Rising Rates and MMHF/Levered Funds
I am curious if anyone has any articulate thoughts or has done the math on what will happen to the pod funds in a rising rate environment given their leverage? Currently the rate paid to brokers is about zero… what if that goes to 3%…?
Since most L/S equity teams at the tighter MMHF are trying to make like 2-3% a year and 5% per year at the looser ones (P72), what will happen when the discount or risk free rate is the same as the alpha they mine from their coverage universe? I feel like this could completely kill the model unless banks continue to underwrite zero percent leverage to the funds given the amount they pay in trading fees/commissions, etc.
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This is something that I had a hard time understanding for a while but clicked all of a sudden. When you are quoting a rate, think about what exactly that means. In this case, lets assume you are talking about the fed funds rate. That is the cost a riskless counter-party has to pay to borrow money. When we want to lever a stock portfolio or get into a short position, we arn't borrowing money, we're borrowing stock, and consequently this different thing we are borrowing has a whole different rate curve to it.
Rates for locates / stock loans for leverage are much lower than $ rates most of the time, simply because there is a TON of inventory in massive co's with very long term horizons. So for example lets say you're a MM PM running a book levered 5x - you can get that exposure for cheap because some mega asset gatherer who knows they want to hold most of their holding in huge size indefinitely (so they dont care about short term moves / dont need their inventory anytime soon) can loan out these holdings to scrape a few extra pennies in interest - this is what a securities lending desk at a bank facilitates. Rough explanation / I'm sure this fails when looked at too much, but this is my rough understanding.
Much simpler than the above (which conflates borrow cost with funding, no offense).
fund x has 100mm of equity and runs 500mm long and 500mm short 10x gross leverage.
They post $50mm of margin on the longs and borrow $450 and pay SOFR+30 on the leverage.
they post $50mm of margin on the shorts and earn a rebate of SOFR - 25 on the $500mm of shorts (assuming all names are easy to borrow).
so they are effectively neutral to rates and are paying 55bps to fund, regardless of whether rates are 1% or 8% or 15%.
Slightly over-simplified but makes the point.
Maybe a stupid question but is there such a thing as a levered long-only fund? Or no precisely because of what you outlined above?
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