 143% a year ago, according to data from New York-based Morgan Stanley. The level has averaged 143 percent since 2005, the data show.

Managers are borrowing more amid a 15% rally in the S&P 500 since June, a gain that was mostly missed by professional investors who speculated shares would fall, according to data from Hedge Fund Research Inc. and International Strategy & Investment Group.

Margin at NYSE firms, a measure of loans by brokers to finance equity purchases, increased for four straight months to $327 billion in November and was 22% higher than a year earlier. While the value of margin loans expands as stocks rise, borrowing has outpaced the benchmark’s gain by about 10 percentage points, data compiled by Bloomberg show.

Bets among hedge funds and other large speculators that S&P 500 futures will climb reached $10.3 billion at the beginning of January, close to a four-year high, according to data compiled by Bloomberg and the U.S. Commodity Futures Trading Commission.