Miguel Ramos Fuentenebro outlines the thinking behind Washington Square's recently launched innovative LSE-listed Carador CDO equity fund.
HW: What is the background to the fund?
MRF: Washington Square was founded in 2003 with a focus on structured credit. The team comprises ten professionals with over 10 years average experience in credit and structured products. The group has two principal areas of activity: our managed synthetic CDO business, of which we currently have EUR 580 mm of notional assets under management and two new CDO structured products in the market; and our credit funds business, which invests in third party structured products.
Carador, our most recently launched credit fund, is an Irish domiciled, LSE listed CDO equity fund, which invests in traditional, cash flow CDO equity
The CDO market has often, and with reason, been considered opaque and transactional. However, many investors have been attracted by the potential risk/reward profile and low correlation with traditional and alternative asset classes. Although, the significant level of resources needed to analyse these transactions has also precluded many investors from getting involved.
Carador offers a professionally managed, diversified vehicle for accessing the asset class with a strong focus on risk management. The listing on the London Stock Exchange offers the best level of transparency and potential liquidity through several market makers. If an investor believes that an allocation to CDO equity could be efficient from a portfolio management perspective, he can now execute his asset allocation decision in a quick and efficient manner through a vehicle such as Carador.
HW: Who are your service providers?
MRF: Auditors: Ernst & Young, UK Counsel: Herbert Smith, Irish Counsel: Arthur Cox, Custodian/Trustee: Northern Trust, Sponsor: ABN AMRO Hoare Govett
HW: How and where do you distribute the fund? What is the profile of your current and targeted client base?
MRF: As Washington Square has a strong bias toward building interactive investor relationships, we have taken responsibility for most of the marketing and business development process on the CDO Equity fund. Whilst we do work with financial institutions on raising capital for specific products, we prefer to maintain control over the fundraising and investor marketing process. In our experience, particularly on the Carador fundraising, our products have a broad investor appeal.
Our client base is diverse and includes pension funds, banks, insurance companies, funds of funds and family offices. Geographically we have tended to focus on Europe and Asia. However, we see scope to expand our investor base into the US in future.
HW: What is the investment process of your fund?
MRF: 3-Step process involving intensive due diligence on CDO managers, analysis of the underlying collateral portfolio, including re-rating the portfolio if necessary, and a full structural analysis of the transaction. This also involves modelling and stress testing for each individual investment, as well as the overall portfolio. For any given CDO we need to feel comfortable not only with the structure, but with each asset in the underlying portfolio.
HW: How do you generate ideas for your fund?
MRF: We constantly monitor CDO arbitrage opportunities across markets and review potential managers. At any one time, we may be reviewing up to 20 different CDO transactions.
HW: What is your approach to managing risk?
MRF: Carador benefits from state of the art, proprietary risk management systems. The fund aims to diversify across a wide range of asset classes and issuers as well as across managers and vintage. Risk analysis is performed at underlying asset level.
For corporate credit CLOs, our experienced credit team individually assesses each asset. Essentially, they will re-rate each and every underlying asset of each prospective CLO investment.
For Structured Finance CDOs, our Structured Products team will undertake an analysis of the underlying pool of collateral, be it ABS, RMBS, or CMBS. Carador has a maximum investment limit per transaction of 5%, although the key to managing the risk is in our ability to quantify default and recovery risk on the entire portfolio of single names across all CDO investments. In our view, this approach minimises the probability of 'tail events'.
Modelling inputs are based on forward-looking estimates by our research group, not just historical trends.
HW: How/against what do you benchmark the performance of your fund?
MRF: Carador has a total return focus, although it aims to pay a regular dividend after ramp up in the region of 12%. Carador will be traded on the London Stock Exchange, and total return for investors will also be a function of market price.
HW: Has your performance been as per budget and expectations? Do you expect your performance or style to change going forward?
MRF: There are few sources of historical performance data for CDO equity investments. Published reports show historical returns in line with our target objective. An interesting characteristic of CDO equity investments has been their low or even negative correlation with other traditional or alternative asset classes. Being a publically traded fund, the advantage of Carador is that it will finally offer a reliable source of pricing information to investors.
HW: What opportunities are you looking at right now?
MRF: The potential arbitrage opportunity offered by CDO equity investments is variable. At the moment, we like transactions backed by senior secured loans and high grade structured finance assets, although our investment decisions are very much on a transaction-by-transaction basis.We can find value in a variety of different underlying assets classes, depending on the structure and the manager.
HW: What events do you expect to see in your sector in the year ahead?
MRF: Many underlying asset classes are facing ongoing credit spread tightening, which can make it difficult to find arbitrage opportunities in the CDO asset class. However, we expect to see attractive arbitrage opportunities coming from new geographical regions such as Asia, i.e. Asian secured loans and RMBS.
We also expect to see transactional fees declining as investors such as Carador become more involved in originating transactions.
HW: How will these changes/future events impact on your own portfolio?
MRF: New innovation and new asset classes will increase the diversity of the portfolio. Greater involvement by equity investors will result in more stable transactions and more diversity in terms of underlying assets and managers.
HW: What differentiates you from other managers in your sector?
MRF: WSQ is a well regarded CDO manager which combines strong fundamental research and proprietary modelling capability. There are very few managers in the structured credit space, which combine strong credit research and structural analysis.
HW: Do you have any plans for similar/other product launches in the near future?
MRF: We are looking to further leverage our expertise in CDOs and our proprietary CDO platform. We expect Carador to become the asset allocation vehicle of choice in the CDO equity space.
(Miguel Ramos Fuentenebro was interviewed during April 2006)