Value Investing Congress – Tetragon: A 60-Cent Dollar?

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Darrell Leong’s write-up of Tetragon Financial Group Limited (AMS:TFG) won him a Benjamin Graham Fellowship.

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In 2002, Reade Griffith (formerly from Citadel), Alexander Jackson (formerly from Highbridge) and Paddy Dear (formerly from UBS) founded Polygon Investment Partners. In May the following year, Polygon launched its flagship hedge fund, the Polygon Global Opportunities Fund, which soon became famous for its investments in convertible credit and event-driven equity. When its AUM started to get too big (reaching $8B at its peak), Griffith and Dear decided to spin off its CLO business, which became Tetragon Financial Group Limited (AMS:TFG). Tetragon IPO-ed in 2007 on the Amsterdam Exchange.

Today, buying into Tetragon Financial Group gives you a stake in a closed-end fund that consists of two main assets –

  1. An investment portfolio consisting $1.8 billion of financial assets and
  2. TFG Asset Management, a global alternative asset management business with $10.5 billion of client assets under management (AUM).

Tetragon Financial Group’s Investment Portfolio

Tetragon Financial Group Limited (AMS:TFG)’s main business is the managing of its investment portfolio, which generated 64% of LTM revenues and 86% of LTM EBITDA. As can be seen in Figure 2, this portfolio primarily consists of US Collateralized Loan Obligations (CLOs) originated pre- (1.0) and post- (2.0) crisis, but also includes investments in European CLOs, direct loans, and equities and credit through TFG’s subsidiary, Polygon.

Tetragon CLO

CLOs are best thought of in terms of their balance sheet. Like a synthetic bank, owners of the CLO profit through the funding spread between its asset yield and its liability yield.

  1. Their assets include securitized pools of leveraged loans1, which are floating rate2 and have a 5-7 year maturity, with an average facility size of $650M, and limited call protection. They are also normally secured on the borrower’s assets, with strict covenants.
  2. Their liabilities are tranched3. This implies a cash flow waterfall when it comes to payment of principal and interest, with the senior notes getting the proceeds first (should the Manager choose not to reinvest them), followed by the mezzanine, and then the residual equity.

Tetragon Financial Group’s portfolio made up of CLO equities

Tetragon Financial Group Limited (AMS:TFG)’s portfolio is primarily made up of majority stakes in CLO equity, which limits its access to principal repayments but also allows it to negotiate more favorable deal terms. Because of its majority stake, Tetragon Financial Group gets decent call options and refinancing rights, which have come in extremely handy in the low-rate environment of the past few years, allowing the company to reduce its average cost of capital.

It is also worth noting the declining portion of U.S. CLO 1.0s as a % of the total Investment Portfolio.

The typical life-span of a CLO includes

  1. the ramp up period, where the CLO manager uses the funds he raises to acquire assets
  2. the reinvestment period, where the collateral manager is permitted to actively trade the underlying assets or use excess cash flows to purchase new ones
  3. the amortization period, where all cash flows are then used to pay down outstanding notes

As can be seen in Fig 3, most of Tetragon Financial Group Limited (AMS:TFG)’s CLOs are nearing the end of their reinvestment date. This has profound implications for the company in terms of:

  1. higher NAV volatility because the fair value of most of its CLO holdings approaches liquidation value and not the discounted future cash flows
  2. the need for management to reinvest the proceeds from the unwinding of CLOs in today’s lower rate environment, and deciding on what to invest in

Tetragon Reinvestment

As can be seen from the decreasing proportion of CLOs in Tetragon Financial Group Limited (AMS:TFG)’s Investment Portfolio, management’s obvious answer to (2) above is to increase its exposure to other asset classes.

TFG Asset Management (TFGAM) generates sustainable management fees.

See full article in PDF format here.

Darrell Leong Long TFG

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