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Investcorp issues first securitisation of a fund of hedge funds

Investcorp, the global investment group announced yesterday the securitisation of up to $500 million of a fund of hedge funds: The Diversified Strategies CFO.

Investcorp, the global investment group announced yesterday the securitisation of up to $500 million of a fund of hedge funds: The Diversified Strategies CFO. The issue is the first market value collateralised fund obligation (CFO) issued in the European market, and one of the first public issues of this type anywhere.

CFOs are structured transactions in which a special purpose vehicle purchases and holds a diversified portfolio of hedge funds and issues securities collateralised by these assets. Credit Suisse First Boston is acting as sole lead manager and book runner on the transaction.

Managed by Investcorp, the Diversified Strategies CFO will invest in a broadly diversified fund of hedge funds, tracking the performance of Investcorp’s established Diversified Strategies Fund. Investments will be heavily tilted towards relative value strategies, but will also include some more directional strategies.

It is anticipated that the bulk of the equity (class D) will be placed by Investcorp with its Gulf investor base.

Structured products have grown rapidly in recent years as the trend towards asset securitisation in financial markets has accelerated. Among the most popular structured products has been the Collateralised Debt Obligation (CDO), of which nearly $400 billion have been issued since 1995. A traditional CDO is created through the securitisation of cash flows from an underlying diversified portfolio of investments, such as high yield bonds or bank loans or collateral.

As the CDO market has matured, investment banks and leading funds of funds have been transporting the concept to the hedge funds industry, creating the CFO.

CDOs are composed of debt and equity tranches. Debt tranches are typically rated by credit agencies and pay a fixed or floating coupon. Meanwhile, equity tranches are not rated, take the risk of first loss on the underlying investment but target a high rate of return. Essentially, the debt tranches are priced similarly to equivalent rated corporate debt, but offer greater diversification, while equity tranches represent an efficiently financed, leveraged participation in the underlying asset. The most common types of CDOs are either ‘cash flow’ or ‘market value’. In a ‘cash flow’ CDO, the underlying collateral remains relatively static and the focus is on the sufficiency of cash flows from the collateral to meet coupon payments to debt holders. In a ‘market value’ CDO, the underlying investment is actively managed and is ‘marked-to-market’.

Investcorp currently has $2.7 billion in assets under management, making it one of the world’s largest funds of hedge funds managers. In total the program has six funds with 11 strategies, and is invested with more than 60 carefully selected hedge fund managers.

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