Synthetic CDOs: Managers bet on long/short CDOs to deliver

The number of long/short CDO structures, or strategies that generate alpha in a deteriorating credit environment, is on the rise. There are very few managed CDOs currently in the market that do not try to include some sort of short strategy. Incorporating efficient long/short techniques into CDOs has become one of the most challenging goals because extracting every last basis point of extra yield is no longer generally perceived to be the best strategy in credit.

It is easy to understand why the consensus over going long corporate credit – which was generally the correct credit strategy over the past four years – has evaporated. The momentum behind a four/five-year bull market is facing a serious check in the form of sub-prime woes and slowing US economic growth.

In the CDO world, an efficient long/short structure is something of a holy grail. It is one thing to...