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HYG, JNK, HY17, And Missing The Trees For The Forest

Tyler Durden's picture


The inter-relationships between various credit market and equity market instruments is a regular part of what we discuss, and most importantly, using these potential dislocations to our advantage. The last few weeks have been awash with notes where we have pointed to divergences and convergences both within credit as well as across credit and equity - most recently today's credit-equity divergence. Peter Tchir, of TF Market Advisors, takes a deeper dive to address some of the reasons for the dislocations and why following the relationships we so vociferously highlight can be highly profitable.

At 1:36 today we sent out a message.  At the time HYG was trading at 87.60 and HY17 (the HYCDX) was trading at 91.125 (mid market). HYG closed at 86.70 (or down more than 1% from that level). HY17 finished the day at 91.125 but several dealers commented on how well bid it was into the close. [Today's summary chart highlighted this convergence]


In typical Wall Street fashion, the HYG (and JNK) is traded off of the equity desk since it is an ETF.  The CDS guys trade the HY17 and half of them wouldn't look at a bond, let alone an ETF.  That is a problem.  HYG has a market cap of 10 billion.  JNK is just over 8 billion.  These are not insignificant numbers, particularly not in the illiquid junk bond market.


HYG had a slow day, but still traded over $200 million.  HY17 had a slow day and probably traded a few billion, so yes, HY17 is more liquid, but the fact that so many "CDS Index" traders ignore these important ETF's is creating opportunities.  Especially when most traditional high yield managers would prefer the HYG/JNK (cash based products) over a CDS product any day of the week.


There are some tracking error issues but HYG generally did a better job than JNK (though JNK seems to have changed what it tracks, so we can't find the historicals and it may be trying to correct those errors).  These tracking errors can be worked on over time, and cannot really be worse than the tracking errors of an index based on 100 relatively illiquid single names, which in turn trade differently than the cash bonds of the "Reference Entity".


There is something to these ETF's, and either the index traders or the cash traders have to pay more attention.


There are still problems with the ETF's.  They have some flexibility over the bonds they hold as they only attempt to approximate the indices.  This is generally good, but as they have gotten bigger, and attracted the attention of the arbs, that is problematic.  Some of the top junk bond managers we talk to, are noticing that the "HYG/JNK" names are trading rich to their peers.  People are ramping up those names in good markets, knowing that inflows will cause the ETF's to buy.  The ETF's are buying at NAV, but the NAV is artificially inflated, because of the early buying (front running has too many negative connotations).


More flexibility would help.  A futures contract could also help - as volumes could spike without the corresponding increases/decreases in shares outstanding - we think that in 5 years all people will trade is futures on Bond Indices (whether directly or on the ETF's) and CDS indices will be a distant memory (and we think 5 years is too long, and for many top bond managers, nightmare rather than memory is the correct word).


It is a shame that the ETF's cannot get new issue allocations.  In some lean years, new issue flipping can be a big part of a high yield funds returns.  With the size these funds have, getting some new issues allocations would make them even more interesting.  Returns would do a lot better, they would truly offer something that investors cannot get on their own.


In response, we think the best mutual funds are doing a better job.  They understand credit selection, the impact of the arb on certain bonds, and the new issue process better.  Those fund managers that are the best should be able to outperform the ETF's and grow assets.  Weaker ones will struggle as they cannot compete with the liquidity or the generic returns.


Just like "HYDI's" changed the high yield market forever (thanks Angie and anyone else who is old enough to remember those), these ETF's are having an impact and the best buy side managers (hedge fund and mutual fund) and best sell-side firms will figure out how to truly incorporate the ETF's into their product offering.


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Thu, 11/10/2011 - 21:10 | 1868450 Barb Dwire
Barb Dwire's picture

Not seeing the Sino Forest thru the trees.

Thu, 11/10/2011 - 22:15 | 1868588 ACP
ACP's picture

Sino Forest has trees?

Thu, 11/10/2011 - 21:17 | 1868462 Undecided
Undecided's picture

Cramer doesn't like us :(


Jim Cramer


Oh, and zero hedge? Didn't they say Morgan Stanley went under or something? Maybe that's who you want to follow? Oh goodie! lol
Thu, 11/10/2011 - 21:27 | 1868481 The Swedish Chef
The Swedish Chef's picture

And we don´t like him...

Thu, 11/10/2011 - 22:53 | 1868663 Comay Mierda
Comay Mierda's picture

I actually agree with him on his AAPL trillion dollar price target. But when that happens a trillion frn's won't buy you a sack of shit. Hyperinflation is a bitch

Thu, 11/10/2011 - 21:31 | 1868492 Miss Expectations
Miss Expectations's picture

We like Cramer

We don't like Cramer

Thu, 11/10/2011 - 21:45 | 1868520 mynhair
mynhair's picture

Gave you a TU, but wonder where the other 'm' went.

Thu, 11/10/2011 - 21:46 | 1868523 DeadFred
DeadFred's picture

Cramer and Goldman are the two best contrarian indicators I know. I love reading his stuff for anti-advice. Can't stand hearing him though. Green arrow in a negative sort of way.

Thu, 11/10/2011 - 21:44 | 1868517 mynhair
mynhair's picture

I like Crammer. He called NG a buy at 14, so I shorted it.

Thu, 11/10/2011 - 21:40 | 1868510 bob_dabolina
bob_dabolina's picture

You guys are genius.

Thu, 11/10/2011 - 21:48 | 1868528 mynhair
mynhair's picture

You can get back to pulling your pud tomorrow when the Quick returns.

Thu, 11/10/2011 - 23:15 | 1868744 kaiserhoff
kaiserhoff's picture

I missed her itty bitty titties.

I really didn't, but Mom says I should say something nice once in a while.  Senile, old Broad says lots of crazy shit.

Thu, 11/10/2011 - 21:51 | 1868534 Myzery
Myzery's picture

Does HYG's recent dividend distribution have anything to do with the divergence?


Thu, 11/10/2011 - 21:53 | 1868541 Myzery
Myzery's picture

and the Dynegy holdings bankruptcy and subsequent Nov. 9th removal from HY17?



Thu, 11/10/2011 - 22:05 | 1868565 mynhair
mynhair's picture

Did you buy at close too?

Thu, 11/10/2011 - 22:14 | 1868584 Caviar Emptor
Caviar Emptor's picture

Credit continues to tell a different story than equities. But that should be no surprise. Credit has become the most accurate barometer of rsik, equities have become the best barometer of monetary expansion ie c banker printing, recklessness and devotion to the Ponzi. 

Thu, 11/10/2011 - 22:24 | 1868600 RiverRoad
RiverRoad's picture

Speaking of "missing the trees for the forest".....turns out that "Xmas tree tax" was a scam thought up by the National Christmas Tree Growers Assn. a "promotional excercise" to bring in advertising money to fight off inroads made by artificial trees.  No surprise there as one of the best tax write offs around are Christmas tree farms.  I know a guy (a former CEO of a Fortune 500 company) who has one and he's been laughing all the way to the bank with his for years.  But it must be that they're not such a great gig now with so many folks going with artificial ones.  There were a lot of indignant posts today on ZH about the "stupid tax"......must be the WH is busy reading ZH.....and the tax was suddenly withdrawn today.  Keep on keepin' on ZHers!

Thu, 11/10/2011 - 22:35 | 1868615 midgetrannyporn
midgetrannyporn's picture

The last few weeks have been awash with notes where we have pointed to divergences and convergences both within credit as well as across credit and equity - most recently today's credit-equity divergence. Peter Tchir, of TF Market Advisors, takes a deeper dive to address some of the reasons for the dislocations and why following the relationships we so vociferously highlight can be highly profitable...


I enjoy the macro divergence-convergence of junk bonds to equities talk very much. It is fertile ground where the heavy hand of the fed is highly evident. However, this piece focuses too much on sawdust junk bond arbitration and ETF paper product sales for my taste.

Thu, 11/10/2011 - 22:43 | 1868630 ZeroPower
ZeroPower's picture

Excellent read from Peter. 

This divergence speaks volumes about the current situation not only between bonds and equities (i.e. UST10yr) but credit as well, and the ETFs supposedly tracking the underlying.

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