Attractive investment opportunities lie in managed synthetic CDOs, says Goldman

Managed synthetic collateralised debt obligations (CDOs) currently present an attractive long-term opportunity for investors, Goldman Sachs said in a new report this week. The CDOs, composed of credit default swaps on corporate credit, take advantage of wide credit spreads and substantial risk premiums evident in the current credit market conditions.

The US investment grade credit markets have recently experienced a period of high spread volatility with wide credit spreads for many fundamentally strong corporate issuers. But as US corporate spreads have moved wider, investment grade defaults have remained substantially below historical maximums.

Goldman Sachs expects the credit quality of the US corporate sector to stabilise and improve over the next few years. Therefore, managed synthetic CDOs offer investors a unique strategy for taking advantage of current credit conditions, according to Alex Reyfman, a New-York based CDO strategist at Goldman Sachs and author of the report, ‘Wide credit spreads create an opportunity in managed synthetic CDOs'. By investing in a synthetic investment grade CDO, investors can allocate to US corporate credit at a historically advantageous time.

The ‘synthetic’ structure provides a degree of protection from single-name default risk. Wider credit default swap spreads in a managed synthetic CDO reference portfolio improve the stability of the issued notes. If the transaction then performs well, the excess spread flows to the equity class.

Reyfman said managed CDOs are an effective risk-controlled strategy for implementing a long-term allocation to corporate credit. In a report released last Friday, Lang Gibson, CDO strategist at Banc of America Securities in New York, also said the increased credit spread of 30-40 basis points in synthetic AAA is attractive if the manager is acting in the long-term interests of the senior debt-holders.

Global synthetic CDO volumes stand at $137.9 billion, with 14% of deals managed, according to Banc of America. Global cash CDO volume is $54 billion to date.