Tranches on the LCDX index debuted in mid-October, receiving a warm reception despite the cautious atmosphere in both the cash and synthetic leveraged loan markets. Dealers shrugged off comparisons to the doomed tranches on the ABX index (TABX) and are quietly confident that LCDX tranches will prove to have merit. However, given the still-fragile state of the credit markets, they are not expecting the new product to take off overnight.
"The market will find a home for this product, whether it’s as big as it is for tranched bond risk or as immaterial as the TABX or somewhere in the middle," says Chip Stevens, head of high-yield cash and derivatives trading at Deutsche Bank in New York. "If it serves a purpose in the marketplace it will get there pretty quickly."
There is a belief that given the size and importance of the leveraged loan market, LCDX tranches are an important development. Loan credit default swaps (LCDS) and the LCDX index both got off to slow starts, note dealers. However, both products have found an audience amid market uncertainty.
Fears that adverse market conditions might stymie the launch of LCDX tranches were unfounded. On the first day of trading, October 10, MarkIt Partners reported $2.5 billion of trading volume. Although not all investors have rushed into the new product, it certainly has its champions.
"I’m a big believer in the tranched LCDX product given the wide spectrum of participants including relative value players, CLO Managers and macro funds," says Ganesh Ramchandran, head of structured credit trading at London-based hedge fund CQS. "Dealers are making tight markets in decent size on the LCDX underlying index. In contrast, TABX suffered from poor liquidity when it was launched during the February ABS crisis."
CQS was among the first investors to trade LCDX tranches upon debut. The fund made some relative value plays between triple-A cash collateralized loan obligations and LCDX tranches. Ramchandran notes that there are also relative-value opportunities between high-yield tranches and LCDX.
Another development expected from the launch of LCDX tranches is single-tranche synthetic CLOs. A handful of investment banks have done bespoke LCDX tranches and this segment of the market might benefit from the recent launch. Single-tranche CLOs might take longer to gain traction.
"You’re going to see demand for the higher parts of the capital structure first and eventually more structured credit investors will come back into the market, increasing demand," says Stevens.