By Katie Greifeld (Bloomberg) — Making cash in the world of credit insurance
typically involves a special license and strategies that cost
millions of dollars to run. Rates expert Harley Bassman wants to
do it in a low-cost exchange-traded fund.
Bassman, who created the MOVE Index to track Treasury
volatility, is co-manager for the Simplify Credit Hedge ETF
(ticker CDX), a proposed new fund that will invest up to 50% of
its assets in credit-default swap index payer options, according
to a filing Tuesday. Those are derivatives that allow investors
to either hedge their position in a company’s bonds or to make a
directional wager.
The ETF is designed to pay off when turmoil hits credit
markets. Options held by the fund can guard against widening
spreads by offering the right to buy protection against default
on over 100 North American and emerging-market companies.
If that sounds complicated, it is. Previous products tied
to default swaps have struggled to gather assets or shuttered.
CDS trading is normally the province of hedge funds and other
institutional players, requiring a hard-to-get license known as
an ISDA Master Agreement and a large pools of assets.
Still, the timing may be fortuitous, with credit markets
looking frothy and S&P Global Ratings warning of rising default
risk amid unprecedented global debt issuance.
“There’s really not many ways available in tradeable format
to protect against the credit markets freezing,” said David
Schawel, chief investment officer at Family Management Corp.
“This seems to be a viable one.”
The recent spike in Treasury yields amid rising concerns
about inflation sparked a selloff in U.S. investment-grade
credit, the worst-performing fixed income asset class this year.
Corporate bonds with the highest credit ratings tend to have the
most duration, making them vulnerable to rates moves. The market
is also under pressure from excess supply.
In addition to swap index options, the Simplify fund will
invest in Treasuries, inflation-protected securities, money-
market funds and investment-grade corporate debt via ETFs,
according to the filing. It’s expected to cost 0.5% a year.
Bassman is a famous industry figure, having specialized in
fixed-income derivatives and structured products during his 26-
year career at Merrill Lynch, according to his personal website.
He later worked at Credit Suisse Group AG and Pimco before
joining Simplify.

Troubled History

The fund is the latest in a list of CDS products, most of
which have faltered.
The ProShares CDS North American High Yield Credit ETF
launched in 2014, but liquidated a few years later after
struggling to attract assets. In Europe, the Tabula North
American CDX High Yield Credit Short fund (ticker TABS) holds
less than $1 million after launching in July. DWS Investments
recently reduced the number of credit derivative ETFs it offers
through its XTrackers label to three from a peak of 15 in 2012.
“This ETF will have its work cut out for it competing with
the massively liquid options on HYG, which many currently use as
way to hedge credit risk or bet against it,” said Eric Balchunas
of Bloomberg Intelligence, referring to the $22 billion iShares
iBoxx High Yield Corporate Bond ETF.
Even though the CDS market is largely inaccessible to
individual investors right now, it’s unclear if retail traders
would even want exposure to default swaps, he added.
While more tactical investors may trade in and out of the
product, there are long stretches of middling performance
associated with such instruments, which are designed to pay out
only in a crisis.
“Shorting credit is easier said than done,” said Peter
Tchir, head of macro strategy at Academy Securities. “It will be
interesting to see if this mix of tools available to the
managers can be harnessed to deliver returns.”
The end result may be that the fund occupies a niche
similar to its underlying strategy, despite the easy access of
an ETF wrapper.
“While likely more complicated initially for retail
investors, this fund could appeal to institutions,” said Todd
Rosenbluth, CFRA’s director of ETF research.

—With assistance from James Crombie.

To contact the reporter on this story:
Katie Greifeld in New York at kgreifeld@bloomberg.net
To contact the editors responsible for this story:
Jeremy Herron at jherron8@bloomberg.net
Yakob Peterseil, Sam Potter

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