Editing Tetragon Financial Group

[[File:Tetragon Financial Group logo.jpg|thumb|Tetragon Financial Group logo]]

'''Tetragon Financial Group (Tetragon) focuses on alternative asset classes offering excess risk-adjusted returns (ie ‘intrinsic alpha’). This includes private equity holdings in alternative asset managers, investments in funds, as well as balance sheet investments in alternative assets. Tetragon posted a 14.1% NAV total return in FY21 in US dollar terms and so far saw only an 0.6% NAV decline in 2022 until end-April. It continues to make distributions to shareholders through NAV-accretive share buybacks (it completed a US$42m tender offer in April 2022) and dividends (with its LTM payout implying a 4.1% yield).'''

'''Cumulative gross returns of Tetragon’s portfolio ex cash (rebased)<ref>Source: Tetragon, Edison Investment Research. Note: *Not adjusted for investments/disposals during respective years.</ref>'''

=== Why invest in Tetragon Financial Group? ===

=== The analyst’s view ===

While the global economy recovers from the pandemic-induced slowdown, investors are now mostly concerned about high inflation and monetary tightening, as well as uncertainties on global supply chains and trade routes (further exacerbated by lockdowns as part of China’s ‘zero-COVID’ policy, and sanctions on Russia following its invasion on Ukraine). The World Bank recently reduced its expected GDP growth in Europe to 2.5% in 2022 from 4.2% earlier (mostly due to rising energy prices) and cut the US growth forecast by 1.2pp to 2.0%. With slowing growth and high inflation, investors are likely to be drawn to (1) assets benefiting from rising interest rates or having embedded inflation protection and (2) alternative assets, which are exhibiting low correlation to equities.

In the near term, the rising interest rates should have a positive impact on collateralised loan obligation (CLO) cash flow generation, especially by increasing the residual cash flow to CLO equity tranches. Since the beginning of 2022, three-month Libor increased from 0.21% to the current 2.20% (27 June) and given the record-high inflation (the US CPI hit a 40-year high of 8.5% in March 2022) the consensus expectation is for the Federal Reserve to continue raising rates throughout 2022. In the long run, however, the increasing cost of debt may translate into higher default rates and collateral quality deterioration. In this scenario, cash flow would be redirected from equity (and potentially also junior debt) tranches due to internal test breaches. So far, the default rate in the United States has increased only slightly (0.6% on a last 12 months (LTM) basis) and is expected to reach 1.5% in 2022 and be in the 1.25–1.75% range in 2023 according to Fitch. This compares to c 4% recorded at the pandemic peak (September 2020) and over 10% in late 2009 as a result of the global financial crisis (Fitch). Tetragon is currently invested only in US-based CLOs, predominantly in equity tranches. Tetragon is exposed to the CLO market in several ways. It owns a 100% stake in CLO manager LCM and CLO-investing asset manager Tetragon Credit Partners (TCIP). Tetragon also invests in TCIP-managed funds, as well as directly into CLOs managed predominantly by LCM but also third-party managers. The combined exposure amounts to 19% of Tetragon’s NAV.

Tetragon Financial Group is a closed-ended investment company traded 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 (including distressed securities and structured credit), convertible bonds, real estate, venture capital, infrastructure, bank loans and TFG Asset Management, a diversified alternative asset manager. The company is domiciled in Guernsey and was founded in August 2005. Before 2018 Tetragon invested through the Tetragon Master Fund, which was amalgamated with Tetragon that year to simplify the structure and reporting. 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 cash dividends may be elected by investors to be paid in sterling, instead of the company’s base operating and reporting currency (US dollars). The quoted shares available to investors on the listed exchanges do not hold any voting rights.

Tetragon is ultimately controlled by its co-founders Reade Griffith and Paddy Dear. They control the voting shares of the company, as well as Tetragon’s investment manager – Tetragon Financial Management (TFM). They co-founded Polygon, which is wholly owned by TFG Asset Management, in 2002. TFM’s investment committee, which determines Tetragon’s investment strategy and approves every major investment, comprises Griffith and Dear as voting members, and Stephen Prince (Head of TFG Asset Management), who all have experience in alternative investments. Tetragon and TFG Asset Management employees cumulatively held 34.5% of outstanding non-voting shares of Tetragon at end-April 2022.

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 to be high-quality specialists with successful track records and aims to invest not only into managed funds, but into the manager as well to supplement its returns with stable fee income and capital appreciation from growing third-party capital.

=== Tetragon’s approach to ESG ===

Tetragon is managed by Tetragon Financial Management (TFM). TFM was founded and is owned by the co-founders of Tetragon (Reade Griffith and Paddy Dear), who also founded Tetragon in 2005 and launched Polygon in 2002 (currently wholly owned by Tetragon). 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 of Tetragon.

Tetragon continues to see TFG Asset Management as its main value driver going forward, which was the case in each financial year from 2017–21. Tetragon aims to continuously expand the entity with new managers, asset classes and strategies and its aggregate assets under management (AUM) reached US$37bn at end FY21 (a 14% five-year CAGR). While Tetragon still considers an IPO of the whole entity as a viable exit route, it now expects that exit transactions of individual asset managers within TFG Asset Management are more likely in the mid-term. Currently, TFG Asset Management comprises nine asset managers, two of which Tetragon considers relatively mature. In the case of three it sees further potential for high growth, while the remaining four are in the early stages of development (see the Asset allocation section for more details on TFG Asset Management managers).

As at end-April 2022, Tetragon’s NAV stood at US$2.7bn across various alternative asset allocations. TFG Asset Management remains its largest portfolio holding (making up 45% of the NAV). It is a wholly owned subsidiary, holding (mostly) majority stakes in alternative asset management companies generating stable fee income from AUM of US$37bn (at end-2021) in infrastructure, real estate, CLOs and private equity as well as hedge funds (see details below). Tetragon invests predominantly into strategies of these companies (42% of Tetragon’s portfolio at end-March 2022). The remaining 14% of the portfolio is Tetragon’s direct investments (7%) and assets managed by third-party managers (7%).

'''Exhibit 1: Portfolio by asset class (April 2022)<ref name=":0">Source: Tetragon Financial Group, Edison Investment Research.</ref>'''

[[File:Portfolio by asset class (April 2022).png|506x506px]]

'''Exhibit 2: Portfolio exposure by manager (March 2022)<ref name=":0" />'''

[[File:Portfolio exposure by manager (March 2022).png]]

=== Private equity and venture capital ===

Apart from direct investments (US$34m at end-March 2022), Tetragon also invests in Banyan Square Partners managed funds focused on co-investments (US$112m), funds managed by Hawke’s Point (US$58m), as well as externally managed investments (US$127m). Hawke’s Point funds invest in mining assets, predominantly gold mines. Hawke’s Point’s projects are early stage, with their value equally dependent on the gold price and their progress in moving up the development curve. An illustration of this is the US$39m loss (30% decrease in value) in FY21, driven predominantly by developments in one gold mine project in Australia.

=== Bank loans ===

=== Other ===

Tetragon’s quoted assets portfolio (‘other equities and credit’, 6% of portfolio at end-April 2022) is concentrated in several high-conviction positions, including in particular tech and biotech stocks. Its real estate investments are executed through or alongside BentallGreenOak’s managed private equity-style funds and co-investment vehicles that focus on opportunistic investments in the US, Europe and Asia (except for the Paraguayan farmland managed by Scimitar). Litigation Finance is a new endeavour for Tetragon and comprise funds managed by Contingency Capital (investing in legal assets). These make up only a minor part of Tetragon’s portfolio for now (c 1% of NAV at end-March 2022).

Tetragon’s reported ongoing charge ratio was 1.70% (flat year-on-year) and included the 1.50% annual management fee. In FY21 Tetragon expensed US$162.1m in management and incentive fees to TFM, which translates to 6.6% of the opening NAV and compares to US$107.1m expensed in FY20 (4.5% of NAV) when the NAV total return stood at 9.5%.

'''Exhibit 3: Tetragon’s NAV per share development in FY21 and until April 2022 (US$/share)'''<ref name=":0" />

'''Exhibit 4b: Price, NAV and benchmark total return performance (%)<ref name=":1" />'''

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|+Exhibit 5: Five-year discrete performance data<ref>Source: Refinitiv. Note: All % on a total return basis in pounds sterling.</ref>

(%)

(%)

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|30/04/18

'''Exhibit 6: FY21 and 4M22 performance by asset class (%)<ref>Source: Tetragon Financial Group, Edison Investment Research. Note: Share of Tetragon’s NAV at end-April 2022 stated on x-axis labels.</ref>'''

'''Exhibit 7: FY21 and 4M22 NAV attribution by asset class (pp)<ref>Source: Tetragon Financial Group, Edison Investment Research Note: Share of Tetragon’s NAV at end-April 2022 stated on x-axis labels.</ref>'''

=== TFG Asset Management ===

As a result, Equitix represented 25.3% of Tetragon’s NAV at end-2021 and given Tetragon’s high discount to NAV (see below for details), it now equals 71% of its market capitalisation. The business grew its AUM by c 23% to £8.0bn (US$10.8bn) in FY21, resulting in a 13% y-o-y increase in management fees (though its primary income declined in FY21). Equitix also increased its income from management services contracts (EMS business) by 21% y-o-y. It expanded its headcount during the year to further stimulate growth in the business and as a result the increase in its operating expenses was responsible for little over half of the US$32.5m opex growth of TFG Asset Management during the year (see below).

LCM (8.3% of Tetragon’s NAV at end-2021) grew its AUM by 26% y-o-y to US$11.2bn after launching six new CLOs in FY21 with an aggregate AUM of US$2.8bn. The business was revalued by c 34% in FY21, assisted by a revised five-year AUM growth assumption of 10% from 6.5% previously and the introduction of a 20% premium for control. LCM continues to be valued using a blended DCF (12.25% discount rate) and market multiples approach, but in the latter case the ratio was changed from 2.5% price/AUM to 12.5x EV/EBITDA as it is a more forward-looking ratio. The prospective AUM growth assumptions were also revised for BentallGreenOak (to 18.4% from 11.9%) and Polygon (to 9.9% from 8.6%). The valuation of LCM further increased in Q122 by US$37m (16%).

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|+Exhibit 9: Selected AIC Flexible Investment sector peer group in sterling terms at 27 June 2022<ref>Source: Morningstar, Edison Investment Research. Note: *Performance data to 30 April 2022. TR = total return in sterling terms. Net gearing is total assets less cash and equivalents as a percentage of net assets (100 = ungeared).</ref>

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Dividend payments decreased in response to the COVID-19 outbreak, with DPS paid from FY20 profits reduced by 46% y-o-y versus FY19 to US$0.40. Consequently, US$44.8m was paid out during 2020 versus US$65.2m i<ref>Source: Tetragon Financial Group, Edison Investment Research.</ref>n 2019 (down 31% y-o-y, due to the Q419 dividend being paid in 2020), but this was mostly offset by a higher buyback amount (see Exhibit 11). In FY21, DPS was increased by just 2% to US$0.41 (although this now implies a solid yield of 4.1% on a last 12-month basis). While no buybacks were performed in FY21, Tetragon conducted a tender offer in April 2022, buying back over 4m shares for a total consideration of US$42m at US$9.75 per share. During 2021, Tetragon acquired 219k shares from TFG Asset Management for a total consideration of US$2.1m.

Shareholders have an option to receive dividends in the form of shares and in FY21 US$11.6m (FY20: US$14.1m) out of the US$35.8m gross dividend paid during the year (FY20: US$44.8m) has been taken in shares by investors. The dividends paid in cash during 2021 amounted to US$24.2m (down from US$30.7m paid in 2020).

'''Exhibit 12: Share price discount to NAV over five years (%)<ref>Source: Refinitiv, Tetragon Financial Group, Edison Investment Research.</ref>'''

The facility has an interest rate of three-month US Libor +3.25%, and Tetragon is also obliged to pay a servicing fee of 0.015% of the total amount and non-usage fee of 0.5% on the undrawn amount. In 2021 the total costs of the credit facility totalled US$5.1m (FY20: US$6.2m), which translates to 0.2% of Tetragon’s opening NAV. During the year, Tetragon repaid US$25m of the facility on a net basis.

The board of directors is entitled to a fixed fee of US$0.4m pa (US$125k each member; Dear and Griffith waived their fee), which can be realised in the form of shares. Additionally, some senior employees of the structure are eligible to equity-based compensation. The shares are bought from the market and held in an escrow account until they are vested upon fulfilment of certain targets. During FY20, Tetragon released 0.4m shares from escrow and 1.6m from treasury shares as stock dividends and equity-based compensation. During FY21 Tetragon bought 0.2m shares from the market, which compares to 6.6m acquired in FY20.

Reade Griffith and Paddy Dear are owners of TFM. Mr Griffith is also employed by TFG Asset Management and is the chief investment officer of Polygon’s event-driven European equity strategies. His current contract has been in place since July 2019 and includes US$9.5m paid in cash upon signing, US$3.75m paid in 2020 and up to 5.6m shares to be granted over seven years depending on performance (of which 0.3m were granted in FY21), which are held in escrow. The employment agreement replaces an earlier agreement, which included a US$0.1m annual salary.

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. At end-2021 90.2m shares were outstanding (96.4m on a fully diluted basis after accounting for potential dilution from equity-based awards). Tetragon holds 38.5m shares in treasury and further 10.9m in an escrow account (dedicated to fulfilling certain equity-based compensation obligations), and in total shares held by Tetragon make up 35% of the shares issued. Co-founders and employees own 34.7% of the non-voting shares outstanding as at end-January 2022.

'''Exhibit 13: Major shareholders<ref>Source: Bloomberg, Tetragon Financial Group, as at 24 June 2022.</ref>'''

'''Exhibit 14: Average daily volume<ref>Source: Refinitiv. Note: 12 months to 24 June 2022. Combined traded volume on Euronext Amsterdam, LSE and OTC markets.</ref>'''

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|0.01%

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