John “Mac” McQuown, the inventor of the first equity index portfolio, has built an interesting financial product that is designed to eliminate credit risk from corporate bonds. He calls it the eBond and Bloomberg has written an excellent and highly in-depth piece about it. An eBond, according to Bloomberg, can be described as such:
His latest handiwork is a hybrid security that embeds a credit-default swap, the derivative that helped push the global financial system to the edge of ruin in 2008, in a corporate bond.By joining the two securities into an instrument called an “exchangeable bond,” or eBond for short, McQuown says companies will be able to transform junk-graded debt into the equivalent of AAA-rated notes.
And he’s hoping it will help him take advantage of possibly the biggest imbalance he’s seen in a career that stretches back to the dawn of quantitative investing -- a looming liquidity crunch in the $8 trillion U.S. corporate bond market. McQuown says reinventing the corporate bond to make it less risky should make it easier to trade.
In many ways, the eBond is not the same as buying a bond and its related CDS, even though on paper they look the same. Put simply, the eBond is a single security; which appears to be a significant feature.
“It’s an important idea that deserves to get off the ground,” says David Booth, co-founder and co-CEO of Dimensional Fund Advisors, an Austin, Texas-based investment firm with $381 billion in assets and another backer of the venture. “The way bonds trade now is abysmal, and if we can make the bond market as liquid and transparent as the stock market, that’s a socially desirable outcome.”
From this perspective, if the development of the eBond results in positive changes to how bonds currently trade, I can see the appeal. However, this seems to be awfully optimistic and that most people would share the sentiment of Bonnie Baha, who notes:
“The way we make money for our clients is by assessing risk and generating risk-adjusted returns, and if you have a security that hedges that risk premium away, then why is it compelling? I would just buy Treasuries,” says Bonnie Baha, the head of global developed credit at DoubleLine Capital, a Los Angeles firm that manages about $64 billion in fixed-income assets. “This product sounds like a great idea in theory, but in practice it may be a solution in search of a problem.”
What do you monkeys think? Does the eBond have the potential to change the bond market for the better? Or is this, in the words of Baha, "a solution in search of a problem"?
Have to say that this is a solution in search of a problem... If the product is more standardized for the buyer, then maybe there will be a small increase in liquidity but removing risk from corporate bonds won't meaningfully increase liquidity
I don't get it. If I want to get interest rate exposure I would long treasury or IR swap/future. The reason to buy corporate bond is to earn credit premium. Simultaneously long CDS protection basically hedged all credit premium/risk and the portfolio return would equal to swap spread.
Makes sense as a hedge instrument only in my mind. I'm not sure I see/understand the appeal if it is to capture premium or yield with downside protection (offsetting?)
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