AN OLD adage in investing is don’t invest in something that you don’t understand. The new private equity-backed bond that has been launched by Temasek Holdings unit, the Azalea Group, potentially comes under this category. It is called Astrea IV.
The marketing literature for the product says that Astrea IV “uniquely transforms” private equity (PE) into bonds through Astrea IV PE bonds. The bonds are backed by cash flows from a portfolio of investments in PE funds.
Astrea IV PE bonds have the characteristics of a typical bond. The retail tranche of the Class A-1 bonds carries an interest rate of 4.35% per annum, paid semi-annually.
This is a decent annual return in the current climate of low-interest rates, and as investors all over the world struggle in their search for yield. The bond has a tenure of 10 years, which is good for retail investors as it locks them into a long-term investment. But it is callable after five years, meaning that it can be redeemed prior to maturity by the issuer if it can refinance the debt at lower interest rates. Amid the continuing uncertainty about where interest rates are headed, this is a typically safe option for issuers to take.
It was 7.4 times subscribed with nearly S$890 million in valid applications received.
Bloom Or Doom?
So, this all looks quite positive for retail investors who are interested in the bonds. However, perhaps they should look deeper into the offering and, in particular, try to understand how the bond plans to make its payments. This is where the complexity of the product arguably comes into play.
The underlying instrument that provides the cash flows for the bonds are the income streams of PE funds. These are nearly impossible for investors to track as PE funds tend to be quite opaque.
Meanwhile, the official document that accompanies the bond issuance lays out the PE fund investments that underpin it. The bulk of the investments are in US-focused funds (62.8%), with the remainder almost evenly allocated between Europe (19.1%) and Asia (18.1%). This injects geographical diversity into the investment product, which is a positive though this has to be taken with a pinch of salt as global economies are highly interconnected these days.
The top three private equity fund investments cited in the document are Blackstone Capital Partners, PAG Asia, and Silver Lake Partners. These are not exactly household names and investors should research them and the other PE funds that are being invested in.
Further, there are so many PE funds these days that good investment opportunities may be harder to come by for them. It could result in PE funds investing in opportunities that may not be their first choice because another private equity fund has got there first.
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Layers Of Complexity
Another layer of complexity comes from the investee companies of these PE funds. According to the document, there are 596 investee companies underlying the private equity funds that, in turn, underly the bonds. No single investee company is larger than 3% of the net asset value (NAV) of a fund.
About 23% of these companies are in the information technology industry while about 21% is from the consumer discretionary sector, which essentially refers to luxury goods. Other sectors to which there is significant exposure (more than 10%) are Industrials, Healthcare, and Financials.
This is all and good, as the bond product is diversified across industry sectors which is more robust than geographical diversification. But as a layman investor, you may wonder how Astrea IV is going to ensure that the specs of its bond are adhered to at the PE fund level, especially the condition that the NAV of an investee company within a PE fund cannot exceed 3% of the NAV of the fund.
This will require close contact between the Azalea Group and the private equity funds. However, there are many PE funds involved and it could be costly. Paying for such costs will also likely come from the cash flows that stream into the bond.
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Innovative But With Uncertainties
While this bond product is certainly innovative, there are too many uncertainties embedded in its design. Having said that, this is not the first time the Azalea Group has issued such a bond. Its track record is solid and this particular bond series has won multiple awards.
Which brings up another investment adage: Past performance does not guarantee future outcomes.
You can’t shake off the feeling that this investment product should have remained in the domain of institutional investors and accredited investors. It is somewhat surprising that the Monetary Authority of Singapore allowed such a product to be sold to the masses.
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