Hedge funds of funds may offer CDO opportunity, says S&P

Standard & Poor’s (S&P) today predicted that collateralised debt obligations (CDOs) of hedge fund of funds will be the next sector to fuel growth in alternative investments.

Speaking at the group's annual global CDO conference in London, Christopher Howley, a director at S&P’s structured finance rating group, said the $500 billion hedge fund industry is experiencing the largest inflows of cash in history, triggering a high level of CDO inquiries.

S&P assigned its first preliminary ratings to a hedge fund of funds transaction, Diversified Strategies CFO. The $500 million hedge fund transaction was lead-managed by Credit Suisse First Boston (AA/Negative/A-1+) with Investcorp Management Services acting as collateral manager.

"S&P currently uses an approach similar to that used for market value CDOs, in which the rated debt is backed by the market value of eligible assets discounted to reflect their inherent volatility over a certain exposure period," said Howley. "The liquidity profile of a fund and its redemption features are, therefore, an important part of the analysis."

Howley added that S&P will publish specific criteria that address structural and quantitative issues regarding this asset class within the second quarter.