Investors in collateralized debt obligations should focus on first-loss pieces and deals backed by European investment-grade equity debt. Giancarlo Saronne, executive director at Lehman Brothers, says leveraged loan-backed deals are senior, contain strong covenants and have exhibited strong historical recoveries. Opportunities abound because institutional buyers cannot invest directly in these, limiting money flows and volatility in the sector, he adds, as part of a panel on CDOs.
The case for investing in the first-loss, or equity, classes is also strong given the improving credit cycle which means that few or no defaults are expected in the near term. Saronne says while credit spreads may be tight already, there is still room for further tightening because default risk represents only 25-30% of the spread on investment-grade corporates.
