Customer margin debt
But J.P. Morgan analysts note what some observers are missing is that margin debt is used by both individual investors and professional investors like hedge funds. And it’s the hedge fund part of the equation that means the market might not be as overheated as many think, they say.
The hedge fund industry has grown at a rapid clip since margin debt last reached record highs in 2007. The total amount of assets under management in hedge funds stood at $2.6 trillion to start 2014, a new all-time high, according to Hedge Fund Research. So part of the overall rise in margin debt likely comes from the fact that there are more hedge funds doing the borrowing, J.P. Morgan analysts say. Compared to the overall level of hedge-fund assets, hedge fund leverage isn’t near its 2007 peak, and is closer to levels during the steep slide in hedge-fund leverage in 2008 and 2009.
To be sure, that is just one piece of the margin-debt picture, since individual investors can borrow against their portfolios as well. But by that measure, the amount of their borrowing being invested back in stocks is still probably less than the overall levels suggest. As advisers say, individual investors often use the borrowed funds for purposes like home renovations, rather than plowing the cash back into the stock market. That means less leverage in the stock market, at least.
Plus, other measures of hedge-fund leverage give the J.P. Morgan analysts “some comfort, ” they say. The bank’s measure of equity leverage from its own prime brokerage business, which lends to hedge funds, remains below all-time highs, backing up the story that hedge funds aren’t borrowing at peak levels. They also compared the volatility of hedge-fund returns against the volatility of the assets they invest in—another way to gauge leverage—and found that the hedge-fund returns were less volatile than they were in 2007, compared to the volatility of their underlying investments.
However, the analysts also offer another way to look at margin debt – one that happens to flashing a warning sign.
The concerning metric is called net debit. NYSE member brokerages report cash and other credits in customers’ margin accounts along with their debt—so the JPM team subtracted the total monthly cash and credit from monthly total debt to get the net amount of money owed.
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This was partially offset by higher lending balances and a broadly stable customer margin.
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