Hedge funds batten down the hatches in turbulence

LONDON (Reuters) - Hedge funds are keeping borrowings and risk low and seeking sanctuary in safe-haven assets during the current market turbulence, but some are beginning to see opportunities to make attractive investments.

The events of the past few days -- the collapse of Lehman Brothers LEH.P, the $50 billion sale of Merrill Lynch MER.N to Bank of America (BAC.N) and the $85 billion rescue of AIG (AIG.N) -- have hit funds' returns and caused many to cut back their bets.

"Managers have been reining in leverage given the extreme volatility in the market. Sentiment is so bad, people are loath to make big bets," said Jack McDonald, chief executive of hedge fund service provider Conifer Securities.

Eclectica Asset Management, co-founded by high-profile hedge fund manager Hugh Hendry, told Reuters its hedge fund had 140 percent of net asset value invested in mid- and long-dated German bunds.

The remainder of its exposure is to bond yield swaps and soft commodities.

"The capital value (of bunds), as people move to safety, will rise. We believe interest rates will fall and we think the Fed will lower rates, but it will want to see some sort of agreement with the Europeans (to lower rates) as it's sick of carrying the can for Europe," a spokesman said.

Yields on 5-year Bunds have fallen from around 4.10 percent in mid-August to 3.75 percent as investors fled to safer investments.

"We've been bearish of banks for a long time," he added. "They will have to go through a 25-year healing process. A number will be bailed out, but the condition will be tighter rules, which means they will not make the profits of the last 10 years."

One major European hedge fund firm, which declined to be identified in order to speak more candidly about its views, said it was running low levels of borrowing and focused on not losing money.

"No-one's immune to what's going on ... We've already been managing down our leveraged position for some time. We're trying to preserve capital in very difficult markets and look for dislocations," said an executive at the firm.

With markets now substantially lower -- the FTSE 100 began the year above 6,400 but on Wednesday fell below the 5,000 mark -- managers think opportunities in equity and other markets are beginning to emerge.

"On a fundamental basis we're beginning to see sectors and individual companies whose stresses mean values, selectively, are very, very attractive," the executive said.

"People are anxiously awaiting signals that we're approaching a bottom and there's a growing shortlist of stocks they want to buy," said Conifer's McDonald.

The shockwaves in global markets -- the FTSE 100 .FTSE fell 3.9 percent on Monday and a further 3.4 percent on Tuesday -- compound the problems for the $2.6 trillion hedge fund industry.

Hedge Fund Research's HFRX Global Hedge Fund Index is down 3.12 percent so far this month, meaning hedge funds have lost 8.01 percent this year.

Meanwhile, hedge funds have also been focused on securing their relationships with prime brokers, who provide services such as financing for trading and settlement of trades.

Augustus Asset Managers has moved its prime brokerage relationship away from Lehman, while GLG Partners (GLG.N) said in a note it had moved "substantially all" of its funds' positions to other prime brokers last week.

(Additional reporting by Jamie McGeever; Editing by David Cowell)