The increasing role of hedge funds in Government of Canada bond auctions

Introduction

Over the past five years, the volume of Government of Canada (GoC) nominal bonds issued nearly doubled, from $122 billion in 2019–20 to $237 billion in 2024–25 (Bank of Canada 2025a).1 Despite this, the standard metrics of auction coverage and average yield show that GoC bond auctions have continued to perform well.

We demonstrate that, starting in 2020, the increased participation of hedge funds at auctions matches the growth in GoC bond issuance. In fact, hedge funds now represent a significant investor class—the largest class after dealers. We find that hedge funds have responded to the higher dollar amount of GoC bond issuance because of their volume-based business models. This higher hedge fund participation—along with the fact they are more willing than other investor types to pay more for these bonds—explains the increased share of hedge funds’ auction allocation.

We explain how hedge funds could be more likely than other types of investors to exit the market suddenly. We also show that their increased participation in auctions could strain the capacity of the balance sheets of dealers’ repurchase agreements (repos). This increased participation supports the cost-effective distribution of Canada’s domestic debt. However, it also represents a vulnerability that is important to acknowledge.

Our analysis focuses on core bond tenors: 2, 5, 10 and 30 years. We use proprietary GoC bond auction data from 1999 to 2024 and identify the business type of bidders (including hedge funds) using an internal Bank of Canada list based on market intelligence about bidders’ business models.

Hedge fund auction participation has increased

Since 2019–20, annual GoC bond issuance has risen considerably across all tenors (Bank of Canada 2025a):2

• from $53 billion to $94 billion in 2-year bonds
• from $33 billion to $63 billion in 5-year bonds
• from $13 billion to $63 billion in 10-year bonds
• from $4 billion to $17 billion in 30-year bonds

Chart 1 shows that hedge fund bidding as a share of total auction bidding in each tenor has also grown considerably since 2010, particularly since 2020.

Hedge funds’ business models can explain why they are the only investor type that increased bidding amid higher debt issuance. Essentially, the broad approach hedge funds take is to:

• identify a perceived mispricing in the market
• take a large position on that perceived mispricing—as seen in hedge funds’ substantial use of leverage using repos

Hedge funds often use relative value strategies, trading on the perceived mispricing between GoC bonds and either:

• futures (cash-futures basis trade)
• swaps (asset swap trade) of a similar term
• provincial or mortgage bonds denominated in Canadian dollars or other sovereign bonds (cross-market trade)

Hedge funds also commonly use strategies based on macroeconomic views (e.g., position on level or shape of the yield curve) or bond pricing at time of auction.

Because the GoC bond market is relatively liquid and efficient, smaller mispricing opportunities can mean that hedge funds need to take larger positions to achieve their desired return. In the cash-futures basis trade which involves a long position in a GoC bond and a short position in a GoC futures contract, hedge funds use leverage to amplify their profits as the spread between the two securities is small (Uthemann and Vala 2024).

Higher issuance volume makes it easier for hedge funds to take larger long positions. This is because it:

• increases available bonds to hold for those positions
• gives the hedge funds a larger base of assets to repo out to fund their positions

As well, a larger known future supply event (i.e., auction) for GoC bonds can facilitate larger short positions.3 That’s because the bigger supply allows hedge funds to obtain the required bonds more easily in the repo market. Further, when the GoC bonds are more liquid, the transaction costs for entering and exiting positions are lower.

Accordingly, the rise in GoC bond issuance has coincided with increased hedge fund borrowing against GoC bonds in the repo market to fund their relative value strategies (Bank of Canada 2024). In 2024, the Canadian Overnight Repo Rate Average (CORRA) persistently rose several basis points above the Bank’s target for the overnight rate. This indicated that hedge funds were holding large, leveraged long bond positions. But the opposite was seen with short positions in 2023 (Plong and Maru 2024a).

Regardless of a hedge fund’s specific strategy, the primary market tends to be a cost-effective way to attain these GoC bond positions in large volumes. Purchasing at auction avoids the price impact that can come from buying or selling a large volume of bonds in the secondary market, and auction yields are often slightly higher than prevailing secondary yields. In addition, some strategies (such as auction-based strategies) rely directly on significant primary market participation.

Chart 2 shows the strong positive relationship between hedge fund bidding (as a share of total bidding) and total GoC bond stock since 1999.

Note that this same participation incentive from a larger debt stock is likely not as strong for other types of investors, mainly because they have less flexibility and greater difficulty taking on leverage (Sandhu and Vala 2023). Investors other than hedge funds are generally more limited by their cash on hand and tend to use less leverage.4 Hedge funds have the largest repo positions across asset managers, followed by pension funds (Aldridge, Sandhu and Tchamova 2024). And while dealers can easily access repos and can position for directional views on rates, they are restricted by the balance sheet constraints imposed by internal risk limits and bank regulation.

The growing concentration of hedge funds in Government of Canada bond auctions comes with risks

Chart 3 shows that the amount of bonds allocated to hedge funds at auctions as a share of total auction allocation has also grown substantially since 2010. It has increased at a faster rate than hedge fund bidding shares because hedge funds tend to bid at more competitive levels than other investor types at auction.5

Since 2019–20, key metrics of auction performance—auction coverage ratio6 and average auction yield—have been mostly stable across all tenors, despite total GoC bond issuance nearly doubling during that time.7 However, this trend comes with risks.

This result follows Arslanalp and Tsuda (2012), who find that foreign non-bank investors—mostly hedge funds in the case of GoC bonds—have a greater flight risk than other types of investors. This greater flight risk is why the increased concentration of hedge funds in sovereign debt markets globally has been seen as contributing to a riskier investor base that compounds the risks from higher general government debt. Canada’s fiscal situation is stronger than the high-risk sovereigns mentioned in Arslanalp and Tsuda (2012), which mitigates potential debt issues. However, this finding suggests that an investor base with a higher concentration of hedge funds nevertheless represents a vulnerability.

This flight risk is evident in several ways. Globally, hedge funds have a high failure rate (see, for example Garbaravicius and Dierick 2005). They also face refinancing risks on leverage or margin calls. Finally, most hedge funds that buy GoC bonds are foreign: without organic commitment to the Canadian market, they could be more likely to pull back during a Canada-specific stress event.

As noted in the Bank of Canada’s Financial Stability Report—2025 (Bank of Canada 2025b), the increasing role of hedge funds extends to the secondary market, which also comes with both benefits and risks. Sandhu and Vala (2023) find that hedge fund trading can promote two-sided GoC markets in normal times, but during the stress period of the COVID-19 pandemic it amplified one-sided GoC selling, which contributed to market illiquidity.

The rising activity of hedge funds in the GoC primary and secondary market could place additional pressure on the total GoC fixed-income infrastructure. Namely, hedge funds’ positioning, both long and short, in the bond market is ultimately financed through the repo market. The aggregate balance sheet for repo books across dealers is finite and driven by several factors (e.g., number of dealers, regulation, central clearing infrastructure). Such pressure points have been reflected in elevated CORRA levels (Plong and Maru 2024b). Therefore, this trend of increased hedge fund participation raises questions of capacity for the repo market. A strain in this repo capacity could also be another source of hedge fund flight risk.

Conclusion

Canada’s recent rising debt environment has incentivized more hedge fund participation in the GoC market, due to their volume- and leverage-based business models. As a result, hedge funds have taken an increased role in absorbing new GoC bond issuance. This has been beneficial for the Government of Canada because it has supported the continued strong performance of GoC bond auctions and has contributed to greater secondary market trading, which bolsters liquidity.

However, this increased hedge fund presence also comes with rising risks of potentially significant investor outflow, given hedge funds’ business models, lack of natural anchor to the GoC bond market and dependence on the repo market to obtain leverage. We hope to increase awareness of these risks with this staff analytical note.

References

Aldridge, P., J. Sandhu and S. Tchamova. 2024. “How Foreign Central Banks Can Affect Liquidity in the Government of Canada Bond Market.” Bank of Canada Staff Analytical Note No. 2024-26.

Arslanalp S. and T. Tsuda. 2012. “Tracking Global Demand for Advanced Economy Sovereign Debt.” International Monetary Fund Working Paper No. 2012/284.

Bank of Canada. 2024. Financial Stability Report—2024.

Bank of Canada. 2025a. Nominal Bonds. Valet API (data download), accessed on April 21, 2025.

Bank of Canada. 2025b. Financial Stability Report—2025.

Chang, B. Y. 2023. “Estimating the Slope of the Demand Function at Auctions for Government of Canada Bonds.” Bank of Canada Staff Discussion Paper No. 2023-12.

Epp, A. and J. Gao. “Are Hedge Funds a Hedge for Increasing Government Debt Issuance?” Bank of Canada Staff Discussion Paper No. 2025-7.

Garbaravicius, T. and F. Dierick. 2005. “Hedge Funds and Their Implications for Financial Stability.” European Central Bank Occasional Paper Series No. 34.

Plong, B. and N. Maru. 2024a. “CORRA: Explaining the Rise in Volumes and Resulting Upward Pressure.” Bank of Canada Staff Analytical Note No. 2024-21.

Plong, B. and N. Maru. 2024b. “What Has Been Putting Upward Pressure on CORRA?” Bank of Canada Staff Analytical Note No. 2024-4.

Sandhu, J. and R. Vala. 2023. “Do Hedge Funds Support Liquidity in the Government of Canada Bond Market?” Bank of Canada Staff Analytical Note No. 2023-11.

Uthemann A. and R. Vala. 2024. “How Big Is Cash-Futures Basis Trading in Canada’s Government Bond Market?” Bank of Canada Staff Analytical Note No. 2024-16.

Endnotes

Acknowledgements

We thank Maxime Beaudet, Alexander Bonnyman, William Bradley, Adrienne Brassard, Bo Young Chang, David Cimon, Meredith Fraser-Ohman, Marie-Lou Lachance, Stéphane Lavoie, Sophie Lefebvre, Neil Maru, Olena Melin, Jeiel Onel Mézil, Stephen Murchison, Boran Plong, Jabir Sandhu, David Smith, Matthieu Truno, Rishi Vala, Nicole van de Wolfshaar and Harri Vikstedt for their helpful comments.