NEW YORK, March 12 (Reuters) - Hedge funds' use of

leverage in equities trading is near record levels after

debt-fueled strategies ballooned in recent years and an upturn

in financial markets prompted riskier bets, according to two

banking sources and recent client notes from major banks.

Fresh data compiled by Goldman Sachs ( GS ), JPMorgan and Morgan

Stanley ( MS ), the three largest global prime brokerages, seen by

Reuters in notes distributed to a restricted group of clients,

show that leverage used to juice up returns is at or close to

historical highs, depending on the bank.

The use of leverage by hedge funds in recent years has drawn

more attention from regulators on the impact it could have on

portfolios, markets and banks. The U.S. Federal Reserve's

scenarios for its annual bank health check will start testing

banks against a scenario in which big hedge funds fail, while

the U.S. Securities and Exchange Commission is asking hedge

funds for more detailed and regular data on exposures.

"Leverage is definitely at a high in the macro (hedge fund)

world," said John Delano, a managing director at Commonfund,

which invests in hedge funds, who said this was fueled by

progress in bringing down inflation and investor confidence in

artificial intelligence.

Goldman Sachs' ( GS ) note showed that hedge funds' leverage in

equity positions was at almost three times their books compared

with 2.35 times a year ago, and a record level over the past

five years, the period the bank uses for comparison.

The data means that for every $100 of their own capital, the

hedge funds had $300 in long and short positions.

JPMorgan showed current use of leverage - at roughly 2.7

times - is close to a peak reached since 2017 and higher than

98% of the time it has been tracked since then. Morgan Stanley ( MS )

also said leverage in the U.S. was higher only 2% of the time

when tracked in the last fourteen years.

BULLISH POSITIONING

The rise in leverage comes as hedge funds become more

bullish following a stock rally which took off at the end of

October, when investors started betting the Federal Reserve

would soon move to cut interest rates. The S&P 500 has

risen roughly 24% since then.

Barclays ( JJCTF ) said in its note that hedge funds across different

strategies are bullish. Global macro hedge funds are now long

equities after unwinding short positions they had last year

while systematic hedge funds are long different equity indexes.

Equity long positions in so-called commodity trading advisors

(CTAs), funds which use computers to follow price trends,

"remain stretched," Barclays ( JJCTF ) added.

"The market is taking the view that everything is fine,"

said Mario Unali, senior portfolio manager at Kairos Partners,

who said he has observed the highest level of leverage for the

last three years among systematic strategies, those that use

computer models based on data to trade.

While traditional hedge funds that go long or short on

stocks based on data analysis by people leveraged roughly two

times their books, equity quantitative and multi-strategy hedge

funds were at 4.5 and 3.1 times, according to a JPMorgan

estimate.

Since 2014, leveraged strategies have become more popular

among investors, outpacing the asset growth seen across the

industry. Multi-strategy and quantitative comprise roughly 32%

of the hedge fund space now versus 24% in 2014, according to

hedge fund research firm PivotalPath.

Still, these strategies are overall seen as less risky

because they tend to match long and short positions and are less

exposed to the ups and downs of stock markets.

The use of higher leverage to bet on a continuing rally

seems to be paying off so far. Equity hedge funds using

systematic strategies posted 6.42% in gains in the first two

months of this year, according to Goldman Sachs ( GS ), outpacing the

world stock index MSCI.

Edoardo Rulli, chief investment officer of UBS Hedge Fund

Solutions, a fund of hedge funds, said current leverage levels

are still maneuverable and are not one of his biggest concerns,

as volatility is lower.

Still, he is keeping an eye on it. "Leverage is always a

concern, so monitoring leverage is key. It can be deadly if

combined with liquidity risk," he said.