Morgan Stanley is advising new and seasoned investors to consider taking advantage of the diverse collateral available in the CDO market, particularly in the 2000 and 2001 vintages, which have seen better performance than earlier deals, according to the firm's current CDO Perspectives.
The strategy is to avoid concentrated exposure to any one underlying market, such as high-yield bonds, explains Sivan Mahadevan, who took over Morgan Stanley's CDO research effort last month and is supported by two research analysts, David Schwartz and Kenny King.
An added incentive to play in the "recently" issued CDO market is that many 2001 deals have ramped up during a tightening collateral environment, the report says.
By looking at the aggregate of weighted average rating factors (WARF) on CDOs issued between 1996 and 2001, only the 2000/2001 deals are in compliance on average, according to Morgan Stanley's CDO database (includes non MS deals). The WARF compliance factor is an indicator of the quality of the collateral with respect to deal constraints.
When observing aggregate WARF compliance factors by collateral type, MS finds that leveraged loan deals are in compliance on average, while HY bond deals (along with the smaller IG and EM backed universe) are out of compliance on average.
Morgan Stanley notes that tranches from these deals tend to have similar spread relationships - spreads narrow as the WARF compliance factor increases. For double-A tranches the relationship is roughly linear. Leverage loan deals have higher spread (and are in compliance) compared to HY bond-backed triple-B tranches.
July saw continued spread tightening, driven by good investor demand for CDOs as well as a rally in IG corporate spreads and higher quality HY names. The rally in the new issue triple-A and double-A spreads is related to tighter swap spreads, while triple-B spreads have tightened relative to both Treasurys and Libor, Morgan Stanley says.
Meanwhile, in the secondary market, triple-A spreads are tighter, in line with new issue spreads and tighter swap spreads. For example, 2001 cohort triple-A spreads are 14 basis points tighter on the month, while 2000 cohort triple-A spreads are five basis points tighter on the month and 10 basis points tighter year-to-date.