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Credit derivatives: Investors’ hunt for value begins

Liquidity remains the primary challenge in the present environment, meaning that few credit managers have ventured beyond the relatively liquid credit derivative indices. Managers including BlueCrest, Cairn Capital, CQS and Pimco are all seeking to take advantage of the unique opportunities the dislocation in the credit market has created, say market participants.

"It’s tough to put on trades and cross significant bid offers other than in the most liquid of instruments," remarks one credit manager. "Most are focused on doing slow-burn trades with little risk and making a quick turn in the highly liquid stuff." Accordingly, most of the action is focused on trading the indices, index options and index tranches.

One of the most profitable and popular trades over the past 12 months has been to go long the equity tranche, while shorting the super-senior tranches. Being long equity was popular a year ago when equity correlation was at historically low levels. Also because correlation was low, super-senior tranches offered very low spreads. That trade has now become crowded, sparking concerns of huge losses in the event that too many players decide to exit simultaneously. Some managers have therefore started to build long positions in super-senior tranches, which look good value as overall credit spreads remain wide, meaning that defaults would have to spike beyond all known historical parameters for investors not to make a return.

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