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Le Liepvre, SG CIB: "Investors are
increasingly sophisticated and have the
technical capabilities necessary for
analyzing these structures." |
Roundtable participants
NU, Euromoney There are more people buying CDOs than ever before in Europe. So, what is driving this interest?
JL, Solent Capital Put simply, lack of assets. There is lots of cheap liquidity at the moment and people are looking for assets to invest in.
DP, Henderson As well as lack of assets, there's lack of spread available. Anyone with a yield requirement over Libor or Euribor will find it hard to find assets that will meet their targets without going into the structured credit space.
AW, FSA And there is another driver: new entrants. The hedge funds who were less present a couple of years ago are now moving into all kinds of new products, including CDOs and negative basis trades, which has meant that certain people are buying things they were not buying in the past.
OM, JP Morgan I think it is more fundamental. Real money investors are increasingly utilizing these products to help execute their broader ALM objectives. Much of the technology that's allowed CDOs risk/return to be tailored are being used more explicitly in asset allocation construction – creating customized payouts profiles that are not otherwise possible by investing in the asset class directly.
HL, SG CIB I would add one more thing: I believe that within the investor community there are more and more people with the technical capabilities to analyze these structures. More and more people are comfortable making these kinds of investments, and the dealers have developed a wide range of products to meet a variety of reverse enquiries, static or managed, be they single-tranche CDOs or CDO-squared or whatever.
JC, Euromoney How much do these new investors understand how these products work? And given the tight spread environment now, and given the leverage, what happens if spreads widen?
DP, Henderson The people we see when we sell these products understand them. But I do have concerns: one is an influx of real-money investors who do not understand them; another is investors who are using them as yield enhancement against a basic corporate benchmark. A lot of clients would not allow the use of leverage in their portfolios to enhance returns. If an asset manager went to a client with the request, "I'd like to borrow a lot of money against your portfolio to increase the returns you're achieving on it," many would refuse because it would be outside their mandate. Yet those asset managers are buying products with the same economic effect, but embedded within a credit-linked note. Real-money accounts which cannot buy credit default swaps should not be able to buy a synthetic CDO with those swaps embedded in them. I think these instruments do have good uses as investments, but their biggest use is the ALM work mentioned before, and where investors have a segregated fund allowed to invest in structured products.
OM, JP Morgan Remember, most of the risk being placed is double- and triple-A. It is true that seasoned buyers are moving down the credit spectrum, some even participating at the equity level by way of dedicated diversified investment programs, but much of the new volume of participants are entering at the upper end of the capital structure where sensitivity to defaults and spread widening is less.
HL, SG CIB I would add two things. First, the dealers have provided investors with sophisticated analytical tools. At SocGen we give single-tranche and CDO-squared prices to investors on deals we're doing. They can run simulations of spread-widening on our products. Second, dealers are designing structures that mitigate the impact of the spread widening, or that allow them to take advantage of it. Three years ago, perhaps, people bought paper because they were comfortable with the spread level at a particular rating. That is no longer the case. Investors really look in the portfolios and ask who the manager is, what their track record on synthetics looks like, what the rating and mark-to-market stability is and so on.
AW, FSA I have a slightly different point of view, in that I believe investors in the higher part of the capital structure are often asked to buy CDO products based solely on the triple-A rating from S&P and Moody's – this may be less true for investors in equity or lower-rated tranches, who are given more time to analyze their investments properly. In the past 12 months, we have often been asked to make a bid for the guarantee of a e200 million tranche of a CLO within one week, and often without even having received an offering memorandum. Even though we are familiar with the European and US leveraged loan markets, I believe that doing one's homework is extremely important. Reading the underlying documents, understanding the structures, analyzing and modelling stress scenarios on the cash flows, and knowing and understanding the manager's strategy are essential steps before investing in any CDO product, even if it takes more time than the market currently offers. At FSA we certainly go through all those steps before guaranteeing any CDO product.
HL, SG CIB On the ABS-side – including cash CLOs – there is so much demand that people are perhaps investing without looking closely enough at the deals. In synthetic CDOs it is a different story, with an investment process which is usually much longer.
JL, Solent Capital I agree. As cash CLOs are marketed, investors are asked to express an interest in order to ensure an allocation. Even then investors are being scaled back. Deals have been over-subscribed three, four and even seven times. Deals get tightened two or three times in the final week of pricing. That is a sign of an over-exuberant market, but it's precisely because people think they understand that asset class well that they're abandoning the normal sort of caution you would expect. Investors are still getting used to synthetics and so still do a lot more due diligence.