Bond Voyage

Read this article to understand:

• The significant role played by 'multi-manager' and 'platform' hedge funds in the government and credit markets
• Why their short-term leveraged strategies may not be truly diversified
• Whether these liquidity-dependent strategies can become a vulnerability

Multi‑manager hedge fund platforms – where independent teams, or “pods”, manage specialised strategies under a single, large structure – have materially reshaped liquidity dynamics in government and credit markets. Their tightly risk‑controlled strategies appear diversified, but funding costs rise and volatility shifts, when shared stop‑loss systems and reliance on short‑dated financing can turn dozens of relative‑value positions into one crowded trade.

Over the past decade, investors have steadily increased their allocations to these platforms – particularly the pod‑based hedge funds – whose disciplined engines have delivered high and seemingly uncorrelated alpha (excess returns). They have delivered double‑digit returns with low volatility, low correlation, and the perception of strong downside protection.

The scale behind liquidity dependence

The reliance on short‑dated funding and continuous liquidity has risen to an industrial scale. Multi‑manager hedge fund platforms have grown to a formidable size. As at the end of March 2024, the hedge fund industry managed $4.3 trillion in assets – $994 billion of which was in multi-strategy money pools, and growing still – with the majority concentrated in a handful of large players.¹

This scale has redefined liquidity and price formation in credit markets, influencing everything from index hedges to single‑name credit default swaps and derivative strategies. We now have an ecosystem where vast sums of capital are deployed with highly similar frameworks, which include tight stop-losses, short-term trading, aggressive leverage and a common reliance on high quality liquidity.

In fixed income, this often translates into curve relative‑value trades, cross‑market basis positions, swap‑spread strategies, short‑dated volatility structures, or carry‑oriented exposures in credit indices and single names. These strategies are entirely legitimate, but they are not independent of one another.

What looks like diversified alpha across dozens of these pods can, on closer inspection, be leverage applied to a surprisingly narrow set of macro conditions:

• Stable rate volatility.
• Compressed credit spreads.
• Predictable funding markets.
• Continuous two‑way liquidity.

The impact of this concentration can ripple across markets when funding costs rise or volatility increases. Strategies that appear diversified can quickly converge, amplify stress and force synchronised unwinds.

As economist Hyman Minsky famously observed, “Stability is destabilising.” When those conditions reverse, correlations between strategies that appear dissimilar can rise sharply – a pattern shown by official research on the two main types of hedge fund strategies in government bond markets, namely cash–futures basis and swap-spread trades.²

When funding stress turns correlation into contagion

Fixed income markets have already shown how quickly correlation can dominate when funding pressures bite. The 2022 UK liability-driven investment episode is a stark reminder: leveraged non‑bank strategies magnified moves in core bond markets, forcing swift policy intervention.

What’s different today is the scale and footprint of liquidity‑dependent strategies. Research from the Bank for International Settlements (BIS) and the US Federal Reserve (Fed) shows that hedge funds, including the pod‑based platforms, have expanded highly leveraged relative‑value positions since 2022, financed largely through short‑term funding facilities such as repos.³ These trades are efficient in calm markets, but introduce sensitivity in adverse conditions.

When volatility rises or repo terms tighten, the unwind can be abrupt. April 2025 provided a glimpse of this dynamic as markets tumbled on fresh US tariffs on imports. Deleveraging pressures rippled through rates markets, underscoring how concentrated funding models can magnify systemic stress.

Liquidity assumptions are under pressure and the footprint of liquidity‑dependent strategies is now significant:

• Turnover in interest-rate derivatives has surged by around 87 per cent since 2022, with government bond futures activity buoyed by arbitrage-driven flows.⁴
• In the euro area, hedge funds’ share of electronic government bond trading has jumped from an estimated 26 per cent to around 56, between 2018 and 2023. This is an underappreciated shift in who sets prices on a day-to-day basis.⁵
• In the UK, the Bank of England (BoE)’s Financial Policy Committee flagged that gilt borrowing for repos by hedge funds approached £100bn in late-2025, concentrated in a small number of firms and often transacted at near-zero haircuts and very short maturities.⁶

These features magnify funding shocks and can force synchronised deleveraging across strategies that appear independent in normal market conditions but behave as a single, crowded trade under stress.

The real question for investors

This is not about whether pod-style hedge fund platforms are ‘good’ or ‘bad’. Their operational discipline and liquidity provision are valuable in calm conditions. The issue is whether the cross‑pod correlation seen in recent years is a long-term structural feature or simply a backdrop effect.

When volatility rises or funding tightens, shared stop‑loss systems and concentrated exposures can push many teams to de‑risk, the same risks, at once. Further, prime‑broker credit supply (extending financing and leverage to clients) can act as a throttle on hedge fund leverage and performance, with constraints biting hardest when opportunities are abundant (as brokers become wary of rising overall market risk) or stress is acute (when brokers become highly risk-averse).

Liquidity is not just a convenience – it’s a risk factor. Investors should stress‑test for liquidity shocks and combine short‑term trades with long‑term strategies that can absorb dislocations and monetise dispersion after the unwind occurs.

However, not all structured activity carries the same risk. In the UK insurance market, insurers increased gilt allocations when gilt–swap spreads widened over the last year, using forward gilt and asset swaps on government bonds to manage pricing and capital within their pension risk transfer strategies. Crucially, these positions are collateralised, asset-liability management aligned and embedded within Solvency II stress‑testing frameworks. The insurers manage long-dated liabilities and regulatory capital – not short-term relative value.

By contrast pod-style hedge fund platforms’ relative-value strategies in government bonds (mentioned earlier), typically employ higher leverage via short-term funding, making them sensitive to margin changes and vulnerable to forced unwinds.

UK authorities and the BIS have highlighted these vulnerabilities.⁷ US fund disclosures show elevated leverage in multi-strategy/relative-value funds, whereas life insurers’ leverage has remained comparatively stable despite holding a significant share of illiquid assets. This shows that structured finance activity’ is not a single risk bucket.

The challenge for asset allocation

None of this is an argument against multi‑manager platforms. Their discipline and analytical sophistication have raised industry standards. The issue is that correlations can jump when interest rate volatility, term premia in bonds and funding costs rise together. Portfolios need to be prepared for synchronised unwinds across these types of positions.

Evidence from the BIS, the Fed and the BoE shows that pods are now material participants in the plumbing of government bonds and credit. That is a strength in calm conditions – and a vulnerability when financing or volatility regimes change.

The solution is not to displace pods, but to complement them. An approach anchored in valuations that adapts through cycles without depending on short-dated funding, should be able to absorb the impact and monetise the dispersion in returns after the unwinds.

Combining short‑term liquidity provision with capital willing to stay the course – temporarily housing the risks over multiple quarters – is what can keep liquidity from becoming the hidden common factor in everyone’s ‘uncorrelated’ alpha.

Liquidity is a risk factor. Recognising its pro‑cyclical nature and building resilience into portfolio design is essential for investors navigating today’s fixed‑income landscape.