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June 3, 2007
CDO's in the news
On Friday, David Evans, in a piece Banks Sell 'Toxic Waste' CDOs to Calpers, Texas Teachers Fund over at Bloomberg blasted pension funds for holding the equity of CDO's. It covers a lot of bases, what's in them, how difficult it is to understand the risks involved, and it attempts to show through a parade that doing so is always a bad idea.
Which strikes me as the wrong attitude for a money manager to hold. Level of returns, the volatility of those returns, and correlation with the returns of other assets are really the only relevant metrics in assessing if the market price of an asset is low, high or fair.
What do we get instead? The treasurer of Orange County, California, Chriss Street that is is a violation of good fund governance to hold "even 1 percent of pension assets into the riskiest portion of a CDO...It's grossly inappropriate to take this level of risk" Which just isn't true, there is no such thing as an asset with too much risk if it is priced properly. One should just hold less of it if the risk involved is high but the price is attractive. As I mentioned once before, with a high enough yield, an asset that will almost surely eventually be worth nothing can be of immense value if the yield before default is high enough. There was a joke once about investments like that in the WSJ, they called them GLOVES or guaranteed lose of value equity shares.
But of the real metrics, price, volatility, covariance with other assets, the article makes no mention.
Thanks to InvestmentTools.com for the tip.
Financial Armageddon in Looking for Mr. Bagholder buys into the cynicism of the Bloomberg piece.
Blown Mortgage in Public pension funds buy bottom of the barrel debt joins those crying foul over pension investments, but has a neat chart to explain why they feel it is such a big deal. It also a link to a a great piece, The US Mortgage Market - Overexposed and Overrated, which makes the case for its title well, but again that still doesn't prove that the equity is a bad deal it depends on (all together now) the yield, the volatility and the covariances.
To really make the case that this stuff is poison to pension funds, you have to establish either (and better both) that:
1) owning even small pieces is incomputable with the duration of the funds' obligations
2) That they they paid the wrong prices for these assets
Hot air to the contrary, I believe neither claim has been established.
Posted by OneEyedMan at June 3, 2007 7:55 PM
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