Barclays Capital research says CLO equity holders could hedge using synthetic tranches

Barclays Capital has published a report 'Hedging CLO equity' which says that the imminent arrival of standard LCDX tranches will increase significantly the liquidity of the market for bespoke tranches of LCDS portfolios. It says investors who hold CLO equity positions are likely to hedge these positions using bespoke LCDS tranches.

Since CLOs are the largest institutional buyers of leveraged loans in the new issue market, and the list of names that are liquid in LCDS are also representative of new issue activity, it should be possible to structure bespoke synthetic equity positions that have similar single name exposure to recently issued cash CLOs, says the report.

The report also discusses two different ways of buying protection on a synthetic equity LCDS tranche: standard synthetic CLO equity and what it calls modified synthetic CLO equity, which involves buying protection on a 0-100% tranche and selling protection on a 9-100% tranche.

Source: Barclays Capital