University endowment plans and private equity investors are starting to look at buying the first-loss classes of collateralized debt obligations, according to sell-side professionals who have been pitching the investments. They say tight spreads in other fixed-income asset classes are causing buyers that had traditionally not dabbled in the riskiest CDO classes to take a look. This comes as first-loss CDO pieces, dubbed equity, have become more stable and, while projected returns have come down to the teens, they are also seen as less risky investments. The identities of the private equity firms are closely guarded secrets given that the sell-side is always looking for new investor bases.
Duke Management and UNC Management are named as two endowments that have looked at investing in CDO equity. It is unclear if they have participated and representatives from the two university plans either declined to comment or could not be reached by press time.
Since the first-loss piece typically is the bottom 10% of a transaction, even small forays by new players would go a long way toward selling new deals, sell-siders say. They point out that new investors would likely invest in at least a couple deals for diversification, probably at around $10 million a pop. Research pros are beginning to put out pieces aimed at the emerging buyers. Wachovia Securities recently put out a report on buying the first-loss class. "Given the fact that there are new investors coming into the CDO equity arena, we thought it would be useful for them," explains Arturo Cifuentes, managing director and head of CDO research.
"It's a totally new investment for them, but at the same time it serves their needs," says one observer. Private equity investors, for example, have long time horizons, while CDO equity pieces offer shorter maturities and instant cash flows. For endowments, CDO equities are increasingly become an investment option as part of alternatives buckets.
