JP Morgan believes cash credit managers are barely making any money, but that this is more to do with constraints on their trading than with their investment skills. King will argue that only through the use of credit default swaps (CDSs) and collateralised debt obligations (CDOs) can they hope to control their risks while investing in credit. “The asymmetric return distribution in credit means they risk losing much more from a single blow-up than they can ever hope to make by avoiding them,” said King.
King added that more cash portfolio managers are turning to JP Morgan to ask for help “gaining permission” to use credit derivatives, either in the form of CDSs or CDOs.
“Illiquidity of the cash market leaves portfolio managers struggling simply to earn carry as the source of their profits. This may be sufficient in a bull market, but is disastrous when spreads are widening,” King said.
But a number of banks, such as Italy's IntesaBCI, and insurers/reinsurers - for example, France's Scor - have cut back or suspended further investments in vanilla and exotic credit derivatives products during the past three months.