elevated thinking

the thinking appears to be create the underlying buying risk (rated whatever) and selling treasuries in a matched trade as a hedge (theoretical duration match) keeping the credit risk unhedged (?) and ignored ?

elevated thinking

“We’re making our own,” says Bob Michele, who oversees $470 billion as head of global fixed income, currency, and commodities at J.P. Morgan Asset Management. The loans that banks sell, which have floating-rate coupons that track rates, are difficult to come by because so much of the market is going there, Michele says. That’s why he’s taken another way in. “We buy corporate issuers’ fixed-rate debt and swap it back to a portfolio of pure credit sensitivity,” he says.

It’s a strategy preferred by many with the resources to pull it off: Columbia Threadneedle Investments and Penn Mutual Asset Management are also among the major managers using Treasury futures and interest rate swaps to protect against Fed rate hikes. The process is simple, but it looks a bit different for each company.

At Columbia Threadneedle, it begins with a call between the firm’s corporate bond trader and his securities dealer of choice, during which the trader arranges to buy a chunk of a given ­company’s debt. He wants to make a pure bet on the credit, ­isolated from the wider rate environment, so as soon as the two agree on a price for the bonds, the corporate trader turns to his colleague on the Treasuries desk to arrange the second leg of the deal.

A quick check of the company’s internal risk-management system shows how much duration the company just took on, and the second trader uses his trading platform to offload a chunk of Treasury-­bond futures with the equivalent duration measure.

The two transactions cancel each other out as far as ­interest rate risk is concerned, leaving only credit, or “spread,” exposure, on Columbia Threadneedle’s books.

The second way into this type of hedge is through an interest rate swap, another derivative instrument readily available to large asset managers. At PGIM, traders use these two strategies more or less interchangeably to hedge duration, depending on which is cheaper at the moment, says Greg Peters, who helps oversee more than $600 billion there.

Leveraged loans offer coupons that rise along with benchmarks such as Libor or the Fed’s overnight Treasury yield. That means they possess lower interest rate risk compared with fixed-rate unsecured corporate bonds of similar maturity.