Bespoke portfolio (CDO)

A bespoke portfolio is a table of reference securities. A bespoke portfolio may serve as the reference portfolio for a synthetic CDO arranged by an investment bank and selected by a particular investor or for that investor by an investment manager.

Overview

The list of reference securities making up a portfolio is one of the primary drivers of the investment outcome of a synthetic CDO. Because the portfolio is not that of a corporate credit index like the CDX or iTraxx, the mean default probabilities of the reference securities, their distribution of default probabilities, their default correlations and the recovery amounts upon default can vary greatly.

In principle, the investor chooses the reference securities and decides on the "attachment" and "detachment" points (that is, the amount of losses that occur before the investor suffers its first dollar of loss; and the upper limit beyond which the investor suffers no further losses). In reality, the arranger demands a good deal of input into the selection of the reference portfolio. Most arrangers manage their risks by buying and selling protection on single-name CDS or on the CDX indexes and therefore they usually avoid taking positions in CDS that cannot readily be traded.

Bespoke portfolios can have very different default correlation characteristics from credit indices with similar distributions of riskiness. Bespoke portfolios almost invariably have numbers of reference securities similar to those of the major credit indices – 100 to 125 reference securities – but bespoke portfolios can include reference securities that have highly correlated default probabilities, either because they are issued by different subsidiaries of the same parent company, because they include closely related but separate companies, or because the bespoke portfolios include much higher concentrations in single industries than occurs in credit indices. Determining the fair default correlations for a bespoke portfolio can be very difficult. The chart on the right shows that differences in correlation can greatly change the probability distribution of defaults and thus change the fair value of any given CDO tranche linked to a particular portfolio.