Epsilon Investment Management'sSteve Stevanovich seems to have been on the money with his call in late May to buy the equity of collateralized debt obligations. He used a recent sell-off as an opportunity to raise capital for his firm by penning a letter on May 26. In the letter, a copy of which was obtained by sister publication Alternative Investment News, Stevanovich urges recipients to invest additional capital in Epsilon Global Value Fund III, as he and senior members of the firm had already done.
The letter says the recent sell-off in CDO equity tranches caused by the downgrade of General Motors' credit created a buying opportunity. The actual market prices of investment-grade corporate bonds are significantly higher than the price at which one can get exposure to the same bonds through a CDO structure. "The massive and unprecedented technical sell off in the CDO market over the last few weeks has created exceptional opportunities for absolute returns," the letter says.
At the time, CDO market watchers said that even though Stevanovich's explanation of the sell-off is accurate, they felt his comparison of CDO equity tranches to vanilla corporates was at best incomplete. An Epsilon spokesman, who returned calls to Stevanovich, defended the firm's methodology, stating that it is only one of a number of different models used by the fund. "In fact, our analysis is turning out to be very accurate. CDO equity tranche prices have gone up by 19.4% since we wrote our letter," the spokesman said. "Instead of the margin calls that were taking place in May, causing managers to liquidate positions, we are now seeing the return of cash collateral thus far in June."