By Mike Duncan | December 2025
A Practitioner’s Guide to What Actually Works
Many institutional credit hedges are expensive box-ticking exercises. They look disciplined in risk reports, satisfy governance committees, and then fail to pay when credit actually breaks.
The problem is not that portfolios are unhedged. It is that most hedges do not hedge the risk that actually matters.
An Asian life insurer paid $30 million in CDS premiums over three years while a Chinese property developer in its portfolio defaulted. The hedge paid nothing – wrong credit, wrong structure. A pension fund accumulated $22 million in negative carry over four years on a rolling hedge programme before quietly discontinuing it. An $8 billion insurance general account ran a five-year CDS programme that cost $142 million and delivered $8 million in benefits – 41% more than it would have cost to just absorb the unhedged losses.
What this paper argues
CDS dominates institutional credit hedging not because it is effective at transferring loss risk, but because it is liquid in normal markets, familiar to consultants, and cleanly fits governance frameworks. It manages spread volatility and accounting optics. It does not reliably pay when portfolios suffer real credit damage – and when it does pay, the liquidity to monetise it often does not exist.
For private credit, infrastructure debt, and long-duration balance-sheet exposures, the mismatch is structural and cannot be engineered away. The honest answer for many portfolios is not a more sophisticated hedge. It is better portfolio construction, structural subordination, more diversification, and, in some cases, accepting the risk unhedged.
What it covers
- Why credit risk is four distinct problems – default, recovery, spread, and liquidity – and why most hedges only address one of them
- The hidden costs of CDS hedging: roll decay, basis risk, jump-to-default illusion, and liquidity disappearance when it matters most
- Index versus single-name CDS: different failure modes, same outcome
- Why credit hedging is ultimately a liquidity problem, not a spread problem
- Structural alternatives that actually transfer risk: subordination, asset-level protection, and insurance-style structures
- Why private credit and infrastructure debt are essentially unhedgeable with liquid instruments – and what to do instead
- Five case studies showing how credit hedges fail in practice, including the diagnostic that terminated an $8 billion programme
- A structural diagnostic: five questions that determine whether your credit hedge is real or governance theatre
The central argument
A hedge that does not improve outcomes under stress is not a hedge. It is an expense. The right question is not whether a credit hedge looks prudent. It is whether it actually works when it needs to.
Read the practitioner paper
The Credit Hedge Illusion – A Practitioner’s Guide to What Actually Works
