By Mary Childs – Sep 17, 2012
Exchange-traded funds are poised to overtake credit derivatives by year-end as a way to speculate on junk bonds.
The value of corporate securities held by the five-largest junk ETFs almost doubled in the past year to a record $31.4 billion, while the net amount of protection bought or sold on the debt using the two current credit-default swaps indexes declined 3 percent to $35 billion, data compiled by Bloomberg show. The ETFs are growing at an average 5.2 percent monthly pace this year, which would put assets at more than $36.5 billion by Dec. 31.
Trading in credit swaps has slowed as the market faces regulation for the first time under the Dodd-Frank Act, potentially making them harder and costlier to buy and sell. The growth of junk-bond ETFs, which are listed on exchanges and brokered like stocks, has accelerated since their inception in 2007 as investors seek a faster and cheaper way to trade debt.
“Product innovation is often the answer to regulatory change and I don’t think it’s any coincidence that we’ve seen this explosion of interest in fixed-income ETFs just at the point at which CDS as a product and asset class comes under pressure,” Will Rhode, director of fixed-income at research firm Tabb Group LLC, said in a telephone interview.
Junk-bond ETFs, which have attracted 25 percent of high- yield fund inflows since 2010 as measured by EPFR Global, are gaining influence in a market where both securities and their derivatives are generally traded off exchanges.
Even investors seeking to hedge against losses on the securities have started using ETFs, with the number of shares borrowed to bet against one run by State Street Corp. surging almost three-fold from the end of 2011.
Credit swaps, created in the 1990s as a means for lenders to protect against losses on corporate debt, gained popularity in the past decade as a way to wager on gains without actually owning bonds or loans.
With the Federal Reserve saying last week it will probably hold its interest-rate target near zero through at least mid- 2015 and conduct a third round of bond purchases to stimulate the economy, investors are gravitating toward the funds to boost returns as demand for default protection diminishes. Continue reading