They were concerned about a warning issued by the central bank about hedge funds and pension funds havingRepos, shorthand for repurchase agreements, are essentially short-term loans backed by high quality collateral such as government bonds. They technically involve selling an asset with a promise to buy it back later. Financial institutions use repo markets to lend or borrow overnight or for short periods of time, typically less than a month.
“The folks that called us are aware that we leverage, we make sure people understand how we use leverage and how it benefits the returns,” Mr. D’Costa, co-founder and president of alternative fixed income hedge fund Algonquin Capital, said in an interview. “They were asking if this was something they should be worried about. I told them that we are not complacent about the fact that we use leverage.
“If there are certain participants in the market who are taking on too much leverage that could certainly be a financial stability concern,” said Vinayak Seshasayee, executive vice-president and head of Canadian fixed income for the Pacific Investment Management Company . “Rather than issue a warning for the system as a whole, I think what they are trying to do is warn individual market participants and institutions: don’t overdo it – a little bit is fine but don’t get ahead of your skis,” he said.
“The pension funds were all over-levered using repo,” said Ed Devlin, chief executive officer of investment fund manager Devlin Capital. “Anything that can happen that disrupts the repo market can now disrupt pensions. The increase in repo at pension plans, I don’t think it’s a crisis, but it is a vulnerability, a system-wide vulnerability that should be tracked.”
If any investors that had, for example, $10-billion worth of basis trades in the market despite only having only $100-million in capital available because, Mr. Devlin said, they were “levering the daylights out of a small discrepancy in Canada, then yes I would see a system-wide problem there.”