A director of research at Quantifi, Dmitry Pugachevsky noted that sub-prime mortgages are subject to credit crisis. In other words, it tends to hurt credit structures. As a result, all the bespoke activities stopped, people do not even want to touch them. However, in several years encountering volatility, these products have shown that they perform stability with good returns. Investors looking for this type of leveraged exposure to credit see it as big risks, big rewards.
A few years ago, CSOs plunged into the amount of negative-yielding debt. Their goal is actually simple; promising heady returns. Theoretically, they must allow investors to make leveraged bets on how likely certain companies are to default. The bank arranging this theory slice a pool of CDS into tranches along with degrees of risk and return. This scheme resembles the mainstream CLO (Collateralized Loan Obligation) where loans come in bundles. Synthetic CDO, on the other hand, based on veterans of these markets said that it is not more complicated than CLOs.
A credit expert investing in both markets agrees by saying that CDO is actually simpler than CLO. He notes that certain features of CSO such as fixed maturity and static pool of credit are easier using financial models. Therefore, it is easier to get your hands around the risk taken. In a bespoke CSO, the investors must choose which companies’ CDS are in the portfolio.
They are also on the hook for any losses arising from the first few defaults, said IFR Asia. Sometimes it would be above 5% or 10% of the portfolio. As a result they could earn around 30% to 40/5 a year depending on the total of leverage they deploy. Senior investors with debt slices tend to have lower returns but they could get a greater level of defaults protection. The deals typically cover $500m to $1bn in size. It includes 80 to 100 names across US and European credit markets. The maturity length tends to be in two years.
