A growing block of investors is circling the equity piece in collateralized debt obligations before the deals come to market and taking a more activist role in their structuring and pricing. A major source of talk at the American Securitization Conference in Las Vegas last week was how some funds that specialize in buying equity tranches--sometimes referred to as the toxic waste of a CDO--have pushed for lower manager fees in addition to negotiating for provisions and structural features that boost the returns. This ability to cut special deals with issuers and newer CDO managers has become a major marketing point for these upstart funds.
"The influence of the CDO equity buyer is really starting to drive the economics of these deals," noted one CDO investor. "There have always been hard-lined equity buyers. But the frequency of these tactics has picked up and so has their buying power," he added.
Market participants pointed to New York-based Tetragon Credit Income Fund, which is managed by hedge fund Polygon Investment Partners, and Illinois-based Magnetar as players who have made a name in this type of approach. Dealer proprietary desks that hold the equity of CDOs their firms have issued are also understood be in close contact with arrangers--in this case the firm's structured credit desk--to get favorable terms. Market participants said the prop desks at most Street firms have built large equity portfolios in the past year, and in particular Lehman Brothers andMorgan Stanley have gained influence.
Calls to Polygon, Magnetar, Lehman and Morgan were not returned by press time.
CDO equity funds have recently pushed for manager fees to be cut significantly, sometimes by as much as half. In addition, hedge funds are reportedly sometimes taking a share in the fees in exchange for swallowing all of the equity, while collecting their own fees for managing the equity portfolio, according to an investor in one such fund. This fee structure is similar to a fund of funds and fully disclosed to investors.
"It's another way to extract fees from investors while effectively buying the market," noted one credit player.
Synthetic asset-backed security CDOs without triggers have become more common as a result of reverse inquiries from funds looking to stoke the returns of the equity piece in these CDOs. "These funds ask for non-call provisions on bonds sooner rather than later and they are getting them," an investor told DW at the conference.
The investor added that some of the new funds even hope to have the ability to kick out collateral or even remove managers based on performance.
Some more established equity funds are not convinced, however. "I think that some of these funds looking to set up now are overselling their abilities to negotiate," said one CDO equity manager.
