The idiosyncratic features of hedge funds peg these investment vehicles as peculiar birds, albeit birds with a nice upside potential. Market sources report CDO investors are anxious to gain exposure to hedge funds via collateralized fund obligations, and a few have reportedly hit the U.S. pipeline.

Market sources report that Concordia Advisors is in the market with a $100 million CFO called Concordia Funding 1, led by Salomon Smith Barney. The deal, with a weighted average life of three years, features an $80 million top tranche reportedly rated Aa3'. Additionally, UBS O'Connor has been marketing UBS Alpha 1 for quite sometime now, reportedly a $500 million CFO lead managed by UBS Warburg; sources report the $260 million triple-A tranche has price talk of 60 to 70 basis points over the 12-month Libor. Finally, a $300 million deal from Societe Generale, named Societe CFO 1, is also in the U.S. pipeline. That deal is reportedly co-managed by Deutsche Bank and Societe Generale.

In an effort to help investors quantify these relatively new investment vehicles, Moody's Investors Service has a forthcoming methodology report titled "Moody's Approach to Rating Collateralized Fund of Hedge Funds Obligations."

Despite their somewhat shadowy nature, hedge funds gained mainstream interest after the poor performance of the stock market. Sources state some CDO investors would like to gain exposure to this universe, as hedge funds are a very diverse asset class. With hundreds of hedge funds in operation, CDO structures believe successful vehicles can be created by taking that diversification and using it to counteract the usual risk factors associated with hedge funds - their illiquid nature and the opacity of the hedge fund universe.

"People are looking for alternative investments. Hedge funds have grown in volume so there are more assets to securitize," said Gary Witt, vice president/senior credit officer at Moody's, and a co-author of the methodology report expected in early July. "As general CDO methodology becomes more widely understood, CFOs benefit,"

Witt said.

While part of CFO analysis is quantitative, there are other items involved in rating them. A unique set of items separates these vehicles from traditional CDOs, namely risk factors and structural features (such as the minimum net worth test). Witt stated CFOs are based on market-value CDO structures and methods, and Moody's has developed a market- value modeling methodology specific to hedge funds for rating these transactions.

Moody's rated two CFOs in 2002: Man Glenwood Alternative Strategies I and Diversified Strategies CFO S.A. The class A tranches of both deals were rated triple-A. Currently, at least two additional CFOs are under review at Moody's, Witt confirmed. He declined to cite specific details.

Moody's, according to Managing Director Jerry Gluck, will only rate a CFO if the fund-of-funds manager has a proven track record of successfully selecting diversified portfolios of hedge funds in accordance with specified selection criteria.

"Virtually anyone with sufficient resources to hire a lawyer, accountant, and prime broker can form a hedge fund. Therefore, it is imperative that a skillful and diligent CFO manager be engaged," Gluck said.

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