As emerging market central banks sell U.S. Treasuries to defend their currencies, hedge funds have surfaced as big buyers of the ultra-safe securities. While speculation about what's driving that abounds, the reason may be as simple as investment managers not wanting to pay someone else money for holding cash.
Data released earlier this month by the Federal Reserve show that households and nonprofit organizations, a group seen as a proxy for hedge fund investments in Treasuries, were the largest buyers of the notes last year, adding $398 billion. That’s the biggest increase on an annual basis since 2009.
It would be quite enticing to think that they're betting the world's going to fall apart and therefore are buying the most liquid and safe assets they can find. Or that they believe interest-rate rises aren't going to be as quick as initially expected, and so Treasuries will post further gains. The reality may be rather more mundane. As the adage goes, cash burns holes in the pockets of investment managers, and in a negative-rate environment, that's more true than ever.
Most funds are required to hold a certain amount of cash to meet redemptions. Last year, many investors yanked their money out as growth in China slowed and U.S. borrowing costs climbed. As a result, gun-shy funds are now holding more cash than they would in less volatile times. That cash, however, is still invested somewhere and usually goes into highly liquid government bonds, like bunds, gilts, JGBs or Treasuries.
It tends to be spread across these various asset classes for two reasons: Even when it comes to cash, fund managers like to diversify, and second, because some clients wanting to redeem their money may be in Spain or Japan instead of New York, they have to be paid in local currency.
The trouble is that now, several of those options are paying negative rates. That may help to explain why, for instance, U.K. gilts due in September 2025 have returned 5.3 percent this year even as talk of Britain leaving the European Union has caused the pound to drop 2.2 percent. Gilts, however, are much less liquid than Treasuries.
It's cheaper to sell Treasuries and convert the resulting U.S. dollars to the various other currencies needed to pay the redemptions. The extreme monetary policy measures of Bank of Japan Governor Haruhiko Kuroda and European Central Bank President Mario Draghi are causing a dollarization of cash holdings at investment funds the world over.
Western Asset's Asian Opportunities Fund is a good example. It's increased U.S. dollars to 84 percent of its cash holdings from near zero 12 months ago, according to data compiled by Bloomberg.
So don't read too much into investment funds' buying of Treasuries. No one likes paying to own cash, after all.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
To contact the author of this story:
Christopher Langner in Singapore at firstname.lastname@example.org
To contact the editor responsible for this story:
Katrina Nicholas at email@example.com