| Collateralised Bond Obligation 101 |
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| 08/01/2006 | |
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Ravi Shankar, managing director and chief investment officer at Epic Asset Management, answers this week's 101 on Collateralised Bond Obligation 1-What is a Collateralised Bond Obligation? Put simply, a CBO is a repackaged security (or series of securities), the payments on which are met by interest and principal payments from a diversified portfolio of bonds held in the CBO structure. The main reason for repackaging in this way is that it is possible to create new securities that offer substantially higher returns and reduced risks compared to the original portfolio of bonds that fund the interest and principal repayments on the newly created securities. This is achieved through the time established concept of portfolio diversification. The resulting bonds are typically tranched (super senior, senior, mezzanine, equity) to match the risk/reward requirements of an investor - effectively creating leverage. 2-What is the objective of such a strategy for an institutional investor? CBOs enable investors to leverage their income in a controlled manner. Whilst returns can be leveraged, it is also possible to minimise potential losses by employing active management of the bond portfolio or, if extra comfort is desired, by utilising financial engineering techniques to protect the principal invested for the term of the structure. 3-What kind of investor should invest in this kind of vehicle? Are there any particular drawbacks? Whilst we believe that CBO's can be attractive to a wide range of investors, because of the complexity and sophistication we would only recommend them to competent professional investors. Potential drawbacks generally arise from over concentration in particular sectors - successful diversification is key. Particularly for mezzanine or equity investors we would counsel that they should be wary of CBOs which contain exposure to other CBO's as part of their underlying portfolio, as the risk concentration in such structures could be increased beyond any additional benefit from their inclusion. |
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Articles of the same Serie : 101 |
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