Attractive returns have always been a selling point for plan sponsors, having led many to seek solace in fixed-income. Samuel Austin, senior portfolio advisor with Seneca Capital Management contends that continues to be the case, with one slight amendment. Pension funds are now eyeing "alternative" fixed-income opportunities CLOs and CDOs.
For instance, the asset manager is currently fine tuning its $300 million Nob Hill II CLO offering, which it expects to price and close during the first quarter. Seneca Capital is also gearing up to bring a CDO-of-CDOs, or CDO-squared, to market midyear, Austin said.
"CDO-of-CDOs invest in a number of different deals so you get the benefit of diversification," Austin said. "You're not just looking at one special purpose corporation, but several of them that have been molded together in this structure. I think it's also very attractive to the pension fund community. The special interest there is that the leverage is relatively modest. We have four or five transactions that we expect to close in 2007."
He added that in an environment with volatility and low yields, those in the pension fund community are concerned as to how they are going to reach their 8% returns. "If you start with a traditional core portfolio that is benchmarked against the Lehman Aggregate, you might be expected to earn in the low-to-mid single-digit returns," he said.
The solution, he said, is for pension funds to invest in CLOs, such as the firm's Nob Hill I, which Seneca Capital closed in August 2006. "CLOs have some special characteristics that are quite attractive and we have a growing interest among pension funds. Bank loans are a very stable and attractive asset class. There has not been a negative year in returns in the bank loan category since the early '90s. How many asset classes can say that," Austin said.
Additionally, CLOs can be viewed as a nice complement to a plan sponsor's private equity allocations, Austin said. While private equity is known to carry a J-Curve delay in getting cash-on-cash returns, CLOs allow investors to see the benefits at a faster rate.
"A CLO that's managed properly is expected to return cash-on-cash every quarter, because just as bank loans have royalty payments, the investors in these deals get their share of royalty payments," he said. And some plan sponsors have already taken the hint.
"The high watermark for me was that our first CLO transaction, we were able to place two-thirds of the equity investment with pension fund clients," he said. He declined to identify the funds, however.
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