This change is aimed at improving liquidity in debt markets and meeting funding demands under growing budget pressures. While the involvement of hedge funds can bring benefits like deeper markets and higher trading activity, it also stirs concerns about the long-term stability of government finances due to their reliance on high leverage and rapid trading strategies.
In the past, agencies such as the Australian Office of Financial Management, Treasury Corporation Victoria and NSW Treasury Corporation preferred long-term, stable investors including large asset managers, insurers and central banks. These “real money” buyers supported market confidence and consistent behaviour. Hedge funds, often labelled as short-term and opportunistic, were usually kept at bay. However, rising borrowing needs and changing market dynamics have led to a shift in this approach.
Hedge funds are now more accepted. Victoria allocated 20% of a recent 2040 bond sale to hedge funds, with 37% going to asset managers and 33% to banks. At the federal level, hedge funds now hold around 5% to 10% of bonds in circulation and have received as much as 24% allocation in recent bond issues. Authorities argue that hedge funds contribute to market liquidity by frequently trading bonds, even stepping into roles once held by government entities, such as acting as market-makers.
Greater hedge fund participation, however, comes with increased risk. The Reserve Bank of Australia has raised concerns about the extreme leverage used in strategies like basis trading, where up to $99 can be borrowed for every $1 invested. These positions could unwind quickly if bond yields rise, potentially disrupting markets. While Australia has not yet faced a crisis like the U.S. bond leverage incident in April, higher exposure raises the risk of future instability.
Even so, sentiments are changing. Federal and state officials suggest that the label of “fast money” no longer reflects today’s hedge fund landscape. Many are now viewed as disciplined and capable of providing stability during periods of market stress. Although the trend toward broader bond allocations appears effective for now, decision-makers are carefully weighing the liquidity benefits against the dangers of relying heavily on fast-moving capital.
