LAGUNA NIGUEL, CALIF. - Credit opportunity funds - defined as a fund that allows the manager to rejigger his or her asset mix - are employing that flexibility to swoop in and purchase discarded CDO bonds, said Dale Leshaw, head of credit at Alcentra, during a panel discussion at Opal Financial Group's CDO Summit held here last week.

When Delphi Corp. bonds were trading down following news of an impending bankruptcy, for example, the funds were in a good position to buy those securities from CDOs, which had to shed them as spreads widened and ratings fell, he said. Following the bankruptcy announcement, of course, the bonds became significantly more expensive. "We can buy those because we're not emotionally attached to ratings," Leshaw said.

In that sense credit opportunity funds are better than say, a market value CDO, because "leverage works for you rather than against you," said Frank Jordan, a partner at Golden Tree Asset Management. "When the market reacts to something, we still want to be able to have leverage to buy stuff," he said.

But with less leverage - credit opportunity funds are typically two-to-three times levered, compared with about 12 times for the average CLO - and a higher cost of funds than CDOs and other structured finance vehicles, more due diligence should be completed on a credit opportunity fund manager before committing to invest, pointed out Todd Kesselman of Precision Capital. Should that manager end up in a bad position, he or she needs to have the skill and liquidity to trade out, he said.

Credit opportunity funds are typically not buy-and-hold investors, Leshaw added, "If we have it for a year, that's a long time." And, as 2006 is anticipated to be a more challenging environment for corporations, investors are anticipating the pipeline for distressed credit to begin building up as lending institutions become more selective about who they will provide liquidity to. California power producer Calpine Corp., for example, is expected to file for bankruptcy any day.

"A lot of companies that got through in the last two-to-three years should not have gotten through," said Seth Brufsky, a partner and portfolio manager at Ares Capital Management, "Good credit picking skills will be a at a premium this year."

(c) 2005 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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