1. Newsroom
  2. Covid-19 crisis: CDS indices have passed their crash test
Menu
UBP in the press 28.05.2020

Covid-19 crisis: CDS indices have passed their crash test

Covid-19 crisis: CDS indices have passed their crash test

Le Temps (26.04.2020) - The Covid-19 crisis has caused major upheaval for equity and bond positions within portfolios.


The newsflow has sometimes prompted indiscriminate selling, causing the sudden reappearance of liquidity risk, or rather illiquidity risk, as a major factor in investment decisions. However, during the recent turmoil, CDS indices have confirmed their status as liquid market instruments, comfortably passing the Covid-19 crash test.

Stress and falling liquidity across all asset classes

Both equity and bond markets have seen a decline in liquidity, caused by market stress and forced selling. All liquidity indicators, such as the difference between bid and ask prices (the “bid-ask spread”), point in the same direction: there is less liquidity for mid-cap stocks and, much less intuitively, for US and European large-cap stocks too (based on the S&P 500 and Eurostoxx 50 indices). Corporate bonds have also been affected.

Credit: sharper drop in liquidity during the Covid-19 crisis

All segments of the credit market have been affected. Technical factors have made the situation worse for short-term US investment-grade credit, because investors use these securities (as well as US Treasuries) as collateral for leveraged positions. Volatile market conditions result in margin calls, and so investors cash in these holdings. Since this market segment is also one in which investors park their cash and have less tolerance for risk, selling of these positions has snowballed. When liquidity falls, bid-ask spreads tend to widen and both buying and selling become more difficult during volatility spikes. This is shown by bond ETFs, which have seen their prices uncouple from their benchmarks. However, CDS indices have stood apart from bonds because of their stable liquidity profiles.

CDS indices have remained liquid: a review of liquidity indicators

Firstly, CDS index transaction costs (as shown by bid-ask spreads) are a fraction of those incurred when trading bonds, which drag down returns, particularly in the high-yield segment. For high-yield CDS indices, the bid-ask spread is 15-25 cents. CDS indices also represent around 80% of daily trading volumes in the euro-denominated credit market. Finally, trading volumes for CDS indices increase during times of stress. In March 2020, volumes for the high-yield CDS index in Europe went from €5 billion per day on average to €20 billion per day, a jump of 300%. For the investment-grade index in the US, volumes surged almost 400% from $24 billion to $118 billion.

Why focus on liquidity and CDS indices when seeking credit exposure?

More liquid instruments perform better during times of stress. Conversely, less liquid instruments fare worse. This has been clearly confirmed during the recent Covid-19 crisis. CDS indices have proven more resilient than traditional bonds, as shown by both bond indices (which are by their nature non-investable) and ETFs (investable). This liquidity advantage is seen during times of stress but also during recoveries when investors unwind credit hedges, and over the medium term, particularly because their transaction costs are almost zero.

The Covid-19 crisis has been a real-life crash test for CDS indices, which have passed it with flying colours. It has confirmed the liquidity benefits of these instruments for investors, either alongside or instead of traditional bond strategies.


DEBAT_Olivier_UBP_72dpi-0219.jpg
Olivier Debat 
Senior Investment Specialist
Global & Absolute Return Fixed Income

Expertise

Agility: at the heart of our discretionary management

Your goals and aspirations are unique – so is our approach to discretionary portfolio management.

Read more
Expertise

Swiss & Global Equities

Why Swiss equities now? This market offers equity investors the stability and agility they need to navigate this volatile period. 

Read more
Expertise

European Equities

European equities offer unrivalled opportunities in terms of breadth of sector and market exposure.

Read more

Most read

UBP in the press 23.11.2020

Frontier debt comes of age

Financial Investigator (20.11.2020) - Frontier debt has grown significantly over the past decade and now warrants serious consideration as a dedicated allocation in investors’ portfolios.

UBP in the press 18.12.2020

The drift towards thematic investing

Rankia Pro (12.2020) - Interview with Didier Chan-Voc-Chun, UBP’s Head of Multi-Management & Fund Research

UBP in the press 04.01.2021

The rise of UBP’s impact strategy

Funds Society (14.12.2020) - The first strategy in UBP's impact investing platform, Positive Impact Equity, has been going from strength to strength since its inception. Impact investing specialist Yvan Delaplace details the strategy’s investment process and broader sustainability trends in the sector.


Further reading

UBP in the press 01.03.2021

Compliance in the RegTech era

Le Temps (01.03.2021) - For two decades, Swiss private banks have been engaged in a new test of endurance as they have had to adapt to a raft of new regulations, tougher tax compliance requirements and the globalisation of their client bases.

UBP in the press 26.02.2021

Charting a course for growth through difficult waters

Hubbis (18.02.2021) - Hubbis caught up with Ranjit Khanna, UBP’s Head of South Asia and Singapore Branch Chief Executive Wealth Management, recently to hear how well UBP in South Asia has weathered the storms of 2020, and how the bank continues to expand its discretionary, advisory and IAM/ family office propositions.

UBP in the press 18.02.2021

Why renewable energy has come of age in 2020

Environmental Finance (05.02.2021) - What changed to make renewable energy such an investment success story in 2020, UBP’s Mathieu Negre asks