Bear Stearns Meltdown

Anyone been following the mess at Bear Stearns? The FT has a good article on the risks of collateralized debt obligations (CDOs) that is worth reading if you are interested in understanding one reason why our housing market has been so robust this last decade.

About a year ago I wrote an investment policy for a non-profit that I was involved with. In the prohibited securities section I wrote in a specific clause prohibiting the investment manager from investing in residual tranche collateralized debt obligations. There was some debate about this as I was aware that there were good returns to be had in this area, like hedge funds, and even though the volatility was higher it was over the long run proven to result in better returns.

In other words, a conservative investment strategy really doesn’t preserve capital while sacraficing potential returns, it really just destroys capital as a consequence of opportunity cost. In retrospect, I sure am glad I excluded CDOs.

link via The Economist