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My 2005 Prediction: Credit as an Asset Class

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With all the New Year’s predictions flying around the Internet and print media, it seemed prudent to join the crowd. But instead of trying to discern which stock will be the next Google, I thought the better path for my modest prophetic abilities was to jump on the credit bandwagon.

Specifically, I believe that credit will become a tradeable and distinct asset class in 2005.

Among hedge funds and loan portfolio managers, credit trading is well established. The development of credit default swaps (CDSs), allows market participants to hedge away the risk of default of a given corporate credit, or for speculators to bet that a given company’s credit condition will improve. This can also be done at the index level, as two products–TRAC-X, developed by JP Morgan and Morgan Stanley, and iBoxx, created by Deutsche Bank and Citigroup–offers buy-side investors broad market exposure to credit with significant liquidity.

Despite the excitement that has accompanied the expansion of the credit derivatives market, no exchange has listed a credit contract. That is set to change, as exchanges in the U.S., Europe, and Asia are in the design phase of products that would allow a wider number of investors to hedge their credit exposure.

As credit spreads have narrowed to their lowest levels in history, the growing demand of investors to hedge credit shows no signs of slowing down. Moreover, a number of market pundits are warning of a credit correction in the coming year. For those who have never traded credit–a group that would include mutual fund managers and commodity trading advisors who limit themselves to exchange-traded products–the further development of credit as an asset class would allow for diversification in an area that has been largely off-limits to them.

Index Dec-04 QTD YTD Description
S&P 500 Index* 3.25% 8.73% 8.99% Large-cap stocks
DJIA* 3.40% 6.97% 3.15% Large-cap stocks
Nasdaq Comp.* 3.75% 14.69% 8.59% Large-cap tech stocks
Russell 1000 Growth 3.92% 9.17% 6.30% Large-cap growth stocks
Russell 1000 Value 3.35% 10.38% 16.49% Large-cap value stocks
Russell 2000 Growth 3.59% 17.08% 14.31% Small-cap growth stocks
Russell 2000 Value 2.39% 24.15% 22.25% Small-cap value stocks
size=”-1″>EAFE 4.39% 15.36% 20.07% Europe, Australasia & Far East Index
Lehman Aggregate 0.92% 0.95% 4.34% U.S. Government Bonds
Lehman High Yield 1.49% 4.58% 11.13% High Yield Corporate Bonds
Calyon Financial Barclay Index 0.47% 6.40% 1.51% Managed Futures
size=”-1″>3-month Treasury Bill 1.31%
All returns are estimates as of December 31, 2004. *Return numbers do not include dividends.


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