The risks deserve a mentionThe sort of risks that tend to accompany “meatier gains” do not receive much of a mention although the article does note “market veterans” drawing parallels with the years leading up to the credit crunch. “Faced with meagre returns in corporate bonds back then,” it says, “traders decided to lever up their positions by slicing up portfolios of credit-default swaps into tranches with varying degrees of risk and return.” Regardless of what happened a decade ago, however, some banks have been stepping up to meet the demand – apparently heartened by the view that the main issue back then was “the quality of the assets stuffed into CDOs, rather than the structure itself”. “And despite the stigma of resembling other complex products that were consigned to the scrap heap,” the IFR piece goes on, “synthetic CDOs have survived and evolved.” Read more:
- The story of the global financial crisis told in six charts
- 10 years on from the collapse of Lehman Brothers – seven charts to consider
As ever, the problem is spotting precisely where – and it may well not be in the CDO sector at all. After all, everybody there says they are well aware what went wrong last time and are taking the appropriate steps to make sure it does not happen again… Even so, when people are focused myopically on returns without much consideration for the associated risks, bad things happen. And in markets, they really can hear you scream.
- Andrew Williams is an author on The Value Perspective, a blog about value investing. It is a long-term investing approach which focuses on exploiting swings in stock market sentiment, targeting companies which are valued at less than their true worth and waiting for a correction.