We talked about the hedge funds (or "hedgies") gaming financial markets this morning. #1591944 well, well.

The hedgies are still a small part of overall non-bank financial intermediation, but the rate at which they’ve been increasing their footprint in markets is striking and has no parallels among traditional non-banks such as insurers and pension funds

Between 2013 and 2026, gross assets of hedge funds increased from $4tn to $13tn, according to the IMF’s semi-annual Global Financial Stability Report.

Crazy graph

their sovereign bond exposures have more than doubled since 2022, and their estimated share of US Treasury holdings rose from 4 per cent in 2022 to 9 per cent last year. As central banks and asset managers have pulled back from government bond markets, hedge funds have stepped into the gap, helping to absorb record levels of sovereign debt supply.

not the kind of buyers you want financing/backstopping your treasury market, but what else?! There are no other natural buyers left but hedgies and stablecoin issuers

The big risk lies in how the hedgies have been doing it. These funds may sit outside the banking system; their leverage does not. They obtain financing from their prime brokers, typically the world’s largest dealer banks. The prime brokerage business is highly concentrated, with the “five largest [banks] serving an estimated two-thirds of funds by assets under management”.

yeah, exactly: faux safety in e.g. stress tests and capital ratios etc:

Leverage is only half of the problem; concentration is the other. The IMF finds that “hedge fund portfolios are becoming increasingly similar”, with the overlap in equity holdings rising particularly quickly among the largest funds. Making matters worse, hedge fund investors are often “hot money”, chasing good performance, then pulling their money when losses hit. If lots of funds own the same things and are all forced to unwind their positions simultaneously, that makes a bad moment worse.

"Hedge funds may not cause the next crisis, but they are large enough, levered enough and similar enough to make any shock much worse."

INFLATION-LINKING returns

Den loves a good indexation take... every price and contract ought to be indexed!

Yesyesyes, CPI is bad metric... (but not actually for the reasons Bitcoiners usually think) But still, indexing contracts -- esp long-term ones -- to some measure of inflation mitigates a lot of the unfair and unpredictable redistribution of (real) value. #1552045, #1555588

...but TIPS and other inflation-linked asset work for only some/specific investors sometimes:

1. LIQUIDITY EVENT:

every investor has to consider the possibility that they might have a liquidity crisis and need to sell before they plan to, and long-duration inflation-linked bonds can undergo extreme price swings at precisely the moments such crises tend to arise (see: the LDI debacle).

2. `????

we all hate losses, and therefore have a tendency to overpay for returns that are nominally certain (this the core tenet of prospect theory). And investments such as linkers and Tips appeal to this form of irrationality.
Liability matching can help us avoid the worst, but it is important not to construct a portfolio that underperforms the alternatives under a wide range of scenarios, in return for the sense that the worst can’t happen.

Can't say I quite understand this point.

"Everything is a trade, and the worst can always happen, no matter how many inflation-indexed bonds, gold bars, annuities, or life-insurance policies you own."