Undisclosed risk factors to Astrea V bonds and why we think the bonds are not of an attractive risk

We bring to you a review of the latest Astrea V PE bonds, a collateralised fund obligation transaction by Azalea Investment Management which is a wholly owned subsidiary of Temasek Holdings. The main reason of not investing in Astrea V PE bonds is because we think this is an investment that is not worth the risk reward return.

We will skip the background information as you may refer to the prospectus and other websites for summary information and will focus only on the salient insights and risk of this transaction. From our various facebook posts and comments and also an earlier post on Tesla from a corporate governance perspective (https://thebearprowl.wixsite.com/website/single-post/2019/02/24/Corporate-Governance-into-Tesla-short-call-A-look-into-DCS-listings-rules-in-Singapore-the-recent-Hyflux-Saga), you may start to appreciate that we care about the education of the retail investors and therefore opine when we see major red flags where others have not.

This also aligns to our core value of providing deep insights. Our Tesla short position have in the past 3 months since initiation being up 37%.

We also think that the prospectus has been inadequate, with a lack of consistency and standardisation of information within.

Four salient insights and undisclosed risk factors

1. The structure

The Astrea V PE bonds are asset-backed securities backed by cash flows from investments in 38 PE funds. Astrea invests in underlying funds, diversifying into a total of 862 companies across the US, Europe, and Asia. Therefore, the retail investor is participating in a Fund of Funds as a debtholder.

The multitude of expenses and fees is higher than any other financial instrument available to retailers. There are also other costs being marketed to you as part of essential safeguards that we will detail below.

At the time of writing, we like to state that we think Astrea will be able to meet all coupon payments on a timely basis. We think the worst case scenario would be an under fulfilment of 1-2 tranches of reserve payment and a minor delay in the mandatory call. This is not attesting to the strength of the underlying investment but because the reward is a very small portion of the entire available pie.

2. The high price of investment

As mentioned earlier, the bonds are backed by cash flows, what is not mentioned is that the purchase price of the bond is the current market value of the underlying fund. The valuation of unlisted companies tends to be at a best case scenario, valued for the purpose of a future disposal, with multiple exponential growth assumptions.

20% of the portfolio are invested in the IT industry whilst the remaining 80% are in industries with stronger cashflow like healthcare, financials, industrials, consumer discretionary and communication services.

Cash flows for coupon and principal payments will be generated from dividends of underlying investment and also from realising these investments at a minimum price of today’s value, which is what you are paying. Where the value of a company underperforms, the manager relies on the value of another company to outperform so as to grow the total net asset value.

This could be viewed as a positive point as compared to a single company bond with the diversification which allows for the opportunity for an outperforming company to offset an underperforming company. Azalea has pointed out that the average vintage of the fund is 5.4 years and are mature funds which are more likely to generate cash flow.

We think 3.85% cashflow is expected and the bigger question is whether the investee companies which are also mature can maintain its value(value being derived from growth and cashflows amongst other things) so that Azalea can sell them to meet principal payments.

3. The senior priority fallacy

It is stated that bondholders, especially the retail portion has senior priority. This is true only from the Astrea perspective. We like to remind you that this is a Fund of Fund, in the event that one of their investments go under, the true senior priority is the debt holders of the underlying investment/company that the fund invests in, followed by equity holders of this company.

The Funds that Astrea is invested in then liquidates their investment and pays off their debtholders followed by equity holders. This equity holder is Astrea. Astrea then pays off debtholders in the stated priority order, which is after paying of all operational creditors protected by legal rights.

Is this really senior priority to investors of Astrea V in an event of financial stress? We think not!

Further, funds typically structure their financing with both debt and equity. Therefore, from a structuring perspective, at the point an investment goes south, there could be less recovery if the fund invest a higher portion in equity as opposed to debt.

4. The withdrawal of investment by other fund participants

This is one of the biggest risk that is not in the prospectus. In recent times, investors have been pulling out funds en masse from private equity and hedge funds. When this happens, the funds may have to sell off their investments to gather cash for this purpose.

In the private equity market, it may be challenging to unwind a portion of investments, they may also be forced to unwind at a less than favorable price.

Unwinding a portion of the investment will also mean that the fund will lose control over their investments. The control premium not only provides a higher sale value, but also allows the investor to direct the strategies and operations of the company. The control premium is the cornerstone for PE.

What this means for you is that even if Azalea does not intend to withdraw investments, the total return of investment may be impacted if the underlying funds are forced into the situation mentioned above.

What these funds can do is block investors withdrawal, but this is rarely done as it will draw the ire of the investors.

Given the current high valuation for global equity markets, we think there is a possible risk to devaluation and withdrawals from fund investors which form a negative feedback loop.

Other takeaways

1. We like the fact that the retail bond portion has been reviewed by a credit rating agency and issued an indicative A+ rating (by S&P). For comparison, Singtel also has an A+ rating. While we will not go into detail of what a credit rating means, we like to point out that it can be re-rated both up and down.

2. There are various safeguards that Azalea has put in place, which no doubt comes at a cost to the bondholder. This includes currency hedges, credit facilities, funding of LTV shortfall by the issuer and the semi-annual reserve payment which means that Azalea will not be able to hide any major underperformance.

3. Affiliation of Azalea Asset Management to Temasek Holdings

Much of the marketing of both Astrea IV & V issues to the Singapore public investors have been the focus of Temasek Holdings Pte Ltd ownership of Azalea Asset Management Pte Ltd.

While we appreciate the fact that Azalea have clearly stated to the retail investing public that its bonds are not capital guaranteed by Temasek Holdings, we would like to reiterate to investors that in the event of any haircut to Astrea V bondholders, our view is that Temasek Holdings would never bail out Astrea V bondholders even if it means harming Temasek political links in Singapore.

Therefore, the structure is such that Astrea V is ringfenced from the previous issue and also from Azalea, as such, any losses from Astrea V cannot be covered by Azalea or any other previous issue.

As Azalea is a fund investment manager, Azalea and the Astrea V bonds do not hold major strategic importance assets in Singapore, there is no incentive for any bailout.

Another reason for this would be moral hazard to the public, and also the negative image of setting a precedence to government bailouts in the future.

This is very different from a corporate entity which may be bailed out due to its strategic importance to Singapore, or where it may cost more to be replaced.

Conclusion - Underwhelming Risk reward ratio

The minimum expected return for a PE investment via equity financing is around 15% on a CAGR basis. The Astrea bondholder is investing for merely 3.85% with the illusion of senior priority, risk of withdrawal by other investors and the high NAV price which is characteristic of an investment into a mature fund.

In addition, there are also the list of risks disclosed in the prospectus which are unique to a PE investment and applicable to you even as a bondholder.

Given the slowing global macro environment which have been agreed by various global central banks statements and reports in the past 6 months, we urge investors to be cautious in aggressive investments due to possible devaluation of asset prices which would directly affect the underlying value of the assets and the cashflows for the Astrea V bonds.

Therefore, it is beyond our understanding as to why one would agree to a 3.85% return.