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July 2021 | Issue 236
Credit index tranche trading on the rise amid low dispersion
Dan Alderson
Deputy editor
At its halfway point, 2021 is shaping up as another big year for credit index tranche trading, with new investors having entered the market and dealers projecting full-year volume could vie with 2020’s record of recent times.
According to data from the Depository Trust & Clearing Corporation, overall index tranche notional volume towards the end of June stood at nearly $133 billion. This puts 2021 easily on track to surpass 2019’s $210.5 billion, but last year’s $270.8 billion is also in sight, according to a market maker in London and one in New York.
“It’s slightly lower than 2020, but you could argue the covid-19 volatility back then in March and April produced anomalous volumes,” says a London-based trader. “Through that lens we’re up 25% on 2019, so the market is still growing. I think we’ll get to $240 billion by year end, but it could be more.”
Dealers say there has been a swing in participation from real money towards hedge funds, which have been underinvested in structured and macro credit.
Tranche trading volumes ($bn)
Source: DTCC
The past three months have brought index tranche valuations to a fine balance, amid competing outlooks for a second half of no defaults versus one in which idiosyncratic risk starts to resurface. Given the absolute tightness of credit spreads, this has had more impact on investor appetite to sell senior protection, with equity sellers still visible, though not in abundance.
“Most investors are in the junior part,” says one investor in New York. “Correlations moved higher in Q1, but have come back since. Even so, equity tranche prices have continued to drop just as a function of the overall move tighter in indices.”
Dispersion remains low, notes the London-based dealer, with Boparan the only constituent in the iTraxx Crossover index to trade above 10 points up front.
“That hasn’t happened since 2009,” he says. “People have been pricing-in zero defaults, but valuations have reached extreme levels not because of leverage. It’s simply that there wasn’t anyone taking the other side of the trade for a while. In Q2 there has been more sense of future dispersion, buying back equity and mezz protection, putting on curve flatteners, seeking balance and fading the risk-on.”
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Global credit funds & CLO's
July 2021 | Issue 236
Published in London & New York.
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