Dubai, UAE; 20 May 2014: Growth in developed economies continues to firm up. The United States briefly lost some momentum as a result of tough winter weather but the general trend remains good and the latest data shows that the economy has recovered from this soft patch. The euro area is still showing signs of improvement driven by the strong economic recovery in peripheral countries. Meanwhile central banks remain extremely cautious: the ECB and the BoJ have both intimated that they are prepared to implement extra and extraordinary stimulus measures. The Fed is to carry on gradually trimming its asset-buying program (so-called “tapering”) and any rise in rates is still a long way off.

This is a positive environment for risky assets and high-yield spreads in particular, which continue to offer attractive valuations via high-yield CDS indices. They remain undervalued, as highlighted by the 6.4% implied default rate while expectations for default rates this year and next stand at only 2.0%, well below the historical average of 4.0%. Considering that high-yield CDS indices bear no interest risk and offer high liquidity in all market conditions, the value proposition for CDS spreads is compelling.

Furthermore, high-yield CDS indices are now modelled on the clearing practices in the interest-rate futures markets, enabling strategies that use CDS indices – such as Union Bancaire Privée’s Global High Yield strategy – to benefit from a zero counterparty risk. Also, by aligning itself with the US regulators’ schedule, which is ahead of Europe’s, Union Bancaire Privée’s fixed-income team offers its European investors a significant advantage, as they can now benefit from daily liquidity with no counterparty risk when using CDSs. 

In three years, Union Bancaire Privée’s Global High Yield strategy has amassed USD 1.48 billion in assets and has outperformed all of its peers, thanks to a unique management approach that uses, amongst other things, CDSs and an exclusive top-down investment policy focusing on analysing macroeconomic conditions and identifying the themes driving the financial markets – unlike most high-yield bond fund managers, who adopt an exclusively bottom-up approach which favours bond selection.

With this approach they are able to adjust the strategy’s exposure according to their expectations, across three dimensions: the exposure to the high-yield market; the geographical exposure to US and European high-yield markets; and the interest-rate exposure, which has been very limited since launch and is practically zero today. Furthermore, the use of CDSs enables the team to adopt a unique positioning, as the strategy is one of the only ones to use these instruments, and to enjoy almost perfect liquidity, given that traditional high-yield bond funds’ liquidity is usually hampered by transaction costs in excess of 1.5%. As well as this, CDSs offer an additional advantage over traditional bond investments in terms of returns. This can be put down to two factors: firstly, whereas the bond universe is finite (increased demand causes prices to rise and returns to fall), the CDS market is not subject to capacity constraints; secondly, CDSs – in contrast to bonds – bear no early repayment call, which preserves their return potential.

The strategy has outperformed its peers in spite of the fact that one of its key characteristics – namely an almost zero exposure to interest rates – actually worked against it between 2011 and 2012 because of the bearish rate environment. The strategy should therefore continue to perform strongly in the current positive environment.