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Hedge funds: Peloton emphasizes the dangers of leverage

Highly levered funds are always at the mercy of credit and liquidity suppliers. So be wary of those active in markets where liquidity can rapidly dry up, says Neil Wilson.

More on Peloton

Since the start of 2008, events in financial markets seem to have become more alarming almost by the day. First we had the unbelievably rapid implosion of the $2 billion Peloton ABS fund, the biggest hedge fund failure we have yet seen outside the US. Then we had the even more stunning near-collapse of Bear Stearns – rescued at the 11th hour by JPMorgan. And then we had a dramatic rash of losses among funds that ply relative-value strategies in Japanese government bonds, such as the Endeavour Fund, which, after eight years among the most low-volatility players in the business, suddenly lost 27% in a matter of days.

When the US sub-prime mortgage market first ran into big problems last year, and the credit crisis began, it seemed clear that there must be repercussions for other markets – and thus for hedge funds too. It was not obvious, however, that one of the first effects last August would be the serious losses suffered by quant funds trading equity market neutral strategies.

Bizarre JGB hit

Likewise with the dramatic events this March. It seemed obvious that the near-collapse of Bear could not go by without disrupting markets somehow.

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