Alternative investments: Collateralized fund obligations issuance by FOHFs increases
An increasing number of funds of hedge funds are issuing collateralized fund obligations. There have been 20 such transactions, 10 of which were launched in 2006. "We expect the number of CFO transactions in 2007 to surpass that of 2006," says Ken Margolis, co-head of global CDOs at Merrill Lynch.
CFOs are long-term managed structured finance products issued by a fund of hedge funds manager. The CFO issues several tranches of differently rated debt securities, and then equity securities, offering different risk-return trade-offs. Performance is based on the pool of underlying hedge fund assets. For example, in February P&G Alternative Investments, a fund of hedge funds and CDO group based in Italy, launched a €150 million CFO called Zoo HF 3. Zoo HF 3 has an underlying pool of 52 hedge funds and 14 different strategies. The CFO comprises five classes of debt ranging from triple A-rated to double B-rated, and one unrated equity class. The debt investors receive semi-annual coupons ranging from six-month Euribor plus 40 basis points to six-month Euribor plus 600bp.
The benefits to a fund of hedge funds in raising assets through a CFO are clear. Fabrice Susini, European head of securitization at BNP Paribas, which put together the Zoo CFO, says: "The management costs are lower than in funds of hedge funds, yes, but the main benefit to a fund of hedge funds manager is that, given the maturity of the CFO being seven to 10 years, he can look at investments as long-term without the worry of redemptions by investors."