Short-dated high yield tranche may be worth a play, says Citi

The recent sell-off has made some  equity tranches of credit indices very attractive, argues Citi in a research note sent out by its trading desk. The bank points out that a long, no-delta, three-year position in the 10-15% tranche of series 11 of the CDX NA HY index would yield an IRR of 58% , assuming this now junior tranche pays back at par when it matures in December 2011.

Investors can still make an annualised return of more than 30% if they hedge out the three widest names in HY11: Hovnanian, Energy Future Holdings and AMR. Series 11 of the index has 87 names remaining, which means that the 10-15%, which trades at just under 87, is now effectively a 0-4% tranche. It would take four defaults with zero recovery to wipe out the tranche.