Credit default swaps losing favor to corp bonds

By Karen Brettell - Analysis

NEW YORK (Reuters) - Corporate bonds are becoming more popular than credit default swaps, as the influence of hedge funds and other leveraged investors declines and money managers seek out more traditional fixed income investments.

Healing equity and credit markets have sparked a surge of new corporate bond supply as investors that had been hoarding cash amid volatile markets gain more confidence in an economic recovery.

"The demand we're seeing for credit is almost exclusively in bonds," said Eric Beinstein, strategist at JPMorgan.

Investors burned by losses on volatile equity markets and alternative investments in 2008 are increasingly allocating funds to fixed income, and these investors prefer debt to derivatives, Beinstein said in a conference call on Friday.

"There has been a shift of ownership from prop desks or hedge funds to cash investors," he said. "This investor base appears to prefer to use 'basic' products and to keep counterparty risk as low as possible, given recent history."

Credit default swaps have been denounced for the role the contracts played in spreading the risks of bad mortgages and other assets, in many cases with extremely high leverage.

Concerns that counterparties on the contracts may be unable to make good on their obligations also came to the fore after the collapse of Lehman Brothers and problems at American International Group, accelerating moves to clear the contracts through central counterparties.

"The lesson from last year is (investors) kind of like owning a bond, there's no counterparty risk," Beinstein said. In many cases bonds also offer covenant protections that CDSs don't have, he said.