Demand for leveraged total return swaps linked to hedge funds and hedge fund indices has risen in the U.S., in spite of poor hedge fund performance in April and by May. Now firms are looking at new spins on the structure, for example, including a basket of hedge funds in a total return swap referenced to the Standard & Poor's 500 index.
Firms have been looking into using leveraged total return swaps linked to both a basket of hedge funds and the S&P 500, said Joel Telpner, a partner with law firm Mayer, Brown, Rowe & Maw in New York, explaining the trade as a way of beating the benchmark by investing in non-correlated assets. For example, the investor pays the bank USD100 to enter a total return swap levered by three. The bank takes the USD100 and invests in the S&P 500. The bank then takes the leveraged cash, or USD200, and invests in a basket of funds, giving the client exposure to hedge fund returns.
Firms are also tweaking the structure in case of continued rising interest rates. Although rates have not gone up enough to make the deal unattractive, one market player in New York said he has seen deals which put together a hedge fund-linked total return swap with a fixed-for-floating interest rate swap to hedge against rate rises.
