Source: B&B Structured Finance Ltd |
In 2005, a new product began to appear in the structured credit market, borrowing a structure originally applied to equities and funds of funds. Usually referred to as credit CPPI, these deals offer investors a principal protected investment where the return is at risk to a leveraged portfolio of credit. However, unlike traditional forms of principal protection, the credit exposure in the CPPI increases as the portfolio performs well, and decreases as the portfolio underperforms.
If the portfolio performs very poorly, the credit exposure to the portfolio is completely reduced and all cash available is invested in highly rated credit so as to guarantee the investor principal at maturity,
Credit CPPI trades can be static or managed and can consist of a portfolio of single names, a credit index, index tranches (see page 48), or some combination of these different investments.
With the credit markets experiencing tight spreads for an extended period of time, and the economics on CDOs looking less attractive, managers are increasingly looking to manage credit CPPI transactions at the time of publication. These deals give managers the ability to go long and short credit opportunistically without the rating agency constraints of CDOs.