Christopher Cloke-Brown, director and head of credit portfolio strategy at Dresdner Kleinwort Wasserstein in London, recommended investors in the senior tranches of CDOs add some high-spread reference entities to their CDOs to boost yield. He explained that the tranches below will take the hit if these names default and the senior tranches will still be safe. "The subordination is like the crumple zone of a car," he explained.
The high-risk names, however, should also have a low correlation to the rest of the deal so that there is less chance of multiple defaults burning through the junior tranches. The same reasoning leads Cloke-Brown to stay away from entering deals with too many banks in the portfolio. This is because banks pay a low spread and are highly correlated to the wider economy.
