Tabula launches credit curve steepener ETF

Fixed income specialist Tabula Investment Management has launched a new ETF providing exposure to the shape of European and North American credit default swap (CDS) curves.

The Tabula Global IG Credit Curve Steepener UCITS ETF (TCRS GY) has listed on Xetra, in euros, and comes to market with €20 million in assets raised pre-launch.

Credit curve steepening describes a situation in which the difference between the spreads on short-term CDS positions and long-term CDS positions are increasing.

The difference between spreads is calculated as the long-term spread minus the short-term spread.

Credit curve steepening has historically been seen during periods of economic recovery and improving market sentiment.

Specifically, the fund is linked to the iTraxx-CDX IG Global Credit Steepener Index, an IHS Markit index, which tracks the return from selling on-the-run 5-year protection and buying on-the-run 10-year protection on the iTraxx Europe and North American CDX indices.

These underlying sub-indices consist of credit positions, equally-weighted, on fixed-rate investment-grade bonds from 125 corporate names. The iTraxx Europe covers euro-denominated bonds from entities domiciled in Europe, while the North American CDX targets US dollar-denominated bonds from companies based in North America.

The performance of the two indices depends on investors’ expectations of corporate defaults for those regions. Generally, these sub-indices will gain as perceived prospects of credit default increase and the cost of insurance rises, as well as, of course, on actual credit events such as late payment, restructuring, and bankruptcy.

The ETF’s reference index (the iTraxx-CDX IG Global Credit Steepener Index) has a target notional to index value ratio of three in terms of short on-the-run 10-year index CDS positions (credit protection buyer) with 50% allocated to the iTraxx Europe and 50% to North American CDX. The target weights of the long 5-year CDS positions (credit protection seller) are determined to offset the credit spread sensitivity of the short 10-year positions. This ensures that the response of the index to parallel shifts in the CDS spread curves is neutral.

The index increases in value when the curve becomes steeper and decreases in value when the curve becomes flatter; ergo, the index will produce a positive return when 5-year credit risk is improving relative to 10-year credit risk.

Given the technical nature of the fund, it would appear to be targeted at sophisticated investors and institutional investors, most notably hedge funds and financial institutions, allowing them to express a distinct view on the trajectory of credit risk expectations and the outlook for defaults whilst immunizing other factors associated with fixed income securities such as interest rates – all in single-ticker solution.

Michael John Lytle, Tabula CEO, commented, “Steepener strategies are a well-known way to generate returns from interest rate curves. This opportunity exists in credit markets too but has been more difficult to access, requiring specialist credit default swap infrastructure and execution capabilities. We have worked with Markit to create a liquid and transparent index that can be accessed via a UCITS ETF.”

The ETF replicates the index through direct replication via CDS index positions and cash collateral (typically investment-grade European sovereign bonds with remaining maturities under one year) for which the fund also earns a collateral yield.

To minimize counterparty risk, CDS trades are executed through regulated brokers and centrally cleared.

The ETF comes with an expense ratio of 0.40%.

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