"Some" of the Parts

PUBLISHER NOTE: New year, new name, new commitment... Thanks for your on-going support and readership, and of course for your willingness to always put your client first. True diversification always begins with accessing uncorrelated risk premia (#WhatAboutBeta) but discipline, due-diligence, transparency, and a client-first ethos must be your educational alpha. Our signature close remains steadfast and everlasting: "Seek education, diversity of both your portfolio and people, and know your risk tolerance. Investing is for the long term."

Forty-eight years ago, The Academy of Motion Picture Arts and Sciences held their 48th Academy Awards Ceremony and the Best Picture Award went to One Flew Over the Cuckoo’s Nest, a screenplay adapted from the 1962 Ken Kesey novel. Both the book, and later movie, were not without controversy and this essay is neither endorsement nor critique, rather a reference point for a single scene involving a poker game. The minimum table stakes were a dime (a tenth of one USD) and the poker chip of choice was a single cigarette. A heated argument ensued during the game when one of the players bets a half of a cigarette. Is it a dime, a nickel (a twentieth of one USD), or “$?!T” as declared by the dealer, Randall McMurphy?

The structuring and traunching of products are relatively new financial tools, having first been deployed in the institutional space in the 1990’s, with the oft-expected retail version arriving just a few years later. Risk, the underlying asset, and liquidity all got the obsidian knife treatment and a new market was born. It worked well until it didn’t work so well anymore, and it mostly proved to be the undoing of the 158-year-old House of Lehman and Bear Stearns, who would have been celebrating its centennial this year rather than its 15th anniversary as a casualty of the GFC. Could ‘dimes’ really be traunched into nickels or was this all just $?!T too??

We may just have another opportunity to find out, or in the words of the American baseballer (and linguist!) Yogi Berra, ‘it’s déjà vu all over again’ with the recent CFO trend. For the uniformed, this is not the CPA/C-suite executive adept at explaining the unexplainable on a quarterly earnings call, but perhaps just as clever, is this new offering. A Collateralized Fund Obligation (“CFO”) is the latest fashion in the structuring industry, although it too is not necessarily new — having been around since the 2000’s, mostly as a very niche product.

A recent FT article provides a good tour of the modern-day version of this space and the usual actors that are on the stage: GP’s, LP’s, and of course the wizards at the law firms, with one of them even referring to this structuring as ‘the technicolor dreamcoat of fund finance’… #WOW1.0! If that’s not enough, the rating agencies are back with some of the highest scores they can dole out, leverage is in play, and it is likely that said leverage sits on top of the already existing leverage via the use of SLOCs. On this last point, the FT article cites a very telling quote regarding transparency, or lack thereof: “just 8% of the 5,350 funds tracked by Preqin would tell (them) whether or not they were using subscription lines …" #WOW2.0!

If this is the camel’s nose into a tent called democratization, count me out! These structures could even play out quite well, but the lack of transparency, fueled by financial wizardry (amped up on steroids) is no way to treat a client, especially when said client is of the retail varietal.

All of this brings me back to Randall McMurphy’s ultimate point in the above referenced movie— when some of the parts can’t be understood, the sum of the parts usually adds up to $?!T.

Seek education, diversity of both your portfolio and people, and know your risk tolerance. Investing is for the long term.