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Performance Analysis of a Collateralized Fund Obligation (CFO) Equity Tranche

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Listed:
  • Shady Aboul-Enein
  • Georges Dionne
  • Nicolas Papageorgiou

Abstract

This article examines the performance of the junior tranche of a Collateralized Fund Obligation (CFO), i.e. the residual claim (equity) on a securitized portfolio of hedge funds. We use a polynomial goal programming model to create optimal portfolios of hedge funds, conditional to investor preferences and diversification constraints (maximum allocation per strategy). For each portfolio we build CFO structures that have different levels of leverage, and analyze both the stand alone performance as well as potential diversification benefits (low systematic risk exposures) of investing in the Equity Tranche of these structures. We find that the unconstrained mean-variance portfolio yields a high performance, but greater exposure to systematic risk. We observe the exact opposite picture in the case of unconstrained optimization where a skewness bias is added, thus proving the existence of a trade-off between stand alone performance and low exposure to systematic risk factors. We provide evidence that leveraged exposure to these hedge fund portfolios through the structuring of CFOs creates value for the Equity Tranche investor.

Suggested Citation

  • Shady Aboul-Enein & Georges Dionne & Nicolas Papageorgiou, 2009. "Performance Analysis of a Collateralized Fund Obligation (CFO) Equity Tranche," Cahiers de recherche 0931, CIRPEE.
    • Handle: RePEc:lvl:lacicr:0931
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    File URL: http://www.cirpee.org/fileadmin/documents/Cahiers_2009/CIRPEE09-31.pdf
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    References listed on IDEAS

    as
    1. Francis A. Longstaff & Brett Myers, 2009. "Valuing Toxic Assets: An Analysis of CDO Equity," NBER Working Papers 14871, National Bureau of Economic Research, Inc.
    2. Amin, Gaurav S. & Kat, Harry M., 2003. "Hedge Fund Performance 1990–2000: Do the “Money Machines” Really Add Value?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 38(2), pages 251-274, June.
    3. Sun, Qian & Yan, Yuxing, 2003. "Skewness persistence with optimal portfolio selection," Journal of Banking & Finance, Elsevier, vol. 27(6), pages 1111-1121, June.
    4. Chunhachinda, Pornchai & Dandapani, Krishnan & Hamid, Shahid & Prakash, Arun J., 1997. "Portfolio selection and skewness: Evidence from international stock markets," Journal of Banking & Finance, Elsevier, vol. 21(2), pages 143-167, February.
    5. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    6. Jarque, Carlos M. & Bera, Anil K., 1980. "Efficient tests for normality, homoscedasticity and serial independence of regression residuals," Economics Letters, Elsevier, vol. 6(3), pages 255-259.
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    Cited by:

    1. Briec, Walter & Kerstens, Kristiaan & Van de Woestyne, Ignace, 2011. "Portfolio Selection with Skewness: A Comparison and a Generalized Two Fund Separation Result," Working Papers 2011/09, Hogeschool-Universiteit Brussel, Faculteit Economie en Management.

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    More about this item

    Keywords

    Collateralized Fund Obligation (CFO); hedge funds; structured finance; portfolio optimization; performance analysis; multivariate linear regression; systematic risk;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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