CDX NA IG and iTraxx Europe have both shed fallen angel constituents, but the impact on the US index is greater, with some of its ejections at deeply distressed levels. “As many of the distressed names are out of the new series, it looks a bit more boring — or homogeneous,” says Jochen Felsenheimer, managing director at Xaia Investment. “I believe we will see many more names dropping out during the next couple of months.” According to one market maker, the less risky replacements in CDX IG series 35 could prompt investors to want to sell equity tranche protection and buy junior mezzanine.

“It has pushed base correlation up,” he says. “It was around 40/41 for equity on series 33, but the new is more like 48. This is the biggest jump at a roll for five years. Fundamentally, the old IG equity is 50 points up front, but it’s a one-way bet on fallen angels.” Felsenheimer predicts a bear market will create new fallen angels, but adds that the IG sell-off is likely to be broad rather than idiosyncratic. “Looking at the CDX IG and iTraxx Main universe, I still believe systemic risk will rise strongly, as we saw in March. This should especially hurt mezz and senior. We are still analysing which one is the best to short.” CDX HY tranches were yet to roll at press time, but they present a much changed structure at the bottom of the stack. Dealers say HY 33 equity has become a 0-5% piece (rather than 0-15%), given the stream of defaults this year, while junior mezz has become 5-15%. iTraxx Crossover S32 equity has become 0-2% (from 0-10%), with junior mezz 2-12%. “The distributions are extremely different,” says the market maker. “Equity will be a good couple of points lower, with more effective loss. The thicker portfolio means 15-25% is much further away from being hit. On HY 33 you are looking at one-third loss distribution in equity, a third in junior mezz and the rest split between senior and super senior. In the new HY it will be more like 60% in equity, 20% in junior mezz and 20% in the rest.”