I was listening to Bloomberg Radio this morning and heard a quick comment that JPM and GS are designing new derivatives that allow for speculative bullish and bearish bets on below investment grade debt.
Here is the article from Bloomberg.
Again, when the hell do we learn. Yea, Wall Street is trying to fill in the gaps by allowing investors to hedge losses in the leveraged loan space, hell even allow investors to short the highly valued debt, but the question is will these prevent losses when the tide turns or will it just be a nice little re-run of 2008's speculative behavior?
Would like to hear the communities thoughts.
Rates will continue to stay low, pushing big funds to buy anything that 'should' beat inflation, and GS/JPM are simply acting as the casino. I don't know if these will create/cause another bubble, but I can guarantee you folks will lose a lot of $$$ buying/selling these simply b/c they don't understand or even want to understand the underlying collateral and how those values will ultimately affect their return. Just another way for people to place their bets, pay a fat fee, and hope for the best.
Yea "hope" is not a great strategy. It's just amazing though, we are back to the financial engineering of products that are too complex to understand. I guess that is just how it goes....
it's amazing that people buy this stuff. granted, it's mostly institutions and for some, this stuff can effectively hedge, but if you're reaching for yield, you're going to get it handed to you.
Yea the big guys will be "playing" with this stuff, but the big guys were also the guys that were playing with the mortgage CDO's in 2008.
The difference this time is that the "big guys" will be primarily the buyside, rather than the sellside due to Volcker. It will be interesting to see if the buyside will be able to exit out fast enough given low liquidity when the panic starts.
So from what I'm getting, these products are similar to the CDOs constructed before the last financial crisis. Except instead of the products derived value stemming from mortgage backed assets, it's coming from loan backed assets? Am I on the right track? Maybe someone could explain the product in layman's terms a bit clearer than the article.
These are swap contracts, not CLO's.
Here's the info on the JP Morgan product being referenced: http://www.markit.com/en/products/data/indices/bond-indices/iboxx/marki…
In other words the swap contract is based on the total return of the iBoxx USD Liquid Leverage Loan index less 3 month LIBOR. The contract allows for investors to bet on the return of the index.
The Liquid Leveraged Loan index consists of liquid senior loans and is supposed to be "a tradable reflection of the corporate high yield bond market." It's mostly B and BB rated.
Anyways, I don't see how this is really that newsworthy. It's a swap tied to a loan index, sure that's an increase in liquidity but to compare it to the economic crisis is silly IMO. The risk profile of this contract is actually fairly straightforward compared to other products. Here's some more info on the index:
http://www.markit.com/assets/en/docs/products/data/indices/bond-indices…
Exactly! Well said.
Very interesting! Thanks for clarifying.
Apologies if this is a dumb question, but just trying to wrap my head around this whole thing. How can these products garner a AAA credit rating when the underlying is mostly B and BB rated?
I don't get why people are saying this is a new type of derivative, it is just a TRS which has been around for a while on a credit index. TRS payments are based on the return of the index so not any where close to the type of inaccurate values on CDO and CDS that caused the financial crisis.
You can short high yield through a number of existing ETFs, like http://www.proshares.com/funds/sjb.html
See http://etfdb.com/etfdb-category/inverse-bonds/ for a list of others.
It'll be interesting to see how these ETF's react to a few HY blowups. I don't know the math behind how the swaps are setup to replicate -1x performance, but I'm interested to know who the counter-parties are and what they start to do in that scenario.
Prospectus for anyone interested in SJB: http://www.proshares.com/funds/prospectus.html?ticker=sjb&doc=0
TXU going into chapter 11 doesn't seem to have moved the notch much on SJB, but I'm not sure how much that expectation was already baked into the price of TXU's HY.
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