Bearish investors flock to hedge from artificial intelligence debt risks

Investors are turning to products that pay out if companies go under to shield their portfolios from a potential bust in the AI sector. Data from DTCC shows that credit default swap activity for several US tech companies has increased by 90% since early September, as investors worry about the risks of financing AI ventures with bonds that may not deliver returns for years.

Wall Street’s tech sell-off already picked up pace last week, driving a surge in hedging, after Oracle and Broadcom posted disappointing earnings.

At the heart of this changing story is Oracle Corporation, a legacy enterprise software and cloud computing powerhouse. Once considered a company that was a pillar of steady revenue and no-frills finance, Oracle has become a leading proxy of AI-linked credit risks.

The price of credit default swaps, or the cost of insuring the company’s debts, is at levels not seen since the 2009 financial crisis.

CDS activity rose particularly in September

The financial performance of tech companies has been on a rollercoaster as investors digest earnings reports and anticipate the impact of AI products from companies such as OpenAI, Google, and Anthropic.

Nonetheless, Oracle and CoreWeave have seen particularly sharp rises in CDS trading as they raise large amounts of debt to underpin data center capacity. Trading in Meta-linked CDS also took off after the company raised $30 billion through bond sales in October to finance its artificial intelligence initiatives.

Nathaniel Rosenbaum, an investment-grade credit strategist at JPMorgan, even noted that single-name CDS volumes had increased substantially this quarter, primarily driven by hyperscalers investing heavily in US data centers.

A top executive at a prominent US credit investment firm also agreed with that assessment, saying, “CDS trading in single names has increased markedly, with folks increasingly using baskets on the big tech companies or on Oracle and Meta specifically. How do you protect yourself and create a hedge? The most common way is a basket of technology CDS.” 

However, CDS interest in highly rated US firms was virtually absent early in the year, when tech companies funded AI expansion from their balance sheets rather than debt markets. The market gained momentum once borrowing replaced cash as the main funding source. Meta, Amazon, Alphabet, and Oracle raised $88 billion this autumn, and JPMorgan predicts $1.5 trillion in investment-grade issuance by 2030.

Oracle’s CDS activity has been on the rise

CDS activity around Oracle has jumped sharply this year, with weekly volumes more than tripling and protection costs hitting their highest point since 2009. The company has accumulated more than $100 billion in debt, mostly to finance data centers and AI infrastructure.

Market data indicate that the company’s CDS is at approximately 126 basis points, significantly above the levels of peers such as Nvidia and Meta.

Although the firm’s assets came under heavy pressure this week after the company fell short of revenue expectations, they dropped further on Friday when it delayed at least one data center build.

Benedict Keim, a portfolio manager at asset manager Altana Wealth, noted, however, that although he did not expect Oracle to default anytime soon, he believed its CDS had been egregiously mispriced. His affiliation, Altana, had first entered the CDS trade in early October, citing Oracle’s rising debt and its heavy exposure to a single customer, OpenAI. 

Recently, Wellington’s Brij Khurana also gave his overall take on CDS trading: “Single-name CDS are having a moment.” He added, “There is much more exposure that banks and private credit players have to individual companies. So they do want to mitigate the risk of that. People are looking for insurance on their holdings.”

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