The tenth series of the North American Investment Grade CDX index (CDX.NA.IG.10) launched into a slightly rosier-than-expected market last week.
Spreads, which had climbed to roughly 200 basis points in the series nine, according to CreditSights, closed at 127 basis points after the first day of trading last Tuesday.
While the predominant factor behind the spread tightening was the improvement in overall market sentiment last week, trading does typically tighten from one index to the next, said Nishul Saperia, a director at Markit.
This is because the new indices usually feature the addition of higher quality names, while removing the ones that have fallen into high yield territory. “You are lifting up the rating of the portfolio on average,” he said. In the most recent roll, seven names that were removed had dropped below investment grade.
Brunswick Corp., Black & Decker, Kohl’s Corp., M.D.C. Holdings, Masco Corp., The New York Times Co. and Viacom are all new additions to the portfolio.
Meanwhile, fallen angels, including Countrywide, Jones Apparel Group, IAC/InterActive Corp., Lennar Corp., Belo Corp., Centex Corp. and Pulte Homes, were taken out. Viacom is the highest-quality addition to series 10, while homebuilder M.D.C. Holdings is the lowest, according to CreditSights.
Interestingly, two of the new entrants to the index were homebuilders, including Masco Corp. While three homebuilders were taken out from series nine, the replacement maintains a similar ratio for both portfolios despite current housing conditions.
Whether or not series 10 spreads will keep their relative tights remains to be seen, especially given the current volatility in the market.
However, the higher quality and more liquid names that have been added to the portfolio should increase trading volume. “The dealers want to increase their flow of business, therefore they are going to include names where they are seeing a lot of client inquiry said Brian Yelvington, strategist at CreditSights. “Whenever you have a market downturn, like we have seen for the past nine months or so, there is going to be more [client] inquiry on higher quality names as managers engineer a flight to quality in their portfolios.”
The new index also provides an advantage to investors looking to make strategic shorts, despite the lower risk measure and spread level.
Since the coupon and spread are much closer together in the new roll than the old index, the upfront payment that is involved in implementing a swap is much lower than in the series nine, Yelvington said. Though the relative investor optimism of late has prevented these trades, if market sentiment changes, “this is where people are going to look to set their shorts because it is on the run and cheaper to implement,” Yelvington said
The North American High Yield CDX index (CDX.NA.HY.10) had set the three year, five year, seven year and 10 year coupons at 500 basis points. Trading will begin on April 1, 2008.
Given how wide spreads are for some of the most distressed companies in the market, there may be some value credits in this particular index.
“I think it is fair to say that there are more distressed credits in this index that could dramatically outperform the index overall, compared to previous indices. That is, if [these credits] can navigate their way through the current turmoil,” Saperia said.
New to the index are Chemtura Corp., Constellation Brands, DirecTV Holdings and Station Casinos.
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