OppenheimerFunds plans to set up a new portfolio to invest in equity classes of collateralized debt obligations, according to a firm official. The fund appears to mark the first time retail investors, to whom the fund would presumably be marketed given Oppenheimer's strong Main Street customer base, have been given the opportunity to participate in that part of the CDO capital structure, according to several market officials.
Oppenheimer is said to be in talks with Merrill Lynch to forge an alliance that would see the new fund invest in equity classes of transactions that Merrill underwrites. "We are looking at that but because we are in the offering phase we can't talk about it," the Oppenheimer official says, declining further comment. It also may be the first time a traditional asset manager has set up a fund to buy the equity portions of other managers' offerings and not just retain its own equity pieces.
An Oppenheimer-Merrill alliance would be logical, according to sell-siders. Merrill has stepped up its underwriting of CDOs since it hired Chris Ricciardi from Credit Suisse First Boston earlier this year and presumably is looking to place as much CDO equity as possible as it originates a flurry of transactions and moves up the league tables. "To the extent that they can't place some of the subordinates or equity, it makes sense to have an alliance with Oppenheimer," says one CDO originator, who notes that Merrill does not have the kind of balance sheet that a bank has. Another rival transactor says: "They've gone from being virtually nowhere to suddenly having this massive desk doing CDO product and it's a challenge to sell all that paper." Ricciardi did not return a call by press time last Wednesday during the holiday-shortened week.
The equity, or first-loss piece of a CDO, is the amount of excess spread available in a transaction. And although still a high-beta investment, investing in equity classes from CDOs is a lot less risky than it used to be, given the growth of more-stable asset classes such as leveraged loan and asset-backed CDOs. Equity returns these days vary but generally range from 13-18%. "
"Default rates have come down substantially, so investors are looking at a much more benign environment and that makes a levered position in the credit risk of the underlying asset class look more attractive," explains Tom Marx , a CDO strategist at Goldman Sachs . "It's an attractive time to invest in CDO equity if you take a diversified approach across asset types and vintages," says another analyst.