Investing in CDO Market

A CDO (Collateralized Debt Obligation) is an investment vehicle consisting of income-producing assets financed by issuing multiple classes of debt and Equity.

A cash flow CDO securitizes a diversified pool of funded debt assets into multiple classes of notes from the cash flows generated by such assets.

A cash flow CDO can be either static or managed. The portfolio of a static cashflow CDO is fixed for the life of the CDO, whereas an asset manager is appointed to actively manage the underlying portfolio of a managed CDO.

The Senior Tranche (or Senior Debt) of a cashflow CDO is typically highly rated as it is ranked first in the priority of payments of the tranches. The Mezzanine Tranche, or Mezzanine Debt, generally refers to the lower rated tranches senior to the Equity but lower in priority to the Senior Debt.

A CDO Equity holder generally owns the rights to receive the “residual” or “excess” cash flow produced by the CDO collateral which remains after paying the CDO liabilities such as expenses and Senior and Mezzanine Tranches interest.

CDO Equity

CDO Equity holders typically receive current income in the form of distributions on a quarterly basis. Any change affecting the cashflow expected on a distribution date can affect the payment to the CDO Equity.

Because a CDO is a leveraged investment vehicle, there is greater potential upside to CDO Equity than for a direct investment in the underlying portfolio, but at the same time, CDO Equity holds significant risks which should be carefully reviewed. Performance of CDO Equity can be significantly affected by a number of factors, including defaults and recoveries on the underlying assets and the failure of certain coverage or collateral quality tests.

The CDO vehicle purchases the collateral on a non-recourse basis with money it raises from the Equity holders and borrows from the Senior and Mezzanine note holders. Unlike certain other types of leveraged investments, CDO investors are not subject to margin call. Consequently, the leverage in the transaction will not directly be affected by interim volatility in the price of the collateral.

CDO Equity represents a hybrid between Fixed Income and Alternative Investment Strategies, offering potential returns comparable to stock and alternative investments. Such returns are attainable by leveraging a diversified portfolio of fixed income assets using a unique long-term, low cost financing with no mark-to-market call and no recourse. Similar to fixed income investments, risk and reward are driven by credit performance rather than earning performance.

CDO Equity Compared to Other High-Return Strategies

Returns on financial assets can be generated through both income and principal appreciation. As the primary driver for returns on Venture Capital and Private Equity investments is principal appreciation, current income is not expected to be high and overall returns are back-ended.

CDO Equity relies on current income for the majority of total return. Current income is generated from assets in collateral pool and distributed from initial investment date, the potential of losing entire principal is low and capital appreciation is limited. Both the timing and source of returns make CDO Equity a natural complement to other investment strategies.

CDO Fund as an Alternative Investment

Traditional funds such as hedge funds, funds of funds and Private Equity funds have focused mainly on the equity and stock markets . Many investors have not had the opportunity to participate in a CDO fund such as Crystal Fund, which targets assets across the diversified $12 trillion credit markets.

The typical underlying assets of a cashflow CDO are leveraged loans and Asset-Backed Securities (ABS). These assets have the added benefit of being uncorrelated to other types of securities that investors hold. For example, the correlation between leverage loans and the S&P 500 index is relatively low.

Benefits of a CDO Equity Fund:

Potential for regular cash distributions and a short duration investment
Achievement of non-recourse leverage to the CDOs’ underlying assets
Exposure to an investment without investing in the technical and capital resources necessary for analysis of each asset
Access to a variety of experienced CDO managers, across asset classes and structures, reducing reliance on any one manager or underlying asset type
Review by the Investment Manager of each CDO manager and structure prior to purchase, and ongoing monitoring of key performance parameters
Uncorrelated credit-driven assets in the investment portfolio enhances total potential return while minimizing risk, as measured by volatility of the CDOs’ underlying assets
Purchasing price and terms that enhance potential returns are obtained by Investment Manager’s leverage of relationships with asset managers, trading desks and arrangers

Risks of a CDO Equity Fund:

Potential of loss of the full amount invested
Limited liquidity
Equity and Mezzanine Tranches of collateralized debt obligations carry risks that can adversely affect the performance of the Fund and demand for its shares.

Investing in the CDO Market A CDO (Collateralized Debt Obligation) is an investment vehicle consisting of income-producing assets financed by issuing multiple classes of debt and Equity. A cash flow CDO securitizes a diversified pool of funded debt assets into multiple classes of notes from the cash flows generated by such assets. A cash flow CDO can be either static or managed. The portfolio of a static cashflow CDO is fixed for the life of the CDO, whereas an asset manager is appointed to actively manage the underlying portfolio of a managed CDO. The Senior Tranche (or Senior Debt) of a cashflow CDO is typically highly rated as it is ranked first in the priority of payments of the tranches. The Mezzanine Tranche, or Mezzanine Debt, generally refers to the lower rated tranches senior to the Equity but lower in priority to the Senior Debt. A CDO Equity holder generally owns the rights to receive the “residual” or “excess” cash flow produced by the CDO collateral which remains after paying the CDO liabilities such as expenses and Senior and Mezzanine Tranches interest. CDO Equity CDO Equity holders typically receive current income in the form of distributions on a quarterly basis. Any change affecting the cashflow expected on a distribution date can affect the payment to the CDO Equity. Because a CDO is a leveraged investment vehicle, there is greater potential upside to CDO Equity than for a direct investment in the underlying portfolio, but at the same time, CDO Equity holds significant risks which should be carefully reviewed. Performance of CDO Equity can be significantly affected by a number of factors, including defaults and recoveries on the underlying assets and the failure of certain coverage or collateral quality tests. The CDO vehicle purchases the collateral on a non-recourse basis with money it raises from the Equity holders and borrows from the Senior and Mezzanine note holders. Unlike certain other types of leveraged investments, CDO investors are not subject to margin call. Consequently, the leverage in the transaction will not directly be affected by interim volatility in the price of the collateral. CDO Equity represents a hybrid between Fixed Income and Alternative Investment Strategies, offering potential returns comparable to stock and alternative investments. Such returns are attainable by leveraging a diversified portfolio of fixed income assets using a unique long-term, low cost financing with no mark-to-market call and no recourse. Similar to fixed income investments, risk and reward are driven by credit performance rather than earning performance. CDO Equity Compared to Other High-Return Strategies Returns on financial assets can be generated through both income and principal appreciation. As the primary driver for returns on Venture Capital and Private Equity investments is principal appreciation, current income is not expected to be high and overall returns are back-ended. CDO Equity relies on current income for the majority of total return. Current income is generated from assets in collateral pool and distributed from initial investment date, the potential of losing entire principal is low and capital appreciation is limited. Both the timing and source of returns make CDO Equity a natural complement to other investment strategies. CDO Fund as an Alternative Investment Traditional funds such as hedge funds, funds of funds and Private Equity funds have focused mainly on the equity and stock markets . Many investors have not had the opportunity to participate in a CDO fund such as Crystal Fund, which targets assets across the diversified $12 trillion credit markets. The typical underlying assets of a cashflow CDO are leveraged loans and Asset-Backed Securities (ABS). These assets have the added benefit of being uncorrelated to other types of securities that investors hold. For example, the correlation between leverage loans and the S&P 500 index is relatively low. Benefits of a CDO Equity Fund: Potential for regular cash distributions and a short duration investment Achievement of non-recourse leverage to the CDOs’ underlying assets Exposure to an investment without investing in the technical and capital resources necessary for analysis of each asset Access to a variety of experienced CDO managers, across asset classes and structures, reducing reliance on any one manager or underlying asset type Review by the Investment Manager of each CDO manager and structure prior to purchase, and ongoing monitoring of key performance parameters Uncorrelated credit-driven assets in the investment portfolio enhances total potential return while minimizing risk, as measured by volatility of the CDOs’ underlying assets Purchasing price and terms that enhance potential returns are obtained by Investment Manager’s leverage of relationships with asset managers, trading desks and arrangers Risks of a CDO Equity Fund: Potential of loss of the full amount invested Limited liquidity Equity and Mezzanine Tranches of collateralized debt obligations carry risks that can adversely affect the performance of the Fund and demand for its shares.		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Investing in the CDO Market