BOCA RATON, FLA. - Growth in the market, and the rise in market-value CDO issuance combined with some fund failures had many Information Management Network ABS East conference attendees discussing pricing transparency in the market. Although previously an overlooked piece of the structured finance puzzle, sources around the resort were keenly focused on this topic this year, thanks to concerns over pending regulation and transparency issues with valuation.
Two hedge fund managers, Harvey Allon from Braddock Financial and Rich John of Old Hill Partners, were joined by attorney Dan Hartnett of Kaye Scholer LLP, on an investor panel that delved into structured product pricing strategies for portfolio managers. The panel was moderated by Granet Kanouse, president of Murrayhill IPS Corp. Given his firm's position as a completely independent pricing service, Kanouse's expertise on this hot topic made for a lively session.
What barometers are tapped by portfolio managers to obtain a price quote can and do vary widely in this industry. Managers typically utilize dealer quotes but those aren't exactly impartial, panelists noted, because they can be impacted by the dealers' needs and concerns. Investor bids are another tool, but groups of bids from investors create their own unique issue - where is the fair market value to be found in a pool of bids that varies widely? And, more often than not, while several bids are pooled close to one price range, there are often outlier bids.
Outlier bids, Kanouse noted, create a whole other level of analytical questions that need to be considered, "Because you have to ask, how much do you focus on an outlier?" Kanouse said. Was that outlier bid really driven by analysis, which it is sometimes dismissed as, and more importantly, what does that outlier bid say about the fair market value of the bond considering the overall pool of bids?
If the decision to sell is always driven by highest price quote, but analysis of the outlier bid isn't considered, there is a strong possibility that quote won't be available the next day, leaving lots of unanswered questions impacting fair market price. Panelists dug further by noting that the outlier bid, as a higher price quote, will ultimately draw the seller's eye. But what about portfolio managers unloading a significant amount of collateral? A large block trade can move the whole market and, not understanding what drove a bid so different from the rest of the pool, have a definitive impact on both the sell side and buy side.
Pending regulation is affecting more than just the accounting portion of the structured finance market. With new regulation of hedge funds currently being considered - and deemed very likely - hedge fund portfolio managers face a future in which they are legally tied to price transparency. Instead of investors inquiring, regulators will be asking managers why they marked a portfolio a certain way, why they purchased or sold at certain prices, and why certain collateral was bought or sold. Regulators will turn to market prices to make their determinations.
"It's important that everyone understands that valuation is becoming an issue - and an issue for the end investor," Murrayhill's Kanouse said, referring to the public nature of many of the constituents in the securization market. With corporate stock trading on the public market, how in-house structured finance professionals mark their portfolios, and the decisions they make, are impacting the end investor much more these days than in years past. "They do have exposure to the positions being taken. So everyone has a stake in the value of that transaction," summed Kanouse.
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