Harley Bassman Wants to Prove History Wrong With a New CDS Fund

(Bloomberg) -- Making cash in the world of credit insurance typically involves a special license and strategies that cost millions of dollars to run. Rates expert Harley Bassman wants to do it in a low-cost exchange-traded fund.

Bassman, who created the MOVE Index to track Treasury volatility, is co-manager for the Simplify Credit Hedge ETF (ticker CDX), a proposed new fund that will invest up to 50% of its assets in credit-default swap index payer options, according to a filing Tuesday. Those are derivatives that allow investors to either hedge their position in a company’s bonds or to make a directional wager.

The ETF is designed to pay off when turmoil hits credit markets. Options held by the fund can guard against widening spreads by offering the right to buy protection against default on over 100 North American and emerging-market companies.

If that sounds complicated, it is. Previous products tied to default swaps have struggled to gather assets or shuttered. CDS trading is normally the province of hedge funds and other institutional players, requiring a hard-to-get license known as an ISDA Master Agreement and a large pools of assets.

Still, the timing may be fortuitous, with credit markets looking frothy and S&P Global Ratings warning of rising default risk amid unprecedented global debt issuance.

“There’s really not many ways available in tradeable format to protect against the credit markets freezing,” said David Schawel, chief investment officer at Family Management Corp. “This seems to be a viable one.”

The recent spike in Treasury yields amid rising concerns about inflation sparked a selloff in U.S. investment-grade credit, the worst-performing fixed income asset class this year. Corporate bonds with the highest credit ratings tend to have the most duration, making them vulnerable to rates moves. The market is also under pressure from excess supply.

In addition to swap index options, the Simplify fund will invest in Treasuries, inflation-protected securities, money-market funds and investment-grade corporate debt via ETFs, according to the filing. It’s expected to cost 0.5% a year.

Bassman is a famous industry figure, having specialized in fixed-income derivatives and structured products during his 26-year career at Merrill Lynch, according to his personal website. He later worked at Credit Suisse Group AG and Pimco before joining Simplify.

Troubled History

The fund is the latest in a list of CDS products, most of which have faltered.

The ProShares CDS North American High Yield Credit ETF launched in 2014, but liquidated a few years later after struggling to attract assets. In Europe, the Tabula North American CDX High Yield Credit Short fund (ticker TABS) holds less than $1 million after launching in July. DWS Investments recently reduced the number of credit derivative ETFs it offers through its XTrackers label to three from a peak of 15 in 2012.

“This ETF will have its work cut out for it competing with the massively liquid options on HYG, which many currently use as way to hedge credit risk or bet against it,” said Eric Balchunas of Bloomberg Intelligence, referring to the $22 billion iShares iBoxx High Yield Corporate Bond ETF.

Even though the CDS market is largely inaccessible to individual investors right now, it’s unclear if retail traders would even want exposure to default swaps, he added.

While more tactical investors may trade in and out of the product, there are long stretches of middling performance associated with such instruments, which are designed to pay out only in a crisis.

“Shorting credit is easier said than done,” said Peter Tchir, head of macro strategy at Academy Securities. “It will be interesting to see if this mix of tools available to the managers can be harnessed to deliver returns.”

The end result may be that the fund occupies a niche similar to its underlying strategy, despite the easy access of an ETF wrapper.

“While likely more complicated initially for retail investors, this fund could appeal to institutions,” said Todd Rosenbluth, CFRA’s director of ETF research.

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