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Etolian Capital, a fixed income hedge fund founded by derivatives honcho George Handjinicolaou, is gearing up to start pre-launch trading next month with an eye to going live in January. Handjinicolaou, former managing director and head of global fixed income emerging markets at Merrill Lynch in New York, said the fund will pursue a quantitative options model to invest in relative-value credit plays, such as capital structure arbitrage.

Collateralized fund obligations (CFOs) represent the latest application of securitization technology to a new asset class--hedge funds--and offer investors debt and equity classes backed by a diversified portfolio of funds managed by a fund-of-hedge-funds manager. Financing investments in hedge funds is nothing new. Banks have financed hedge funds for many years. But financing the investment using securitization technology and tapping institutional investors is new, with the first two publicly rated deals having closed this past summer, and a growing pipeline at dealers and rating agencies. Relative to the collateral backing conventional CDOs, a CFO's underlying hedge fund collateral is much more diversified, having high risk-adjusted returns and very low correlation to traditional equity and fixed income asset classes. These features, together with low historic return volatility and relatively low absolute losses, even in distressed markets, make hedge funds both an attractive addition to an investment portfolio and an attractive asset class to securitize. Investment in a CFO provides equity investors with efficient, non-recourse leverage, and offers debt investors with an opportunity to lend against an asset class less correlated with credit markets. The universe of hedge funds includes as many as 5,000 hedge funds managing in excess of USD550 billion in assets. Hedge fund investment strategies may be grouped broadly into 12 to 15 different styles, such as merger arbitrage and distressed situations. Fund of funds managers strive to assemble a portfolio of hedge funds that is resistant to event risk by employing multiple managers having diverse investment strategies, with the goal of achieving "equity-like returns with bond-like volatility." CFOs offer portfolio managers with another way to increase assets under management and diversify funding sources, as well as provide longer term financing than bank lines.

New York-based multi-strategy hedge fund D.E. Shaw, with USD4.3 billion in capital under management, has hired Kevin Fox, former senior v.p. and general manager of commodity services at Aquila, to launch an energy trading operation. D.E. Shaw expects to trade both physically and financially settled energy contracts and has hired additional trading personnel, according to an official familiar with the fund's strategy. Fox, who is due to join the secretive hedge fund today, could not be reached for comment. Officials at D.E. Shaw in New York declined all comment.

The Council of Europe Development Bank has entered a cross-currency interest rate swap to convert a AUD100 million (USD55 million) fixed rate bond into a euro-denominated synthetic floater. Arturo Seco, deputy treasury manager at the Council in Paris, said the bank pays three-month Euribor and receives the 5.25% coupon on the bond. The swap mirrors the five-year maturity of the bond.

Nederlandse Waterschapsbank, a public sector finance agency, has entered a foreign exchange swap to convert the proceeds of a recent Australian dollar-denominated bond into euros. Tom Meuwissen, head of treasury, said the bank always exchanges foreign currency issues into euros, to alleviate currency exposure.

The European Investment Bank has entered two interest rate swaps to convert a recent fixed-rate bond offering into a floating-rate liability. The firm entered a fixed-to-floating swap on the back of a recent GBP200 million (USD312.9 million) bond sale and a GBP100 million increase to an existing bond, said an EIB official. The swaps were put on as part of the bank's policy to hedge interest rate risk on its bond sales.

Capital Invest, which manages roughly E4 billion in fixed-income assets from its Vienna office, will reduce its corporate bond holdings further if the economic outlook in the U.S. and Europe continues to deteriorate. Andreas Schuster, portfolio manager, says the firm currently devotes roughly 15% of its portfolio to corporate bonds, but will reduce that to 10% if the general picture emerging from Europe continues to worsen and there are signs of continued weakness in the U.S. for the fourth quarter. For example, worsening data from economic surveys, in particular, consumer spending, could prompt the move. The firm has been reinvesting its assets in European government and euro-denominated government bonds, and will continue to do so.

Restructuring a company is often a zero-sum game. So, it is only natural that there would be some finger-pointing involved when things go wrong, as constituents fight to get the biggest piece of the pie. But during a role-playing session at the Distressed Debt Summit 2002 this past week, one speaker representing the interests of the secured lenders shed a little light onto his frustration when the finger was pointed at him. "As always, we are the culpable ones because we had the bad judgment to lend you money," he said.

Nelson Capital Management plans to swap 5% of the firm's $120 million portfolio into corporates from agencies but wants to see better corporate earnings reports over the next few weeks before making the move, according to Palo Alto, Calif.-based portfolio manager Brian Roberts. The move is predicated on the view that the economy is improving and corporate bonds will outperform agencies.

This chart, provided by Citibank/Salomon Smith Barney Inc., tracks bid-ask prices for par credit facilities that trade in the secondary market. It also tracks facility amounts, ratings, pricing and maturities

The Texas Permanent School Fund is planning to add up to 2-3% of its portfolio, or $140-210 million, to corporate bonds over the next two or three months in a bid to add yield. Carlos Veintemillas, portfolio manager overseeing some $7 billion of taxable fixed-income in Austin, says he is looking at short duration single- and double-A credits. To finance the purchases, the fund will use the proceeds from prepayments in its mortgage-backed securities portfolio, and new cash from royalties the fund receives for oil and gas fields on public lands. Veintemillas says he is waiting for evidence of increased capital expenditures by companies before making the move.

The Catholic University of America has made its first foray into distressed debt, investing $4 million in the asset class, according to Ralph Beaudoin, v.p. of finance and treasurer. The roughly $130 million endowment decided to enter the distressed arena because the asset class is performing well at a time when few other investments are, Beaudoin said, emphasizing the counter-cyclical nature of distressed debt. "Distressed is having its day in the sun," he added.