A big focus for credit hedge funds and other traders in the past couple of months has been the opportunities created by the rapid increase in liquidity in high-yield credit derivatives. Since the two rival index providers merged in July volumes have taken off.
“There’s huge volume in all the high-yield indexes,” says Will Roberts, head of structured credit trading at Goldman Sachs, referring to the 100-name product as well as its main offshoots – the BB sub-index, the single-B sub-index and the high-beta index. “The high-yield tranche market is also very active. We’re printing multiple trades a week where at the start of the year we were doing very little.” His colleague, Eric Oberg, head of credit derivatives trading, adds: “And the main index trades at an eighth of a point. You can’t get that anywhere else in high yield.”
It has not followed the same path as indices in other products, though, says Boaz Weinstein, head of integrated credit trading at Deutsche Bank: “In those cases the underlying individual securities were liquid prior to the roll-out of an index. In high yield, for the most part, it’s the other way round. The liquidity in the high-yield credit derivatives index is so good that it’s actually improving liquidity and generating a lot of liquidity in single-name default swaps as well as bonds. If you look, you can trade at least 80 of the 100 names in the main index.”
Not everyone is seeing that just yet, though that could be in part because the growth has been so recent. “It gets less liquid in high-yield default swaps, but that’s the nature of the market,” says Kevin Akioka, senior fixed-income strategist at Payden and Rygel. “Single-name default trading in high yield is less active. I’d say that you can trade between 20 and 30 names in the index relatively well.” The difference hinges on what “relatively well” means to different players. A hedge fund is going to have different needs to a mutual fund, and they are already bringing in new strategies. “Index arb trading is getting popular,” says Weinstein. “A trader might, say, buy the BB subindex, which is pretty liquid, and then buy protection on individual names.”
Since the start of the year Weinstein and his colleagues have been encouraging their clients to look at the rich/cheap analysis of the index as a proxy lead indicator of sentiment and relative value. “It’s becoming a bit like the Vix,” he says. “If the high-yield 100 index is at, say, 99 and fair value is 101, then the index is two points cheap to fair value. Clients use that to find optimal entry and exit points for trading the high-yield market. So, for example, in May when high-yield credits were vulnerable, the index was over four points below fair value. Some hedge funds were still looking to short the index at that point, so we pointed out to them that it was historically cheap.”
