Portfolios: prevalent but problematic

When asked to identify the most exciting area in the derivatives market, a speaker at last month’s Risk USA conference in Boston responded: “There’s only one story at the moment, and that’s single-tranche CDOs.” As the popularity of such bespoke deals has increased in the past year, Risk has exposed many hitherto hidden controversies surrounding the products. And ratings arbitrage, credit substitution rights and adverse selection are just some of the problems that have troubled the buy side.

One of any potential investor’s fundamental concerns is to select an efficient reference portfolio. But it seems dealers are divided over what their role should be in bespoke deal portfolio selection (see article). In our second article on single-tranche CDOs, we highlight the changing nature of hedge funds’ involvement in this market – they have shifted from investing in to managing bespoke deals (see article).

Although the ubiquity of products such as CDOs and nth-to-default