Burned subprime investors eye commodities for growth

By Walden Siew - analysis

NEW YORK (Reuters) - Investors and fund managers bitten by the collapse in subprime mortgages are now looking for new opportunities to trade bonds linked to traditionally volatile commodity prices and risky emerging markets.

While the ensuing credit crunch from the subprime collapse reduced liquidity and rocked markets globally, there are some who see a comeback in packaging commodities and emerging market securities -- even though they are viewed as some of the riskiest investments in the marketplace.

"These are very new markets," said Mirko Mikelic, a fund manager at Fifth Third Asset Management in Grand Rapids, Michigan. "I don't think many investors feel yet they are going to be compensated...I think people will look at it, but it's not clear if it's a viable market."

Some managers are already setting up deals, however. But the shape of the business is changing. The era of the small manager "has probably come to an end," according to Alex Cigolle, chief investment officer of Strategos Capital Management, the CDO management unit of Philadelphia-based Cohen & Co. "You're going to see massive consolidation."

That shrinking market is sparking a new migration on Wall Street. Now, in a search for higher-yielding assets -- and new jobs -- an army of structured credit experts is studying products such as Collateralized Commodity Obligations, or CCOs, that are tied to the performance of a portfolio of underlying commodities, such as precious metals or energy prices.

For more details on CCOs, see

The gravitation toward commodities makes sense as new records in oil, gold and wheat prices helped five of the world's best-known commodity indexes gain an average of 18 percent through September, trouncing stocks and bonds.

"Things like debt linked to commodities and emerging market CDOs are still being sold," said Lars Gloessner, a senior consultant for Huxley Associates, a Wall Street job recruiter. "Those might potentially be areas where people will shift and where deals might get done."

"Businesses are disappearing because there are no deals to manage," Gloessner said. "People are talking about CDO-like structures on other products."

CCO

Here's how a typical CCO works. The issuer sells protection on the underlying commodity portfolio to the counterparty under what is known as a "trigger swap agreement."

To fund its obligations under the swap, the issuer sells notes in the amount of the protection sold, according to Fitch Ratings. Proceeds from the notes then serve as collateral for the issuer's exposure under the swap until it matures.

At maturity the issuer liquidates the remaining asset and returns the proceeds to noteholders.

Like CDOs, the risk of owning CCOs depends on the structure's exposure to declining assets and diversification.

The risk is if there is a "trigger event," in which the valuation price of a commodity falls below a predetermined trigger price at a specified time or over a specified period.