Within the collateralized debt obligation community a philosophical difference has emerged between CDO managers and bond buysiders. CDO managers are taking issue with the notion of CDOs as vehicles for vacuuming up undesirable credits, viewing them instead as leveraged funds. Buysiders, on the other hand, see the structured products as liquidity providers, particularly for lower rated credits.
"If the bonds aren't good enough for mutual funds, they shouldn't be included in a CDO," says Brian McManus, CDO manager at Merrill Lynch. While "it is true that the corporate market needs liquidity, it is naïve [of the buyside] to think CDOs can provide it for them," he adds. There has always been a misunderstanding about CDOs, "I think even people who know CDOs think of them in a certain way, but they really need to be viewed as looking for quality credits. Managers should learn they don't have to hit home runs all the time."
But buysiders see CDOs as having a different mandate than other funds. "They have a different risk profile than we would have, they are less risk averse," says Mike Dineen, portfolio manager at MONY Group in New York. This difference enables them to buy up credits other buysiders wouldn't, thereby providing liquidity and making a market. "They provide a technical kicker to higher risk issues," says Dineen. Andy Palmer, portfolio manager for ASB Asset Management in Washington, D.C. agrees, noting "CDOs come into the high-grade market and buy up bonds that have been beaten up, in particular intermediate bonds, providing a back up bid, which is good."
"We have to be careful CDOs aren't used as a dumping ground for the market," says McManus, adding CDOs aren't arbitrage but "really just leveraged funds that play with asset liability spreads." It is because CDOs are so leveraged that it is especially important managers look for undervalued credits rather poor quality bonds that blow up.