Credit derivatives markets ended an explosive week with a whimper on Friday as trade slowed to a trickle.
But nerves remained on edge thanks to reports of distress in the hedge fund world.
New York-based investment firm DB Zwirn & Co said it would liquidate its two largest hedge funds after clients asked to withdraw more than $2 billion. Separately, Bloomberg reported that AQR Capital Management’s largest hedge fund has lost almost 15 per cent this year as market swings tripped up computer models the managers use to make trades.
“The announced liquidation of the Zwirn funds is in line with our concerns that poor market performance will lead to hedge fund redemptions and forced selling, analysts at Dresdner Kleinwort wrote in a note. “This adds to the concern over CPDO and Market Value CLO selling.”
Analysts are worried that hedge fund liquidations could play a part in driving credit spreads to levels that trigger the unwinding of complex structured products. Fear of a chain reaction of liquidations has dominated credit derivatives markets this week, driving the cost of protecting corporate debt against default to record highs.
“If a few hedge funds blow up it’s normal, but if they’ve got into accounting problems it raises a bigger and important issue,” said Mehernosh Engineer at BNP Paribas.
The iTraxx Crossover index, which measures the cost of insuring the debt of 50 mostly-junk rated names against default, fell 12 basis points to about 575bp in morning trade. This means it cost €575,000 annually to insure €10m of Crossover debt over five years.
The iTraxx Europe index of 125 investment-grade credits rose 0.25bp to 123.75bp.
Mr Engineer said trading was extremely light. “The traders are thinking, ‘it’s been a brutal week – let’s take a rest on Friday’. You can see it across all asset classes, though it could be short lived.”