Alt Investments

HNWIs Warned on Structured Credit Vehicles

Ian Allison 26 April 2006

HNWIs Warned on Structured Credit Vehicles

Sophisticated investors are being offered access to a range of structured credit vehicles which are currently being spun out of the alternat...

Sophisticated investors are being offered access to a range of structured credit vehicles which are currently being spun out of the alternatives market in a wave of listings on the London Stock Exchange. This raises the question of how risky these types of products are when made available on a retail basis. Collateralised debt obligations, collateralised loan obligations and mortgage-backed securities are instruments that pool together groups of loans and other debts, which are then split up into units that are sold on with varying risk profiles, depending on how likely the debts are to be repaid. At a recent hedge fund conference in London hosted by Tara Capital, Florian Homm, chief investment officer of Absolute Capital Management, said: "Unidentified objects [CDOs] are out there and as interest rates go up they are not going to do well. You don’t get lots of S&P warnings. In fact the only option left to unwary pension funds exposed to CDOs is to sue." These complex products, which have historically been the reserve of a small market of specialists, have recently been opening up to individual investors. A swathe of listings of structured credit vehicles follows the massive amount of cash flowing into hedge funds globally. The route to retail for these types of alternative credit funds has typically been trailed by high net worth investors. Recent news of listings has included Caliber which came out of Cambridge Place; Queen's Walk, which was floated off by Cheyne Capital Management; and most recently, Carador, which spun out of Washington Square. Each raised between €50 million ($62 million) and €400 million, from institutional investors or high net worth individuals. Plans are afoot to bring to market at least ten more deals before the end of this year, with one or two likely to list within the next month. Citigroup, Credit Suisse and Merrill Lynch are among the banks thought to have mandates to prepare vehicles for floats. Miguel Ramos, managing partner, Washington Square, told WealthBriefing: “The key thing to remember is that there are basically two types of CDOs; firstly synthetic CDOs, the ones that there were so much trouble with last year, which included Parmalat for instance, and the second type which we are dealing in, which are known as cash-flow CDOs.” The market for CDOs is small and there is an imbalance between supply and demand. Also from a credit perspective, CDOs are mis-priced, said Mr Ramos. “Cash flow CDOs, the old fashioned variety, have been around since about 1987. These are a lot less leveraged, and involve assets that are senior in the asset structure; senior secured loans which create a more stable spread with lower volatility.” “With the synthetic CDOs we have seen them fall and rise and fall: 3 per cent to 9 per cent and back down again over a short period of time. We would recommend that investors keep their exposure to CDOs on the low side, at a maximum of about 5 per cent. The problem has been a lack of investment vehicles to meet these requirements – we have seen demand from HNWIs and family offices, especially from the US.” The key is diversification. In the same way that investors might want to access hedge funds by degree, perhaps via a fund of funds, they do not want to have to select and buy single CDOs. They make more sense as part of a portfolio, said Mr Ramos. “Pension funds look to diversification - they are happy to outsource a mandate for example. We are offering them exposure to about 20 transactions with Carador and this has proved attractive to early adopters. We have raised €50 million, and while we intend to steadily increase this we are not going to rush,” added Mr Ramos.

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