Hedge funds can support market functioning in normal times by providing liquidity and price discovery, but their high leverage, crowded trades, and interconnections can magnify shocks, so stronger monitoring and safeguards are needed.

During stress, leverage and crowded positions can trigger rapid deleveraging and intensified market instability, making orderly functioning more challenging.

Outstanding growth has pushed hedge funds to about $13 trillion in assets by early 2026, up from $4 trillion in 2013, placing them at roughly 5% of non-bank financial intermediation.

The size increase over the past decade has been dramatic, with assets tripling as funds expand their reach.

The IMF urges stronger monitoring, closure of data gaps, cross-border information sharing, stress testing, and tools like margin requirements, haircut rules, and better collateral management to reduce synchronized deleveraging risks.

Leverage is fueled by repurchase agreements and prime brokerage financing, widening the gap between gross and net assets by nearly $6 trillion since 2013 and raising vulnerability to margin calls.

Geographic concentration is high, with over 80% of assets managed in the US, Cayman Islands, Luxembourg, and Ireland, tying hedge funds closely to global banks and prime brokers.

Carry trades in currencies like the yen and Swiss franc can spill over into sharp FX moves and potentially transmit stress to equities.

Redemptions and performance-sensitive withdrawals can trigger correlated liquidations, deepening price falls, especially for funds with flexible withdrawal terms.

Growth has been powered by leverage, including synthetic leverage via derivatives, expanding funds’ capacity and reach.

Crowded trades among large managers raise the risk of synchronized selling, increasing volatility and drawdowns in equities during stress.

Regulators should balance maintaining liquidity and market functioning with safeguards to curb moral hazard, including stronger counterparty risk management and credible central-bank backstops.