As market conditions evolve and technicals between the syntethic (CDS) and cash (bonds) market change the attractiveness of instruments for the same issuer, investors should focus on the best way to access the capital structure.
As we discussed at the height of the crisis last year, the many technical factors that were unique to the sell-off drove the basis1 into record negative territory, increasing the incentive for investors to express long views via the cash markets2. More recently however, the relationship has reversed as the record reach for spread has caused bonds to outperform CDS over the past few months (see figure 1). Additionally, with convexity worsening and the cash price of global high yield at a 6 year high3, CDS is well positioned to capture the upside if spreads continue to tighten off the back of central bank stimulus and the ongoing hunt for yield. It can also be said that for those thinking we are in a reflationary environment, it does not hurt to lower the interest rate exposure by favouring CDS over bonds.
Figure 1.
Source: Federated Hermes, Bloomberg. Past performance is not a guide to future performance.
