Hedge funds' role comes into focus following European bond turmoil
TLT•Hedge funds account for more than half of trading in Europe's roughly $13 trillion government bond market, up from 30% in 2020, and their sovereign bond exposure has more than doubled since 2022, the IMF says. Investors said rapid unwinding of trades may have worsened the recent volatility in French bonds.
1. Growing market role
The sharp sell-off in European government bonds this month has raised concerns that hedge funds' growing role is making the market more vulnerable. The European Central Bank estimates hedge funds account for more than half of trading in the roughly $13 trillion market, compared with 30% in 2020. The IMF says hedge fund exposure to sovereign bonds has more than doubled since 2022.
2. Trades may amplify moves
French 10-year yields surged to 24-year highs, while the two-day increase in the premium investors demand to hold French debt over German bonds was nearly 25 basis points, the most since the euro zone debt crisis. Some investors said the scale and speed of the moves suggested hedge funds were fuelling volatility as they unwound trades. The IMF has warned that hedge fund borrowing and crowded trades can amplify price dislocations and liquidity strains during periods of stress.
3. Regulators are watching
Hedge funds' strategies can be sensitive to price and volatility changes, and their use of debt may lead them to exit positions quickly when markets move against them. But hedge funds are also an important source of liquidity as central banks, pension funds and banks draw back from government bonds. The IMF said markets had managed recent stress well, and fund managers said the volatility had generally not affected their strategies.
