Insight’s Whiteley employs CDS as Brexit hedge

Co-manager Adam Whiteley said the Insight team thought a Brexit scenario would call into question the continued existence of the EU as a whole, in part because it could set a precedent for other countries to leave the bloc.

As a result, the managers have sought to protect their portfolio via a CDS index position, which would appreciate in value in the event of a bond sell-off.

“One area where things are liquid and you can take genuine option exposure is on the CDS indices, so we’ve built in some option protection on the iTraxx Main [index]. It allows us to know upfront the cost that we’ve spent on the option premium, and to frame for the pay-off if markets do move,” Mr Whiteley said.

The use of the iTraxx, an index that tracks the probability of default for a range of European corporate bonds, underlines the managers’ strategy.

He added: “For us, the obvious thing is that UK assets [will] suffer. We think if we do get a Leave vote then it will quickly spill over into something much larger and there will be question marks placed over the whole concept of the EU.

“UK assets have suffered so far this year, and there was an element of that negativity that was already in the price. A more natural thing would be to look for what would be the next derivative and in this case we think it would be the broader European setup.”

It is not just a potential Brexit that has caused the manager to reduce the fund’s amount of aggregate risk.

Mr Whiteley pointed to a number of other “risk events” at the end of June, including a US Federal Reserve meeting at which interest rates could be raised, a repeat Spanish election, and the start of the European Central Bank’s (ECB) corporate bond-buying programme.

The derisking has been achieved through the sale of both cash and physical bonds, as well as introducing hedging strategies such as the CDS options.

“In April we reduced the amount of aggregate risk in the fund, having seen quite a move in terms of valuations. [These are] less attractive than they were at the worst of the February [sell-off], but [the move] also reflects those risk events that we’ve spoken about coming through June.”

The US is the team’s preferred market for investment-grade credit, particularly long-dated debt. Mr Whiteley said sterling credit, while offering similar value, was a smaller pool of opportunity and that the ECB’s indiscriminate bond-buying programme had driven up the price for European credit.

“Sterling credit offers similar strategic value, but it’s a much smaller opportunity set and it’s less easy to trade that market,” he said.

“If we’ve got a choice of the two, the dollar market – which is a lot larger – is a more natural place for us to allocate. Euro credit is expensive and the ECB has made it more expensive and more difficult for investors to participate in.”