Tuesday, June 26, 2007

SLCG Research: Collateralized Mortgage Obligations

SLCG released today ‘A CMO Primer: the law of Conservation of Structured Securities Risk’.

Recently, the finance industry witnessed the bailout of two Bears Sterns hedge funds and the collapse of Brookstreet Securities. Both had portfolio holdings of collateralized mortgage obligations (CMOs) and suffered huge losses thereof. We have seen such CMO losses before, when in 1994 interest rates rose, CMOs fell in value and bond mutual funds suffered unexpected losses.

In this paper, Dr Craig McCann provides a selective history and description of CMOs to help investors understand their risks. Dr McCann finds that CMO losses cannot simply be explained by credit losses in subprime mortgages, the increase in interest rates and the slow appreciation of home prices, and that CMOs can be misrepresented as having little interest rate risk when they in fact have substantial interest rate risk. Unsophisticated investors should have a clear understanding of CMOs and know the concentration of CMOs in their funds.

Friday, June 15, 2007

SLCG Research: Closed-end Fund IPOs

SLCG released today ‘Closed-end Fund IPOs’.

In this paper, Dr Edward O’Neal explains how closed-end funds trade at a discount to their net asset value (NAV).  Dr O’Neal finds that at the initial public offering (IPO), a closed-end fund’s offering price is set at its NAV. Yet during the year after the IPO, a closed-end fund’s price drops as much as 5% from its offering price at the IPO. Furthermore, investors pay huge commissions on the sale of the closed-end fund, generating a premium in the closed-end fund at the IPO.

Given the premium at the IPO and the subsequent discount after the IPO, investors are warned not to buy closed-end funds at the IPO.