The investor base for sovereign debt: Why diversification matters

Jumps in government bond yields in early 2026 have increased borrowing costs for sovereign debt managers. This largely reflects shifting expectations about inflation and monetary policy following spikes in energy prices.1 However, the resulting volatility has also revived concerns that the growing role of certain investor groups may be amplifying price swings.

Against this backdrop, sovereign issuers must remain mindful of who is active in their markets. An investor base that is overly concentrated in more price-sensitive and leveraged investors increases the risk that volatility could weaken auction demand or trigger divestments. 

While excessive concentration of the investor base is not currently a major risk across OECD countries, three key trends identified in the OECD Global Debt Report 2026 since 2007 have made it more relevant (Figure 1). 

First, central banks entered as large net buyers through quantitative easing, especially in response to the global financial crisis (GFC), euro area crisis, and COVID-19 pandemic, but began unwinding these programmes starting in 2022.2 This unwinding, combined with elevated sovereign debt issuance since the pandemic, has led to a sharp increase in net supply post-2022 (Figure 2, Panel A) and a deterioration of the supply-demand balance.3 This is likely to worsen as the conflict in the Middle East can potentially drive up interest costs and as governments finance fiscal packages to offset the impacts of higher energy costs on populations.

Second, banks and other monetary financial institutions (MFIs) became net sellers as post-GFC banking regulations raised the cost of warehousing bonds for intermediation. As a result, banks have been less able to absorb this higher net supply, with bond yields rising relative to swap rates, as reflected in more strongly negative swap spreads (Figure 2, Panel B).

Third, despite lower bank holdings since the GFC and lower central bank holdings since 2022, bond auctions across major OECD issuers have continued to be well supported (Figure 3) as foreign investors and investment funds - many of which are hedge funds - have responded to more supply by increasing their holdings. This has been important for issuers, as it has ensured strong demand for supply events and helped to mitigate the increase in their funding costs. 

In 2025, hedge funds were marginal buyers in over half of OECD countries. In the United States, greater auction absorption by non-dealers has eased dealer intermediation burdens and kept price pressures steady. In Canada, hedge fund auction allocations have gone from effectively zero to 40-50% in the last fifteen years, as more debt issuance has made their business models -which depend on scaling up relative value strategies more viable .

The positive impact of hedge fund participation also extends to secondary market liquidity. As bond-warehousing costs have risen for traditional bank market-makers, hedge funds have taken on a larger role in liquidity provision. This liquidity helps sovereigns borrow regularly at scale at near-market prices and allows other participants to transfer risk with limited price impact. 

In 2025, almost a quarter of OECD sovereigns reported that hedge funds played a warehousing role in their bond markets. Hedge funds also accounted for more than half of electronic trading in European government bonds on Tradeweb, up from about a quarter in 2018. Their relative value trading can also help smooth out price dislocations across the curve, improving price alignment and fair-value signals.4 They are reportedly playing this role in nearly two-thirds of OECD sovereign bond markets.

However, the newly critical role of this investor type does create risks of over-reliance, especially in more volatile market conditions. While hedge funds can employ different strategies that lead to distinct behaviors, some commonalities in their strategies and properties can amplify volatility. In the case of a large shock, hedge funds may exit more quickly and in larger volumes from a sovereign’s bond market than domestic dealers and financial intermediaries; this can be due to higher use of leverage, shorter holding periods, less organic commitment to one particular sovereign market, and/or riskier business models leading to attrition. This could abruptly raise government funding costs. Hedge funds’ high leverage can also amplify price moves, and in a crisis, they may contribute to sudden unwinds, weighing on market liquidity. 

This post-2022 shift towards a greater reliance on hedge funds and foreign investors is a current manifestation of a broader theme. When a sovereign bond market is growing and/or other investor types are retreating, marginal investors are critical - but they also pose risks if they are too concentrated in one type (or types) with correlated behaviour. This correlation can take many forms (Figure 4), each with its own consequences. 

An investor base skewed to short- or long-duration preferences can compromise the issuer’s ability to maintain a balanced programme of issuance.5 Too many price-sensitive or short-horizon investors can leave the market vulnerable to sudden price spikes and mass selloffs. At the same time, too many price-insensitive, hold-to-maturity investors can lead to scarcity and illiquidity. 

While a sovereign issuer can mitigate these risks by better understanding the behaviour of its marginal investors, it should also make continued efforts to incentivise new and different investors to enter its market. For example, by bringing in new dealers of different types, revisiting auction rules, introducing measures to attract more retail investors, engaging in more active investor relations, or showing greater flexibility as to the maturities/bonds it offers.6

With sovereign debt issuance rising to record levels globally, maintaining an investor base with diverse properties and behaviors is more important than ever to support debt managers’ objectives of stable, low-cost issuance. Further, as heightened volatility causes some investors to pull back and any de-anchoring of inflation expectations could further reduce demand for duration, continually attracting new types of investors will be crucial. This will provide a robust backstop for demand and mitigate volatility through a balanced mix of positions and flows among market participants. Without a major change in countries' fiscal positions, monetary policy, or regulation, this need for investor base diversification is only likely to grow.