Tetragon Financial Group — Leveraging up for new investments

Tetragon’s portfolio recorded a 3.0% gain on valuation in H123, translating into a 1.7% NAV per share increase (in total return terms) after ongoing costs, with share buybacks adding 1.6pp to its NAV performance in H123. The growth of the portfolio was driven roughly equally by direct listed equity and credit investments, private equity assets and TFG Asset Management, while the impact of the remaining asset classes on NAV performance was less pronounced (see Exhibit 2).

Tetragon’s return on equity (ROE) of 1.7% in H123 was behind its long-term performance (9.9% over the last five years on average) and its 10–15% target (see Exhibit 3). Meanwhile, Tetragon’s performance is clearly ahead of its direct peers (see Exhibit 4) from the AIC Flexible Investment sector across all presented periods, with Tetragon being the top performer over 10 years. 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 renders none of the companies a perfect direct comparator.

The ‘other equities and credit’ bucket, which consists predominantly of stocks (92% of the pool), was up 16% in H123, contributing 1.1pp to Tetragon’s NAV. The stock portfolio is concentrated in a few high-conviction names, and therefore its performance (up 17.5% in the period) was mostly driven by individual developments within companies. According to the company, the rebound in two tech stocks after their 2022 losses was the main driver of the portfolio, further supported by positive Phase II trial data announced by one of its biotech holdings and a tactical trade in a US regional bank where the manager seized an opportunity arising from a temporary valuation dislocation.

Tetragon’s private equity assets, which make up 16% of its total portfolio, showed an 8.4% appreciation, translating into 1.2pp NAV accretion. Growth was driven by funds managed by Hawke’s Point, which showed 23.7% growth (up US$14.0m) in the period due to operational progress at one of its Australian gold project investments and positive exploration results and corporate developments in another Australian investment. The second growth factor was a US$10.7m revaluation of Tetragon’s direct private equity investments (which we understand consists mostly of its investment in Ripple Labs). In the ongoing case against Ripple, the US judge has recently ruled that the company did not violate federal securities law by selling its XRP token on public exchanges, with the announcement triggering a 72% rally in the XRP price. While the news was positive for the company, we note that Tetragon holds Ripple’s preferred stock rather than tokens. The ruling is not final, and Ripple Labs did violate the law in its sales of tokens directly to sophisticated investors.

TFG Asset Management represents 50% of Tetragon’s NAV and remains the main driver of its results. It recorded a US$30.2m uplift on the back of a US$53.2m upward revaluation of Equitix. The manager focuses on integrated core infrastructure and delivered against its business plan according to Tetragon. The strong cash flow generation allowed Equitix to distribute US$9.1m in dividends to Tetragon in H123 as well as to reduce its leverage. The valuation was also supported by a strong sterling (up 5% against the dollar in the six months to end June 2023), while the valuation multiples of listed peers used to value Equitix contracted by 5%. While the downward revaluations of the remaining asset managers within TFG Asset Management partially offset Equitix’s gains due to various reasons (multiples contraction, reduction of carried interest estimates in the case of BentallGreenOak, or working capital support in the case of ramping up businesses), overall, we believe that TFG Asset Management presented good operating results. Total income increased 6.3% y-o-y (to US$135.7m) and net income rose by 4.3% y-o-y (to US$33.7m). TFG Asset Management currently manages US$41.8bn of assets, up from US$41.2bn at end-December 2022.

Tetragon’s exposure to bank loans (10% of the portfolio) consists predominantly of majority positions in CLO equity tranches in the US. While their valuation remained broadly flat (up 0.2% vs end-2022), the tranches continue to distribute healthy cash flow on the back of increased interest rates while default rates remain low. In H123, Tetragon received US$32.3m from its bank loans (although this may also include disposals made during the period) out of US$119.4m cash proceeds from the total portfolio.

The default rate in the US leveraged loans sector started to increase (although it still remains below long-term averages). As of April 2023, the trailing 12-month default rate in US leveraged loans stood at 1.42%, and S&P expects it to increase to 2.5% by March 2024 – back to its long term average – in its base-case scenario. Some speculative-grade companies faced problems with refinancings as primary markets became more restrictive, limiting their access to capital. In its pessimistic scenario, S&P sees the default rate as high as 4.5% by March next year.

Having said that, all CLO structures Tetragon is invested in were compliant with their junior-most overcollateralisation (O/C) tests at end-June 2023. The manager sees some minor deterioration in the quality of the collateral, but any impairment losses were offset by higher-yielding reinvestment opportunities and increasing cash generation, leading to a flat valuation. Tetragon continues to view CLOs as attractive vehicles for obtaining long-term exposure to the leveraged loan asset class, and currently invests predominantly through funds managed by Tetragon Credit Partners. The fund TCI IV remains in its investment phase, being 74.5% funded (with Tetragon’s commitment at US$25.6m).

Tetragon’s investments in hedge funds, real estate and legal assets made up 26% of its NAV at end-June 2023 and their total attribution to H123 NAV performance was -0.4pp. The Polygon European Equity Opportunity Fund (11% of NAV) had a net performance of -4.3% for its Absolute Return share class, which is likely attributable to low volatility and low volumes of corporate activity in Europe, as the fund’s strategy is event-driven, focusing on mergers and acquisitions and deep-value dislocations. At the same time, Acasta Global Fund (4% of NAV), which focuses on credit opportunities with a particular focus on convertible assets, delivered a strong 9.1% net return for its flagship share class (compared to 0.7% for its benchmark). Real estate assets (5% of NAV) were down 2.1%, mostly on the back of a revaluation of hotel and residential property located in the US. While Tetragon does not disclose details of its real estate assets managed by BentallGreenOak (72% of Tetragon’s exposure to real estate), some comfort for investors may come from the fact that the majority of them concentrate on middle-market opportunities. In a recent study, McKinsey highlighted that the shifts in behaviour induced by the pandemic are here to stay and expects c 13% lower office demand by 2030 for the nine ‘superstar’ cities it has studied globally. This applies predominantly to the urban cores as their populations have dropped by up to 7%, putting pressure on rents and therefore valuation in the formerly most sought-after areas.

As at end-H123 Tetragon’s net gearing increased to 9.5%, from 6.1% at end-2022, while previously (2015–19) Tetragon has kept considerable amounts of cash at hand. As at end-June, Tetragon had US$300m of its US$400m credit facility drawn and its net debt position stood at US$262.3m.

In H123 Tetragon continued its investments and distributions to shareholders. It has invested in the portfolio US$22.8m net of disposals and distributions (the gross investment volume stood at US$142.2m), paid US$10.3m in dividends and closed a US$25.1m tender offer on share repurchases (in April 2023). Including its ongoing costs, the total net cash outflow in H123 amounted to US$95.7m.

It has invested US$31.7m (net) into private equity assets, predominantly in external funds (US$12.6m) and an undisclosed direct investment (US$10.5m). Tetragon also committed US$10.6m to its hedge funds, with US$20m invested in Polygon European Equity Opportunity Fund (managed by majority-owned Polygon) while reducing its holdings in funds managed by minority-owned Acasta by US$10m. Another US$9.3m (net) was provided to TFG Asset Management.

As at end-H123, Tetragon had US$100m in undrawn credit. On top of that, its available resources also included cash at hand (as the net debt position stood at US$262.3m, with US$300m drawn from the facility), which compares to US$113.5m of capital commitments. It is important to note that 44% of these commitments are to funds managed by wholly owned asset managers (Contingency Capital and Tetragon Credit Partners).