Investors seek protection from risk of AI debt bust

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Trading in products that pay when companies default is on the rise, as investors look for ways to protect their portfolios from the risk of the AI ​​boom turning into a bust.

Volumes of so-called credit default swaps linked to a handful of US technology groups have risen 90 per cent since early September, according to data from clearinghouse DTCC.

The growing use of these strategies highlights how uneasy some investors feel about technology companies rushing into bond deals to finance AI infrastructure, which can take years to generate returns.

The rush to hedge against potential defaults comes as a technology sell-off returned on Wall Street last week due to earnings at software group Oracle and chipmaker Broadcom that fell short of investors’ lofty expectations.

Debt and stocks of companies linked to the technology boom have fallen in recent months, as traders scrutinize earnings reports and discuss how competing artificial intelligence products from companies such as OpenAI, Google and Anthropic will impact demand for chips and data centers.

The rise in CDS trading was particularly pronounced for Oracle and cloud computing company CoreWeave, both of which are raising billions of dollars in debt to secure data center capacity.

A new market has emerged for Meta CDS after the company sold $30 billion in bonds to fund artificial intelligence projects in October.

Credit default swaps (CDS) are used to protect against default, but also to hedge against or bet on fluctuations in bond prices.

“Single-name CDS volumes rose significantly this quarter, especially for large-scale companies” that are building massive data centers across the United States, said Nathaniel Rosenbaum, investment-grade credit strategist at JPMorgan.

A senior executive at a large US credit investment firm echoed this sentiment, noting that “CDS trading in individual names has increased significantly, with people increasingly using baskets in big tech companies or in Oracle and Meta specifically.”

“How do you protect yourself and create a hedge? The most common method is a basket of technology credit default swaps,” the person added.

Highly rated US companies had little to no appetite for credit default swaps at the start of the year, when technology groups were primarily financing their AI spending with their massive cash piles and strong profits.

The market heated up once these companies started tapping debt markets to cover their rising costs. Meta, Amazon, Alphabet and Oracle raised a combined $88 billion this fall to fund AI projects, with JPMorgan predicting that investment-grade companies are on track to raise $1.5 trillion by 2030.

One investor at a specialist asset management company said: “People have gone from believing that there is virtually no credit risk to believing that there is some risk based on the name, and this calls for hedging.”

For Oracle, which has a lower credit rating than some of its investment-grade peers, weekly trading volumes for credit default swaps have more than tripled this year. The cost of purchasing derivatives has risen to its highest level since 2009.

Oracle stocks and bonds suffered a major sell-off this week after beating analysts’ third-quarter revenue estimates. It fell further on Friday after it delayed the construction of at least one data center.

“We don’t see Oracle defaulting anytime soon, however [the company’s CDS] “They were grossly mispriced,” said Benedict Kim, a portfolio manager at asset manager Altana Wealth, which is betting against Oracle with its credit default swaps.

Altana entered the trade in early October after assessing Oracle’s increasing debt levels and reliance on one client – ChatGPT maker OpenAI. “It was low-hanging fruit,” said Matteo Sciamma of Altana.

“Single-name CDS are having a moment,” said Brij Khurana, a portfolio manager in Wellington.

“There is much greater exposure of banks and private lenders to individual companies,” he added. “So they want to mitigate the risk of that. People are looking for insurance on their property.”