Most recently hailed as the creator of the newly formed securities known as Diversified Asset Securitization Holdings (DASH) - the first collateralized debt obligations to be entirely backed by lower-rated CMBS and ABS - Asset Allocation & Management Co. is destined to be a driving force in the asset-backed and commercial mortgaged-backed securities markets going forward.

Moreover, AAM is now selectively buying the lower classes of a deal that Constellation Financial Management Company is bringing to the market.

Chicago-based AAM recently teamed up with Prudential Securities Inc. to create one of the first ABS/CMBS-backed CBO's. These highly structured securities give investors more leeway: Lower-rated, higher yielding CMBS and ABS are repackaged into various-rated tranches, allowing investors to choose their level of risk and average life.

"Last year we closed with Prudential on an asset-backed CBO deal, for which we are going to be the collateral manager," said Larry Zeno, portfolio manager and principal with the company. "It's a CBO that substitutes ABS and CMBS, overwhelmingly investment-grade, for high yield corporate bonds as the CBO collateral. We believe on a risk-adjusted basis this CBO is far less prone to rating downgrades than high yield corporate CBO's and history has proven us right so far."

The DASH 99-1 has two triple-A-rated classes, one fixed-rate, one floating-rate, a triple-B-rated fixed class and an Equity class that AAM and its clients retained.

Tapping the Private Placement Market

AAM was formed with the purpose of serving as an investment manager to the insurance industry. Its goal is to more effectively manage assets for the medium size insurance company allowing them to maximize the performance of their investment portfolio and to provide an efficient means to do so from a cost point of view.

"We're a private partnership formed in 1982 from three senior partners from Northern Trust Co. We're fully independent and owned by the principals of the company."

AAM manages about $10 billion of fixed income, with $3 billion of that being structured ABS and CMBS product, although it does have other side asset classes.

"The private placement market is dominated by insurance companies given their traditional buy and hold' mentality and their need to put yield on the books," said Zeno. "Insurance companies typically do not need the liquidity of accounts that are benchmarked against the traditional indices. AAM is different from many insurance companies given we do not earmark a specific amount of money to be invested in a given asset class, including privates. We will select whatever asset class that offers the highest risk adjusted returns and subordinated structured product offered that for much of 1999."

The company dabbles quite frequently with $1 billion of its portfolio being private placement or Rule144A, and $600 million of that is in structured product.

"Of the three billion we have in structured product roughly $600 million is private," Zeno explained. "We're way overweighted in structured product, because we have always had the belief that structured product has less inherent credit risk than similarly rated corporate bonds. We still have a couple of billion in the public market but many of the new structures come out first in the private placement market."

Some of the private asset classes that look attractive to Zeno are mutual fund receivables deals and franchise deals in terms of spreads and the collateral credit quality.

What Makes Them Special

"We are a relatively small company that works very closely. All of the traders and portfolio managers are within shouting distance." Zeno said. "We don't have to wait for approval from a formal committee that meets once a week to get approval on new asset classes. We have the charter to look at new asset classes and evaluate them on their own merits."

The company has also maintained a bias towards structured products over corporate credit products, a strategy that has proven beneficial to the company.

"Our total return numbers in the long run have outperformed our benchmarks significantly," he said. "We think structured product is by its nature cheap and will remain cheap until you get a large component in some of these major fixed income indices."

Its target for 1999 varied from account to account, as all its insurance company accounts are individually managed. AAM targets for CMBS were in the 10% to 15% range, including both public and private placements.

"After the fall of 1998, when the market blew up and asset-backeds really widened out, we wanted to do an internal structure within our client base to raise about $50 million or $60 million that would invest in many of the same distressed ABS and CMBS, that went in to the DASH deal," Zeno said.

Currently, the company covers all sectors of the market, focusing on the ones that would offer the greatest relative value vis-a-vis other assets. It is often the newer, more esoteric structures that offer that advantage.

"We look at any new asset class that is in the market," said Zeno. "We're typically, but not exclusively an investment-grade buyer. We will look at non-investment-grade securities and investigate new structures."

When the company is embarking on a new deal, AAM takes several things into consideration.

"We look at the experience of the issuer and/or servicer, historic data with regard to the specific asset class they are securitizing and, if available, historic credit performance data to get us comfortable with future performance," he said.

"This way we can really have an idea of what a worst-case scenario might be. We also have to question whether it makes sense from a business-viability point of view."

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