Tetragon Financial Group 06 November 2019

Tetragon Financial Group Limited (Tetragon) invests in a broad range of alternative assets. It aims to generate returns on equity of between 10-15% per year across cycles, and seeks to distribute a proportion of these returns through a dividend. The company has net assets of $2.27bn, and is traded on the Specialist Fund Segment of the LSE (primary listing on Euronext Amsterdam) with both a US dollar and an unhedged sterling share class.

Tetragon invests in a diversified set of alternative assets, including bank loans, real estate, credit, convertible bonds and infrastructure. As at 30 September 2019 around 62% was invested in those asset types, while 31% was invested, private equity style, in the equity of investment management companies who manage the funds through which Tetragon obtains its exposure. The balance (7%) was held in cash.

In the Portfolio section we provide more detail on the underlying assets themselves. Tetragon aims to identify and invest in a range of uncorrelated alternative asset classes, using managers who can achieve the trust’s total return objectives. However, in also owning stakes in alternative asset management companies, Tetragon aims to leverage the depth and breadth of their investment platform, to grow assets and ultimately achieve strong returns from these investments too. The uplift in valuation from two of their holdings in investment management companies during the first half of 2019 reinforces this approach.

The company’s objective (capital appreciation and distributable income) has been achieved so far. Tetragon’s NAV performance has been strong both in absolute terms and relative to equity and alternative funds. Putting this in the context of the broad investment trust universe, over five years the fund has generated a similar quantum of returns to Scottish Mortgage, but with the same volatility as RIT Capital.

Importantly, Tetragon has exhibited NAV correlation to equity markets at a fraction of the level of those two trusts; over five years Tetragon has exhibited a correlation of just 0.16 against the MSCI ACWI. In terms of capital preservation, the maximum drawdown over five years is significantly lower than Scottish Mortgage or RIT Capital, at -8.5%. Not surprisingly, Tetragon’s alpha and Sharpe ratio statistics are better than the other two trusts, which in our view are both very good performers in their own right.

Source: Morningstar, as at 31 October 2019

In our view, Tetragon has demonstrated that its size and closed-ended nature, along with the experience of the company’s investment manager, give the trust a distinct advantage in achieving its investment objective and strategy.

As we highlighted in our article earlier this year, Tetragon seems to be one of the most underappreciated companies in the London listed fund sector. It trades on a gaping discount despite being, in NAV total return terms, the third best performer over ten years in the AIC’s universe of 418 LSE funds (and second best in share price terms: source https://www.theaic.co.uk as at 30 September 2019). Certainly, there are factors which might justify some sort of discount to NAV, despite what we see as an excellent track record. However a discount of 47% surely allows a significant margin of safety. Ultimately, the management and employees of Tetragon’s investment manager own 28% of the company, which surely provides more long-term alignment than most incentive structures employed in the fund management world?

Having generated US dollar NAV total returns of 11.2% per annum since the trust’s IPO, long-term returns are comparable to Scottish Mortgage, which trades around par (and often at a premium to NAV). However Tetragon’s track record of capital protection is better than RIT Capital, which trades on a premium of around 10% and is feted for its defensive qualities. There are plenty of theoretical reasons for the discount of 47%, but in our view it is untenable at this level over the long run.

With the extended bull market, discounts across the sector have narrowed towards historically tight levels. Everywhere we hear investors querying how long the equities bull run can last. As Q4 2018 demonstrated, even slight worries about the future upwards path of interest rates can lead to significant falls in asset prices. Tetragon is large and diversified, with what we see as low equity or bond market correlation. We also see that it has outperformed equity markets, but has low exposure to equities as an asset class. For investors looking for wealth preservation, or a place to park capital away from equities at elevated valuations, Tetragon could represent one place to hide out a potential storm.

The discount may take time to narrow, but ultimately, if the NAV continues to exhibit characteristics even close to those demonstrated over recent years, in our view it can only be a matter of time before this occurs.