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US credit derivatives increasingly chosen by investors 

March 2, 2016

Joe Rennison and Mary Childs, The Financial Times

Investors facing difficulties in selling corporate bonds are increasingly relying on credit derivatives for their portfolios, a trend that has reinforced a severe dislocation within the market.

Credit derivatives track the likelihood of default of a company’s debt and can either reference an individual entity or an index. Selling credit protection is a bet on the credit quality of a company improving, and hence provides an investor with an alternative to buying bonds.

This year, investors have gravitated towards a popular US credit derivative index, the CDX, rather than spend money and own investment grade rated bonds sold by companies.

Such a preference reflects the aversion among some bond fund managers about the lack of liquidity within the corporate debt market and also their need to hold greater amounts of cash in order to cover redemptions from investors. The ability to buy and sell large amounts of bonds — and alter the composition of investment portfolios — has deteriorated in recent years as tougher regulations have curtailed banks from their traditional role in supporting the market.

“Any incoming cash is being invested into the more liquid index products by selling protection on CDX," said Anindya Basu, credit derivative strategist at Citi. "It enables them to remain nimble in case redemptions arrive or there is a market sell-off.” Read more


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