European fixed income specialist Tabula Investment Management has launched a new ETF providing short exposure to North American high-yield credit through access to the corporate credit default swap (CDS) market.
Jason Smith, CIO of Tabula Investment Management.
The Tabula North American CDX High Yield Credit Short UCITS ETF (TABS LN) has listed on the London Stock Exchange in US dollars and comes with an expense ratio of 0.50%.
The ETF is linked to the CDX North American High Yield Credit Short Index, an index developed in partnership with IHS Markit, which measures the performance of inverse credit exposure to North American high-yield bonds without the direct interest rate risk inherent in traditional corporate bond indices.
The strategy incurs a charge (effectively an insurance premium for acquiring protection) for shorting the credit risk embedded within issuers’ bonds. This is reflected in a negative annual yield which is presently estimated at -4.48% (gross).
Swap performance depends on investors’ expectations of default with the value of the swap position gaining as perceived prospects of credit default increase and the cost of insurance rises, as well as, of course, on actual ‘credit events’.
In the case of credit events, the ISDA Credit Determinations Committee votes to determine if a credit event has occurred for an entity. Such events typically include late payment, bankruptcy, and restructuring.
Specifically, the index reflects the return from buying protection on the CDX North American High Yield 5y Index which includes 100 sub-investment-grade entities and represents the most widely traded segment of the North American high-yield credit market.
Constituents are equally weighted and rebalanced monthly, while a new on-the-run index series is published twice a year to reflect rating and liquidity changes.
The fund is the only Europe-listed ETF offering this type of exposure and comes at a time when year-to-date defaults in US corporate credit are at their highest level since 2009.
The current series has had six defaults and, therefore, has 94 issuers remaining. Nearly half (47%) of the index’s exposure is allocated to companies from the consumer sector, followed by industrials (21%), telecommunications (15%), and energy (9%). The largest credit bucket is BB (48%) with the index also having significant exposure to bonds rated B (28%) and CCC (14%).
The index’s strategy produced negative returns between -3% and -9% per year over the past five calendar years as the longest US bull market on record was characterised by steady growth and low levels of corporate defaults. Following the turmoil caused by the Covid-19 pandemic, however, the index has gained 14.7% year-to-date (30 June).
Michael John Lytle, CEO of Tabula Investment Management, commented, “This is a very opportune time to launch an ETF that enables investors to hedge against the North American high-yield corporate credit market. Defaults have been rising, and downgrades have accelerated sharply this year. We are also seeing an increase in the number of ‘fallen angels’ – companies that have their debt rating reduced to high-yield status due to their deteriorating financial position – and this too could lead to further uncertainty.”
Jason Smith, CIO of Tabula Investment Management, added, “Financial market indicators are optimistic relative to both credit and economic indicators. Defaults in North American corporate credit are at the highest rate for 11 years and predictions from leading rating agencies estimate they could increase to between 5% and 15.5% by March 2021. Investors need to review their exposure to high-yield US debt and consider strategies for protecting against any rise in defaults.”
The ETF complements Tabula’s existing CDS-linked fund suite which comprises ETFs targeting European credit strategies. These include the Tabula European iTraxx Crossover Credit UCITS ETF (TECC LN), which targets long exposure to high-yield credit, the Tabula European Performance Credit UCITS ETF (TCEP LN) targeting both investment-grade and high-yield credit, and the Tabula European iTraxx Crossover Credit Short UCITS ETF (TECS LN) which provides short exposure to European high-yield credit.
These funds come with expense ratios ranging between 0.40% and 0.50%.