To Hedge the Fed

Chidem Kurdas

However Ben Bernanke phrases the Federal Reserve’s intentions this afternoon, significant uncertainty will remain about the reversal of the Fed’s $85 billion-a-month purchases of debt instruments. What’s an investor to do?

Everybody wants to escape the unknown consequences of the Great QE Unwinding. Some common themes can be discerned in commentaries by credit managers. The object is to profit or at least not lose whether the Fed continues quantitative easing at the current pace or reverses in short order.

Here are three themes—short sell, long wait, deep diligent analysis.

Short sell: Borrow and sell Treasuries and investment-grade bonds. The latter rarely goes up in price, so if your short bet is wrong, the loss will likely be small. Private equity manager KKR says it may do this in its credit funds. Meanwhile everybody is selling junk bonds but shorting them carries high risk. If the Fed decides to stay with quantitative easing for a while, high-yield paper could recover.

Long wait: Among the credit areas, direct private loans are more promising than public market bonds. Lending to financially troubled yet promising companies can be very lucrative, but it requires time. Some managers want at least five years before they have to exit a position.

Deep analysis: Goldman Sachs’ credit group says there are “attractive idiosyncratic opportunities” to be found in the junk bond market, identified via “rigorous fundamental analysis”.

The Goldman group is very cautious about new high-yield issues. They warn that “the issuance of CCC-rated bonds in 2012 was near 2007 levels.” But they do not use the bubble word.

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