What have been the most significant developments in the credit markets in recent years?
The most significant developments have been the emergence of new products (e.g. ETFs on credit indices), and the return of some older products (e.g. tranches). During, and after, the credit crisis of 2008, tranche trading all but disappeared; it is now back with gusto. Bespoke tranche trading reached $80 Billion issuance in 2018, and continues to grow rapidly. There is also more confidence that this is a sustainable trend with the development of a stronger secondary market and traded maturities extending beyond two or three years. Although it is far cry from pre-crisis level, these are encouraging signs for the tranche market’s revival.
Which tranches are more popular now: index or bespoke?
The volume of bespoke tranche issuance in 2018 is still significantly lower than index tranche trading, which reached $215 Billion in 2018. One reason is that with index tranches, banks can trade all pieces of the capital structure independently, whereas for bespokes they need to issue the whole capital structure. There are also several popular strategies that are only possible in a more liquid index tranche market—such as equity vs. mezzanine, or curve trades like short- vs. long-term tranches. Most liquid on-the-run index tranches have five-year maturity (now IG31 and HY31), but to play the curve shape, short-end IG/HY 25-27 are also popular.
“Quantifi is the established leader in the structured credit space, with a single solution covering pre-trade analytics, trading and post-trade valuation, risk management, and reporting. We provide a turnkey solution that integrates easily with existing systems and allows market participants to rapidly take advantage of trading opportunities as they occur.”
Rohan Douglas, CEO, Quantifi
The bespoke tranche market has had a great 2019 so far, but what is tempting new investors into the space?
Banks—the main sellers of bespoke tranches—do not want any significant market risk, so they need buyers for all sectors of the capital structure. There has been a steady increase in investor interest in this space. Each part of capital structure has its own risks: equity—mostly idiosyncratic, senior (systemic, mezzanine)—a mix of both. They also have their own, individual attractions: mezzanine provides the most efficient leverage, short-dated senior is good for funding, and long-dated is better for real investment. Investor interest might shift—super-senior has taken the place of equity. Both ends of the capital structure are now liquid, with super-senior tranches having a 4-5 bps margin.
While the main buyers of bespoke tranches are still hedge funds, there is a big interest in CSO from cash investors who hedge credit risk in synthetic market, mostly with equity tranches. For these investors, CSO as a product makes perfect sense, allowing buyers to express a view on different parts of the market and to go short. Diversity of names/tranches is also attractive, and comparing with cash (CLO), CSOs react much faster and provide a better relative value instrument. There is also noticeable interest among insurers and pension funds, which mainly look for super-senior tranches.
What major developments do you anticipate from the market in the future?
It will be interesting to note whether we will see ratings for bespoke tranches anytime soon. Moody’s and S&P’s have updated their methodology but currently very few tranches are rated. If this happens, it could lead to an even bigger influx of institutional investors.
What differentiates Quantifi from its competitors in the structured credit space?
Quantifi is the established leader in the structured credit space, with a single solution covering pre-trade analytics, trading and post-trade valuation, risk management, and reporting. We provide a turnkey solution that integrates easily with existing systems and allows market participants to rapidly take advantage of trading opportunities as they occur.
