Friday 06/26/2009 11:57 AM ET - Dow Jones News
By Jacob Bunge
Of DOW JONES NEWSWIRES
CHICAGO -(Dow Jones)- An Obama administration plan to shift over-the-counter financial derivatives into clearinghouses opens the door for a host of new hedge fund trading strategies, and more managers are laying plans to incorporate the instruments into their portfolios.
The move by exchanges to standardize OTC products such as credit derivatives and interest rate swaps, a precursor to central clearing and exchange trading, makes the instruments palatable for a wide swath of hedge funds and commodity trading advisers that prefer standardized products for their liquidity and price transparency.
"It's a whole new frontier for us," said Craig Caudle, chief executive of Liberty Funds Group Inc., a managed futures-focused firm that oversees about $120 million.
Many hedge funds are already heavily involved in OTC markets, but other firms like Liberty restrict trading to on-exchange products that are easier to trade and don't carry counterparty risk.
That universe is expanding with efforts to move over-the-counter instruments onto exchange-backed clearing services, and Caudle said he's been keeping a close watch on the new products being added to CME Group Inc.'s (CME) ClearPort platform, which provides central counterparty clearing for bilateral OTC trades.
As market participants warm to the idea of clearing their OTC business - with a push from Washington, which views clearing as a means of reducing systemic risk in off-exchange markets - exchanges like CME, IntercontinentalExchange Inc. (ICE), Nasdaq OMX (NDAQ), NYSE Euronext (NYX) and Deutsche Boerse (DB1.XE) have moved to provide clearing for an ever-expanding array of instruments.
CME's ClearPort has added more than 175 new products to the ClearPort platform this year alone, including swaps on corn, electricity and natural gas; the exchange is also planning to clear credit derivatives and interest rate swaps.
"When you talk about being able to trade everything from a credit default swap to a grain swap, I think it's a great opportunity, especially for people that are quantitatively oriented because you can apply your rules across a greater spectrum," Caudle said.
Justin Dew, senior managing director of Welton Investment Corp., said the lack of liquidity and price transparency in credit instruments has kept the $500 million managed futures and global macro firm on the sidelines, but that may change.
"If there's liquidity in credit default swaps, and (the market) moves and you can trade it, we'll be there," said Dew, speaking on the sidelines of the Managed Funds Association Forum in Chicago this week.
Dew welcomed the push by regulators and exchanges to standardize over-the-counter products. "It opens up new markets," he said. "It's nothing but good."
Some managers remain leery of off-exchange products. Ken Armstead, partner and chief investment officer of Absolute Plus Management, said that his firm does just fine trading on-exchange products in a variety of asset classes, and that won't change anytime soon.
"There's enough opportunities in the liquid, transparent markets that are very harvestable," said Armstead, who also attended the MFA event. "Our focus has always been on liquidity and scalability."
Armstead pointed out that transparency can be a "double-edged sword" for investors who follow OTC products as they migrate onto centrally cleared platforms.
With more price transparency, traders could see profits in OTC trading shrink, and overall volume in the market may decline, he said.
-By Jacob Bunge, Dow Jones Newswires; 312-750 4117; email@example.com
(END) Dow Jones Newswires
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