DB Plans Slow To Buy In To CDOs

January 4, 2002 (PLANSPONSOR.com) - Collateralized debt obligations (CDOs) can play an important diversification role in a portfolio, but sponsors of defined benefit plans have been slow to warm to these investments.

These instruments, securitized pools that draw together an assortment of debt instruments, are usually broken down into tranches with differing interest rates and degrees of risk.  They offer yields midway between those of investment-grade debt and junk bonds.

Standard & Poor’s (S&P) reports that during the second quarter of 2001, while yields fluctuate:

  • the average institutional spread for BB-rated CDO tranches was LIBOR plus 3.18%
  • down from LIBOR plus 3.26% in the first quarter,
  • while investment-grade credit averaged LIBOR plus 2.14%,
  • and¬†speculative-grade credit averaged LIBOR plus 9.38%

By mid-year 2001, according to S&P, 70 CDO transactions were completed versus 55 for all of last year; the value of those deals totaled $24.65 billion compared to $23.88 billion for all of last year.

Demand for CDOs has been highest among insurance companies, foreign interests, financial companies, and hedge funds. But their complicated structures and relative newness make them a difficult sell to pension oversight boards.

“There have been several other plans that have looked at participating in CDOs,” says Andrew Dickey, managing director of structured credit at David L Babson & Company. “But, the big issue for many public employee plans is that this is an alternative asset class and typically, within their own staff, they would not necessarily have the people to review these individual investment transactions.”