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Off the beaten track

Last week saw some fairly wild swings in share prices and other financial instruments. There were gyrations in financial instruments I had not even heard of. Such is the complexity of modern investment life that unless you make an effort to keep abreast of develop-ments in markets, products and indices, you can find yourself significantly out of touch.

The accelerating pace of change was at the forefront of my mind as I rose to address a couple of dozen students from the University of Colorado. This is the second year I have been involved in contributing to an Anglo-American initiative to broaden the education of our transatlantic cousins. Having covered such comparatively recent developments as exchange traded funds, real estate investment trusts, structured products, infrastructure funds and a host of alternative investments, I was unaware that a new (to me, at any rate) investment opportunity was to hove into sight not once but twice in the same day.

Escaping from the clutches of the students, I rushed to take in the latest G&N investment trust seminar. Among those presenting was Invesco’s Paul Read. His topic was the Invesco leveraged high-yield fund but as a fixed-income manager he understandably chose to devote the bulk of his stay at the lectern to sharing his views on current turmoil in credit markets. The Fed had pronounced on interest rates the previous day, leaving them on hold but suggesting that any easing may be some way off, despite acknowledging the turmoil present in financial markets.

It is clear that Read views the uncertainty now factored into markets as more of an opportunity than a threat. Given that the following day saw share prices nosedive, I hope he is right. His point is that markets are over-reacting to the problems disclosed through the collapse of sub-prime CDO valuations. Given that a story was circulating last week that a Thai bank had bought a portfolio of these loans at just 9 cents in the dollar, he is probably not too wide of the mark.

The evidence that Read produced to demonstrate the hysteria present in the credit market was the behaviour of the iTraxx index. This is where I moved outside my comfort zone. iTraxx? Was this a new ETF promoted by Barclays to follow some esoteric index? As the name suggests, it is a tracking device but one designed to follow the fortunes of the cost of insuring against bond defaults. Put simply, the higher this index rises, the more investors are worried about the chance of default.

In trading earlier this year, the iTraxx Europe Crossover – to give the full name of this particular instrument – traded below 200 in spread terms, having spent much of 2006 between 200 and 300. Recently it has nudged 500 – twice. In other words, the perceived cost of insuring a bond portfolio against default has risen more than two-and-a-half times this year. Now, that is what I call volatility.

Volumes have mushroomed in this previously obscure derivatives contract but it is who is dealing that is of greatest concern. Credit trading desks are being joined by foreign exchange dealers, fund managers and possibly even by Mrs Watanabe and the investment clubs of Peoria. A new mousetrap encourages a whole new breed of mice to sniff the cheese. The added liquidity is welcome but it makes it that much more difficult to spot who might be left holding the baby when the music stops. Read’s opportunism is to be applauded but don’t for one moment believe we are in for a smooth ride.

Brian Tora (brian.tora@centaur.co.uk) is principal of The Tora Partnership

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