Collateralized debt obligation investors are asking dealers to structure synthetic CDOs in which managers can use credit-default swaps to hedge positions or lock in profits, which can then be used to add credit support to the transaction, typically called a short bucket. James Hart, portfolio manager at ZAIS Group Investment Advisors in Dublin, with over USD3.5 billion under management, said he would be more likely to buy a CDO tranche with this facility because it protects the portfolio against credit deterioration.
Deutsche Bank is currently working on a transaction that contains this feature, according to a market official. And JPMorgan also has similar transactions in the pipeline, said a firm official. "We've seen a lot of reverse inquiries for new applications of managers' skill, such as the ability to short a credit," he added. Officials at Deutsche Bank declined comment.
The first deal to have this facility was Deutsche Bank's Jazz transaction, which is managed by AXA Investment Managers. Although this deal sparked a flurry of managed deals, most of them did not have the facility to short credits. Rather, managers were only allowed to sell protection and buy bonds. One of the reasons it has been difficult to launch these types of transactions is there are not enough managers with the expertise to actively use credit-default swaps for hedging, bankers said.
But things are changing, according to one banker. Managers are becoming more comfortable with synthetic transactions in general and the rating agencies are also becoming more familiar with managers actively using credit-default swaps. "As we see more of them, we will get more comfortable with short buckets being included on transactions," said Andrew Jackson, director in European structured finance at Fitch Ratings in London.
Adam Clayton, director in structured credit trading at Merrill Lynch in London, said none of the managed deals the firm is working on currently have this structure. Clayton concedes this feature could be attractive, but is wary of increasing the complexity of deals. "Most investors are asking for defensive structures and although this can be seen as defensive, it adds another level of complexity for investors to understand."
