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Derivatives

Hedge Fund Flows Expand Credit Plays

The influx of macro hedge funds into synthetic asset-backed securities has created opportunities for other credit investors, according to speakers on a hedge fund panel.

The influx of macro hedge funds into synthetic asset-backed securities has created opportunities for other credit investors, according to speakers on a hedge fund panel. The funds have prompted a jump in volatility by shorting credits, allowing synthetic collateralized debt obligation managers to ramp up their own deals by selling protection based on mispricings.

"The macro hedge funds don't have the expertise and appreciation for infrastructure in terms of data or models," said Charles Schorin, portfolio manager at Elliott Associates. "You see OWICs [offers wanted in competition] that are so similar. They see someone wants to buy protection and think, 'That must be a bad bond.'" That herd mentality leaves room to find credits that have been overly punished, he added.

Many investors in the space have learned their lessons the hard way and have been forced to alter their trading strategies, attendees noted. "If you were short single-names and long the index, you have learned a really painful lesson this year," said one portfolio manager in an aside with DW.

Supply and demand technicals have not matched up, with vastly different single-name bid and offer lists from both camps driving the mismatch week to week. Rampant tiering in single-name ABS CDS has driven the divide between implied good and bad vintages wider. This may have implications for the CDO bid for synthetic ABS as the arbitrage becomes more unstable, panelists noted.

Dealers are partly to blame for the influx of macro hedge funds. "Dealers didn't want to cover the other side of the [protection] trade," said Kevin Jenks, senior portfolio manager at HBK Investments. He referred to dealers selling protection on the CDOs they underwrite. "They created this market so they could feed the CDO machine and play this game for years to come."

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