UBS Warburg is working on its first collateralized fund obligation with sister company and hedge fund specialistO'Connor . In the structure O'Connor will select a portfolio of 40 hedge funds diversified across region and strategy and the investment bank will tranche the risk, according to officials familiar with the deal. Officials at UBS and O'Connor declined comment.
The size of the deal will depend on the size of the equity investment the firm can raise, according to one official familiar with the deal. For each dollar of equity the firm can issue three dollars of mezzanine risk. The official expects the deal to be around USD350 million.
Investors will be able to buy into the CFO through three tranches of credit-linked notes rated AAA, A and BBB and an equity piece. The deal, which will probably price in the next two months, is expected to price wider than a traditional collateralized debt obligation because investors are not familiar with the asset class, for example the AAA tranche will be around 15-20 basis points over three-month LIBOR instead of 5-8bps, said rivals.
The motivation behind the deal is to give O'Connor a new funding stream and diversify CDO investors' portfolios, according to officials. A rival structurer expects more deals to hit the market because of the demand for diversity. Another said some investors may shy away from the CFOs because they, and the rating agencies, do not have expertise in the hedge fund sector. However, the deals have a lower leverage than traditional CDOs. For example, the UBS deal will have a leverage of four times the equity tranche, whereas a traditional synthetic investment-grade CDO may have a leverage of up to 20 times. In addition, the rating agencies are more conservative in ratings these deals, he added.
