Tetragon Financial Group — FY23 growth driven by idiosyncratic factors

Tetragon Financial Group is a closed-ended investment company trading on the London Stock Exchange (LSE) and Euronext Amsterdam. It invests in a broad variety of asset classes with exposure to public and private equities and credit, convertible bonds, real estate, venture capital, infrastructure, CLOs, legal assets and TFG Asset Management, a diversified alternative asset manager. The company is domiciled in Guernsey and was founded in August 2005. Tetragon’s shares were admitted to trading on Euronext Amsterdam in April 2007 and listed on the Specialist Fund Segment of the LSE in November 2015 (ticker: TFG). In April 2018, an additional sterling LSE market quote was introduced under the ticker TFGS and investors may elect to be paid cash dividends in sterling, instead of the company’s base operating and reporting currency (US dollars), as well as in Tetragon shares. Tetragon's listed shares are all non-voting.

Tetragon is ultimately controlled by its co-founders, Reade Griffith and Paddy Dear. They own the voting shares in the company, as well as Tetragon’s investment manager – Tetragon Financial Management (TFM). TFM’s Investment and Risk Committee, which determines Tetragon’s investment strategy and approves all major investments, comprises Griffith and Dear as voting members and Stephen Prince (CEO of TFG Asset Management), who all have experience in alternative investments. Tetragon and TFG Asset Management employees cumulatively held 39.2% of outstanding non-voting shares in Tetragon at end-December 2023.

The investment manager focuses on alternative asset classes that it believes offer ‘intrinsic alpha’ (excess returns relative to their assessed investment risk) and aims to diversify its portfolio of assets that are relatively uncorrelated with broader financial markets. New investment analyses include evaluations of risk/reward, correlation, duration and liquidity characteristics. Tetragon searches for managers it believes are high-quality specialists with successful track records, and aims to invest not only in managed funds, but also in the manager to supplement its returns with stable fee income and capital appreciation from growing third-party capital.

When assessing whether to acquire a stake in a new asset manager, TFM takes into consideration performance track record, reputation, regulatory requirements, infrastructure needs and asset-gathering capacity. The potential profitability and scalability of the asset management business are also important considerations. To mitigate potential correlated risks across asset managers, Tetragon seeks to diversify exposure across asset classes, investment vehicles, duration and investor type.

Tetragon is managed by TFM. TFM was founded and is owned by the co-founders of Tetragon (Reade Griffith and Paddy Dear). While Tetragon pays management fees to TFM, in terms of decision making it can be viewed as a self-managed entity, because the investment manager is owned and run by the same two individuals who indirectly own voting shares in Tetragon.

TFM aims to manage a diversified portfolio with limited correlation with broader macro factors rather than actively positioning the portfolio in anticipation of a particular scenario materialising in financial markets. In 2024, Tetragon plans to continue funding commitments towards TFG Asset Management and expects that allocation of capital to TFG Asset Management will therefore increase. Tetragon sees TFG Asset Management as its main value driver and is considering setting up new managers, acquisitions and partial disposals as viable future developments (including the disposal of BGO expected in 2026 based on SunLife’s call option). The potential disposal/IPO of TFG Asset Management is being taken into account, although it is unlikely in the near future. Tetragon expects a stable allocation to most of its asset classes in 2024, as disposals and distributions are likely to be reinvested in new assets, and an increase in allocation to funds managed by Banyan Square Partners (private equity) and Contingency Capital (legal assets) in line with its investment commitments. Tetragon also hopes to make allocations to new asset classes, although it hasn’t stated a particular direction.

For 2024, Tetragon expects the interest rate environment to ease, subject to an uncertain period of ‘the last mile of disinflation’. It believes that the markets are balancing hopes of a ‘soft landing’ with concerns around slowing global GDP, exacerbated lately by hints of weakening in the US job market. Nevertheless, after the 2023 rally in tech stocks, Tetragon expects the valuations of equities in other sectors to improve, supporting returns in Tetragon’s hedge fund strategies, which have limited exposure to stocks that have surged in 2023. Tetragon sees politics as the main risk factor for 2024, as growing geopolitical tensions across Europe, the Middle East and Asia add to overall economic uncertainty, as well as disturbing supply chains. In 2024, more than two billion voters in more than 50 countries will go to the polls, including in the US and UK, and Tetragon acknowledges that there could be significant political change against a geopolitically strained and economically complex backdrop.

Tetragon manages a US$3.0bn (gross asset value) diversified portfolio of alternative assets as at end-February 2023. The vast majority of the portfolio is internally managed, as roughly half (data as at end-December 2023) is represented by TFG Asset Management (Tetragon’s ownership of asset management businesses), a further 34% is managed by majority-owned asset managers and 11% is direct private equity and listed investments. While 15% of the portfolio is managed by third parties, we note that 8pp of that exposure is represented by funds managed by minority-owned asset managers within TFG Asset Management: BGO (3.9% of NAV) and Acasta Partners (3.8%). During 2023, Tetragon’s portfolio generated US$307m in distributions (US$93m net of investments), representing 11% of its opening NAV (3% net). Nevertheless, this did not fully cover Tetragon’s dividend distributions and ongoing costs, and in effect the net indebtedness increased to US$244m and 8.6% of NAV (from US$168m and 6.1% of NAV at end-2022), which was subsequently decreased to 6.5% at end-February 2024 following distributions predominantly from other equities and credit.

TFG Asset Management is an umbrella entity of Tetragon’s stakes in asset managers with various investment mandates. It currently comprises 10 asset managers with combined AUM of US$41.5bn (including minority-owned BGO on a pro rata basis and minority-owned Acasta Partners in full). As at end-December 2023, TFG Asset Management is valued at US$1.3bn, representing 48% of Tetragon’s NAV. In 2023, the company distributed US$5m to Tetragon on a net basis (US$65.7m distributions and US$61.0m investments), with the main distributions being the dividend from Equitix (US$28m) and contractual payments from BGO (US$18m), mostly offset by further investments including working capital support for managers in the ramp-up phase.

The largest asset within TFG Asset Management (and the largest single investment in Tetragon’s portfolio) remains its 75% stake in the integrated core infrastructure manager, Equitix, representing 26% of Tetragon’s NAV. Equitix manages a portfolio of more than 360 assets across 21 countries valued at £10.9bn as at end-2023, generating substantial fee income and the main driver of TFG Asset Management’s 2023 US$77m net profit, according to our calculations.

A further 10% of Tetragon’s NAV is represented by its 13% stake in BGO (formerly BentallGreenOak), which manages 64m square feet of real estate space around the world valued at US$83bn. The value of Tetragon’s investment is based on an agreed series of fixed and variable distributions, as well as a put/call option valuation, which were put in place in 2019 following the merger of GreenOak Real Estate with Bentall Kennedy.

Wholly owned LCM represents 9% of Tetragon’s NAV, valued at US$259m at end-2023. It is a CLO manager and originator with AUM of US$10.7bn, which decreased from US$12.5bn at end-2022. LCM did not launch any new structures in 2023 due to the unfavourable environment, while the continued distributions from existing structures diminished their size. Importantly, all LCM-managed CLOs were compliant with their junior-most over-collateralisation tests.

Five further asset managers are wholly owned by Tetragon. Westbourne River Partners (formerly Polygon) manages predominantly open-ended hedge funds as well as private equity vehicles with AUM of US$0.9bn. Tetragon Credit Partners manages US$0.9bn in CLO investments (focused on equity tranches). Hawke’s Point provides capital to companies in the mining and resource sectors and its current portfolio comprises a series of gold and battery metal assets in North America and Australia valued at US$0.1bn in total. Banyan Square Partners focuses on minority PE investments in enterprise software and technology sectors, with current AUM of US$0.1bn.

Tetragon also has a non-controlling stake in Acasta Partners, which invests predominantly in convertible bonds and volatility-linked instruments, while having a multi-disciplinary approach and broad investment mandate including commodities and other opportunities across the credit markets. While Tetragon sold the majority of its stake in a management buyout in 2021, it still provides infrastructure and other services to the manager, which remains closely linked to TFG Asset Management. Similarly, Tetragon holds minority stake and provides all infrastructure for Contingency Capital, which invests in credit-oriented legal assets and has AUM of US$0.7bn.

Tetragon’s investments in open-ended hedge funds made up 20% of its NAV at end-2023. It invests predominantly in funds managed by TFG Asset Management’s managers – Westbourne River Partners (79% of the exposure) and Acasta Partners (19%). The largest exposure is to Westbourne River Event Fund, which is focused on high-conviction, catalyst-driven European stocks, and its portfolio is relatively concentrated. In 2023, Tetragon invested US$32m in hedge funds (US$29m of which was into Westbourne River Event Fund) and sold US$17m (US$10m of which was from Acasta funds), implying a net investment of US$16m.

Tetragon invests in private equity assets through funds and directly on its balance sheet. The majority of the exposure is through funds managed by wholly owned managers (Banyan Square Partners 25%, Hawke’s Point 23%) and direct investments (22%), with the remaining 30% (5% of total NAV) managed by third-party managers. Third-party exposure is granular and consists of 36 positions across Europe and North America. The direct investments pool represents mainly (93%) Tetragon investment in preferred shares of Ripple Labs, a cryptocurrency-focused technology company developing a payment protocol and an exchange network. Tetragon invested US$41m on a net basis in private equity assets, predominantly in third-party managed funds (US$19m net in six new positions) and direct investments (US$15m net).

Tetragon invests predominantly through equity positions in CLO structures, both through its own balance sheet (55%) and through Tetragon Credit Partners’ funds (45%) and its exposure to bank loans represents 9% of its NAV. The direct investments are predominantly made into CLO structures originated and managed by fully owned LCM (96% of direct CLO investments). At the same time, Tetragon Credit Partners invests a part of its funds in CLOs launched by LCM. Over 2023, CLOs distributed US$77m to Tetragon, predominantly through amortisations, while Tetragon invested a modest US$6m into Tetragon Credit Partners’ funds amid subdued new CLO issuance during the year, effectively reducing its exposure to bank loans by US$60m.

Tetragon’s exposure to equities and credit increased to US$212m and 8% of NAV over 2023 (reflecting the strong performance of stocks, see below), despite hefty disposals of US$119m. The exposure consists mainly of a concentrated portfolio of a few high-conviction stocks (93%), supplemented by minor public debt investments.

The majority (74%) of Tetragon’s US$148m (5% of NAV) real estate investments are allocated to funds managed by BGO. The funds focus on opportunistic investments in the mid-market across the US, Europe and Asia (predominantly Tokyo). The remaining real estate exposure consists of an investment in commercial farmland in Paraguay managed by Scimitar.

In 2023, Tetragon delivered a 6.4% NAV TR and a 5.5% RoE, which was below its target range (RoE of 10–15%), and in the first two months of 2024 its NAV decreased by 0.6%. Meanwhile, long-term performance remains within its target, with 11.1% RoE since inception to end-February 2024. Tetragon’s portfolio of alternative assets that present a low correlation with equity and credit markets naturally did not follow the equities rally of 2023, with the MSCI AC World delivering a 22.8% return. Having said that, the main driver of Tetragon’s NAV accretion was performance of its stock portfolio (led by one biotech stock), which delivered a 68% increase in value and 4.5pp in NAV return. The second best performing assets were private equity positions, predominantly Hawke’s Point’s gold mining projects and Ripple Labs. Overall, all Tetragon’s asset classes delivered a profit in 2023, except for real estate investments, which posted a 4% loss.

TFG Asset Management’s value remained broadly flat in 2023 (up 0.5%) as the growth of Equitix (up 7.8%) was mostly offset by LCM (down 12.2%) and the remaining asset managers (down 2.9% in total). Equitix continues its solid growth – in 2023 its AUM increased to £10.9bn (from £10bn at end-2022), stemming from fund-raising in its managed accounts and initial commitments towards Fund VII. It posted a US$53m gain in valuation mainly on the back of solid results momentum, despite a 14% contraction in market multiples. On the other hand, LCM’s AUM decreased by 14% y-o-y to US$10.7bn, reflecting a combination of not issuing any new deals due to market conditions and amortising some existing deals, which directly translated to a lower valuation based on AUM multiples.

TFG Asset Management generated a US$77m profit, 6% higher y-o-y. Tetragon recognised US$18.4m income from BGO, reflecting its fixed quarterly contractual payments, variable payments and carried interest, which amounted to US$17.8m on a cash basis. Management fees increased by 6% to US$180m, which was predominantly attributable to the increasing AUM of Equitix, as well as the full-year effect of CLOs launched by LCM in 2022. Performance fees increased by 33.3%, but this was mostly driven by minority owned Acasta Partners. On the other hand, operating costs increased by 12% y-o-y to US$205m, with 67% of the increase attributable to Equitix as it added headcount and continued to scale up.

The portfolio of stocks was the largest contributor to Tetragon’s NAV performance, rallying 68% year-on-year and providing US$124m in gains in FY23. Approximately two-thirds of gains was driven by companies providing AI infrastructure and AI applications, and the remaining part was largely attributable to a UK-based biotech company reporting encouraging developments for its potential cancer and autoimmune therapies. Tetragon used the opportunity to sell part of the portfolio, realising US$119m cash inflow.

Tetragon’s private equity investments were the second-best performing asset class within its portfolio. The US$91m gain (24% of opening value) was driven by 86% y-o-y valuation growth in funds managed by Hawke’s Point and a 50% gain on Ripple Labs. The valuation gain of the Hawke’s Point fund was driven by operational progress at one of its Australian gold project investments. Ripple Labs (issuer of XRP token) benefited from good newsflow. In July 2023, a US judge ruled that Ripple Labs did not violate federal securities law by selling its XRP token on public exchanges, and the court subsequently dismissed the Securities and Exchange Commission’s (SEC’s) request for an interlocutory appeal. Simultaneously, crypto markets and related assets rallied on the back of expectations that the SEC is preparing to approve the first spot bitcoin ETFs.

Tetragon investments in CLO equity tranches delivered a 3.7% valuation gain in 2023, contributing 0.4pp to NAV accretion. CLO equity positions benefit from rising risk-free rates, which translates to higher residual payments as well as good reinvestment opportunities, which materialised predominantly in LCM-managed positions. The loan losses level remains benign and all CLO structures, in which Tetragon held direct and indirect interest, passed their junior-most over-collateralisation tests, although Tetragon saw some realisation of losses on loans of older vintage, which partially offset revaluation gains. Tetragon also directed the optional redemption of one non LCM-managed CLO, which increased the cash distributions received in 2023.

The remaining assets in Tetragon’s portfolio (hedge funds, real estate and legal assets, comprising 27% of NAV at end-2023) were broadly flat in 2023 (see Exhibits 6 and 7) and did not contribute to NAV development meaningfully.

In Exhibit 10 we present a sterling-based comparison of Tetragon with eight members of the AIC Flexible Investment sector. We note that the Flexible Investment sector varies widely in terms of investment strategies and mandates, and Tetragon’s investment approach is very diversified, which means none of the companies is a perfect direct comparator. That said, we consider Caledonia Investments, RIT Capital Partners and abrdn Diversified Income & Growth (ADIG) better comparators, given the relatively high share of private market investments in their portfolios. However, we note that ADIG’s managed wind-down was recently approved by shareholders. Tetragon shows above-average NAV returns in every presented period. Despite this and having an above-average dividend yield, Tetragon trades at the widest discount among peers.

Tetragon does not target a specific dividend payout ratio. Its board declares dividends, based on the recommendation of the investment manager, subject to the approval of Tetragon’s voting shareholder and adherence to applicable law. Dividends are paid quarterly in May, August, November and March each year. Additionally, Tetragon regularly buys back shares from the market, with the programmes conducted through a Dutch auction at a price close to the shares’ market price, resulting in NAV accretion.

In 2023, Tetragon distributed US$60m to shareholders by purchasing 5.7m shares through auctions, and a further US$23m in dividends, which translates to 3.0% of opening NAV in total. It has also recently concluded another US$25m tender offer. Tetragon repurchased 2.4m shares at US$10.25 per share – a 67% discount to end-February NAV and 2.5% premium to current share price. The tender was subject to 25% reduction, as 3.3m shares were tendered by investors.

Shareholders may elect to receive dividends in the form of Tetragon shares and to receive dividends in sterling rather than in US dollars. The next US$0.11 quarterly dividend payment will be made on 3 April 2024 and DPS of US$0.44 paid from FY23 profits implies a 4.4% dividend yield. Tetragon has been gradually increasing its dividend per share over FY20–23, although payments have not yet returned to pre-pandemic levels. On the other hand, the lower DPS has been offset by higher share buybacks and the aggregate distributions are broadly in line with the pre-pandemic level. Having said that, the total distribution from FY23 profits was down 14% y-o-y.

Tetragon shares currently trade at a 68% discount to last reported NAV per share, which is broadly in line with its three-year average of 66%. Tetragon persistently trades at a significantly higher discount than its peers (see Exhibit 10), and we have discussed the possible reasons (including the fact that shareholders only have access to non-voting shares, a complex structure that is difficult to understand, as well as limited disclosures on some of the underlying assets) in previous notes.

Tetragon has a US$400m revolving credit facility in place, which was set up to manage portfolio liquidity and bridge any timing mismatches between investments and realisations. Having said that, Tetragon has remained in a slightly geared position for most of the time since 2020, with net gearing at end-2023 at 8.6% of NAV. The facility expires in 2032 and bears the following interest: a servicing fee of 0.015% of the total amount, a non-usage fee of 0.5% on any undrawn amount (US$150m at end-2023) and the Secured Overnight Financing Rate (SOFR) + 3.40% on the drawn amount (US$250m at end-2023). As at end-February 2024, net gearing has reduced to 6.5%.

Historically, Tetragon kept 10–20% of its NAV in cash available for new investments and has gradually reduced its net cash position over the last years (see Exhibit 14). Maintaining a lower cash balance was allowed by entering into a revolving credit facility. The undrawn amount of credit facility (US$150m) covers Tetragon’s unfunded commitments (US$95m) in full.

Tetragon pays a management fee of 1.5% of NAV pa to TFM, calculated monthly. In addition, it pays a quarterly incentive fee of 25% of NAV accretion, subject to a hurdle rate of term SOFR2 + 2.75% recalculated each quarter (Q124: 8.1% in total). The incentive fee is also subject to a high-water mark and the shortfall below the hurdle rate is not carried forward. However, the high-water mark is calculated based only on the previous quarter’s NAV, which effectively means the high-water mark only applies to the two prior quarters.

Tetragon’s ongoing charge ratio stood at 1.75% in FY22, broadly flat from 1.74% in FY22. Incentive fees in FY23 amounted to US$16.3m (down from 26.5m in FY22 and US$124.6m in 2021), which translated to 0.6% of opening NAV (0.9% and 5.0% in FY22 and FY21, respectively). Therefore, the overall ongoing charge (including incentive fees) ratio stood at 2.34%, down from 2.66% in FY22, according to our calculations.

From 2024, the board of directors will be entitled to a fixed fee of US$0.45m pa (US$150k for each member, up from US$125k previously; Dear and Griffith waived their fee). The directors have the option to elect to receive Tetragon shares instead of their quarterly fee, and 6.2k shares were granted in 2023 (versus 6.5k in 2022). Tetragon has an equity-based compensation scheme for some of its senior employees. The shares are bought from the market and held in an escrow account until they are vested on fulfilment of certain targets. In 2023, Tetragon bought 5.7m shares from the market via modified Dutch auctions and released 1.3m from treasury and escrow.

Tetragon’s issued share capital consists of 10 voting shares and 139.7m non-voting shares. The voting shares are indirectly owned by the co-founders and are not entitled to any distributions. However, the co-founders also hold large stakes in Tetragon’s non-voting shares. Excluding shares held in treasury (48m) and escrow (11m, see fees and charges section above), the total outstanding number of shares stood at 81m (91m on a fully diluted basis, including equity-based awards). Tetragon has strong employee ownership, aligning the interests of the company with those of shareholders, which stood at 39.2% as at end-December 2023.

Tetragon’s shares are traded on the Euronext Amsterdam and the LSE, with median daily turnover of US$34k and US$10k over the last 12 months, respectively. Management highlights that due to Tetragon’s focus on professional institutions, the majority of turnover on its shares takes place on the OTC markets and in batches. Taking OTC trading into account, the average daily volume amounts to US$59k (see Exhibit 16).

Tetragon’s board comprises five directors, three of whom are independent. Each board member stands for re-election by Tetragon’s voting shareholders each year at the AGM, with the voting shares controlled by Reade Griffith and Paddy Dear, non-independent board directors appointed in 2007 and 2005, respectively. Both are co-founders of Tetragon, Westbourne River Partners, TFG Asset Management and TFM. Reade Griffith is also employed by TFG Asset Management. For detailed biographies of the board members see our April 2019 note.