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The More Boring The Better The Performance

10 November 2015 by lberuti

The recent macro led rally coupled with inflows into HY funds already sitting on high cash balances in a market that struggles to offer meaningful secondary liquidity led to a decent amount of credit index (iTraxx Crossover – ITXEX - in this case) being sold. This has led to ITXEX outperforming HY cash and single names, creating a large negative index basis (ie difference between the quoted value of ITXEX and its theoretical value). Arbitrageurs are on a mission to bring this basis back to zero, and they have been consistently selling protection on single names over the last couple of months. Dealers can recycle CDS on high to mid beta names fairly easily, as their perceived idiosyncratic risk generates decent liquidity and 2 way flows. But for the most boring names in the index, arbitrage led enquiries represent the bulk of their business, and the question rapidly becomes for them: “how short risk can I be on Trionista (or Unilab, or Sol Melia, or Techem, or Convatec) given that I do not expect technicals to change any time soon?”. With the risk appetite in the dealer community running at an all-time low, the answer is “not very”. The CDS risk premia of these names have collapsed and is now largely uncorrelated to their fundamentals, and disconnected from other asset classes, particularly bonds. Credit index basis can generate all sort of bases.