LONDON (Reuters) - Hedge funds appear to have spotted an opportunity in the European Central Bank's bond-buying scheme and are snapping up long-dated debt in anticipation of profits from selling it back to the central bank later.
Data from Bank of America Merrill Lynch shows hedge funds have almost doubled their take-up of euro zone bonds sold with maturities over 15 years since 2014, expecting ECB purchases to be focused in this area in coming months.
The current average maturity of purchases is around eight years, which is well below the 12-year average of the eligible pool of assets. This suggests the ECB - which has no target maturity - has up until now been buying towards the short end.
"Hedge funds are buying up long-end bonds... until ultimately the ECB relieves them (of them)," said BAML rates strategist Ralf Preusser.
Analysts have sought potentially profitable opportunities in the ECB's scheme all along, but with less than a year left, the arrival of hedge funds suggests a group known for its volatile asset allocation has now joined the fray.
Leveraged investors such as hedge funds are often the first out if markets go against them, exacerbating price swings in bond markets where liquidity has become sparse. Analysts said the presence of the ECB as a huge buyer could moderate this.
BAML data shows hedge funds have on average been allocated 15 percent of long-dated euro zone government bonds sold via syndication in 2016, nearly double the 8 percent average two years ago.
In part, this has been driven by the search for yield, while a scarcity of eligible shorter-dated bonds has reinforced the idea that the ECB will have to buy at the longer end.
Analysts estimate some 500 billion euros of euro area bonds with maturities between two and 30 years yield less than the ECB's deposit rate, making them ineligible for the QE programme.
"When it comes to hedge funds they try to pre-empt that move up the curve and, of course, the push for the ECB is to also go up the curve as they are running out of qualifying bonds," said Rabbani Wahhab, a senior fixed income portfolio manager at London and Capital.
BAML's Preusser said Dutch and German central banks, which have skewed their purchases towards shorter-dated bonds, are already buying longer-dated bonds on behalf of the ECB.
Some predict the ECB may eventually have to buy bonds beyond its current 30-year limit, if inflation and growth do not pick up and it has to prolong the scheme. Any increased buying of longer maturities would also likely pull down yields of bonds that fall outside the ECB's pool.
Bank estimates show euro zone governments sold around 30 billion euros of 50-year bonds between 2006 and 2015. This year alone has seen 9 billion euros sold, with Italy also expected to issue later in the year.
A breakdown of recent 50-year bond sales in France and Spain shows hedge funds accounted for 13 percent of the take-up in each country and for 17 percent in a similar auction in Belgium in April - making them among the biggest investors in those ultra-long dated issues.
One London-based banker, who recently arranged long-dated bond sales for euro zone governments, said there had been a surge of inquiries this year from hedge funds for ultra-long debt.
Speaking on condition of anonymity, he said the funds, mainly from Britain and the United States, routinely call to ask for views on when the ECB will start buying longer-dated bonds.
"They are buying for short-term gains over a three- to six-month horizon," said the banker.
This speculative money comes on top of the traditional demand for long-dated bonds from pension funds and insurers that need to match liabilities and others looking for insurance against the prospect of the euro zone sliding into a Japan-style decade of deflation.
Editing by Nigel Stephenson/Jeremy Gaunt