Hedge funds and other investors are reviving a type of securitized product that blew up during the financial crisis. This time around they're convinced that the structures will not only weather the next downturn, but might even profit from it.
Money managers are resurrecting collateralized debt obligations that bundle risky bonds and loans into new, higher-rated securities. Issuers such as Anchorage Capital Group and Fortress Investment Group are betting tweaks to the products will allow them to keep enough cash on the sidelines that, when the next slowdown hits, they'll be able to swoop in and buy the most beaten-down debt on the cheap.
The expansion of the asset class is another example of how money managers are bracing for a slump despite the credit market's resiliency in recent years. They're also making tweaks to collateralized loan obligation structures — such as boosting their capacity to hold lower-rated debt — in preparation for a potential jump in rating downgrades. New entrants include Blackstone Group's credit hedge fund, which sold its first post-crisis CDO late last year, and B. Riley Capital Management, which is starting up a unit to issue the securities.
"Now is the time you have to be active," said Tim Gramatovich, who joined B. Riley in March to lead its CDO efforts. "We see the opportunity set in secondary loans, with a healthy dose of bonds."
Issuers say today's CDOs bear little resemblance to the ones that helped nearly bring down the global financial system. For starters, they argue that corporate debt is far less risky than the subprime mortgages and credit derivatives that ended up in the securities a decade ago. CDO issuers are also more restricted in how much borrowed money they can use to juice returns, both compared to previous years and what's permissible in a CLO.