Would I Invest in Astrea IV 4.35% Bonds?
- Original Post from (The) Boring Investor

Recently, Temasek launched a Private Equity (PE) bond for retail investors known as Astrea IV 4.35% bond. It is the first PE bond open to retail investors. Would I invest my money in this bond?


First of all, let us understand what this bond is all about. This bond is issued by Astrea IV Pte Ltd, an indirect wholly owned subsidiary of Temasek, to hold a portfolio of PE investments. The investments are managed by 27 General Partners in 36 PE funds and invested in 596 companies. 86.1% of these funds are invested in buyouts, with 12.3% in growth equity and 1.6% in private debt.


Buyout funds are funds that privatise publicly listed companies, cut the excesses in the companies and streamline their operations to make them more efficient, and seek to exit the companies by selling them or listing them again. An example is Amtek Engineering, which was delisted from SGX in 2007 after being bought out by a PE fund, and was relisted as Interplex Holdings in 2010. And the story did not end there. Interplex Holdings itself was delisted in 2016 after being bought out by another PE fund.


The issuer, Astrea IV, has 3 classes of bonds, as follow:


  • Class A-1 - SGD242M 4.35% senior bonds that are open to retail investors and which are the subject of this post.

  • Class A-2 - USD210M senior bonds open only to Institutional and/or Accredited Investors. Class A-2 bonds have the same seniority as Class A-1 bonds.

  • Class B - USD110M bonds junior bonds open only toInstitutional and/orAccredited Investors.



The structure of the bonds is such that Class A bonds have priority to interest payments and bond redemption. In addition, it can borrow money from banks to make interest payments in the event that there are insufficient cashflows to do so. Moreover, its Loan-to-Value (LTV) ratio is capped at 50% of the portfolio value. If this threshold is crossed, it will have to cut debt levels. Furthermore, Class A bonds are senior to Class B bonds and shareholder equity. For Class A bonds to lose money, the portfolio that Astrea IV invests in must lose at least 64.4% of its value. So, it is quite safe, isn't it?


First of all, you need to recognise that Astrea IV, the company that you are investing into by buying the retail bond, is essentially a fund of funds. Although its LTV is capped at 50%, this is only at the Astrea IV level. The funds that Astrea IV invests into could have their own borrowings and these are not counted in the 50% LTV cap. After accounting for these borrowings at the lower levels (i.e. look-through basis), the leverage could be much higher. As a hypothetical example, Company A could have shareholder equity of $50M and bonds of $50M. Using this $100M, Company A invests into Company B. Company B borrows another $100M. Company B invests the $200M into a property. How much of the investment in the property is funded by equity and borrowings? The answer is $50M in equity and $150M in borrowings. Thus, even though the LTV at Company A's level is only 50%, on a look-through basis, the LTV is 75%! Does LTV on a look-through basis matter? For Company A's equity to be wiped out completely and its bonds to start losing money, the property's value only need to fall by 25% ($50M equity out of $200M asset value). So, LTV on a look-through basis does matter!


Secondly, most of the money are invested in buyout funds. Buyouts are usually highly leveraged operations. In the process of buying out companies, they take on large debts and usually pay a premium to acquire a 100% stake in the companies. After successfully acquiring the companies (which are usually cashflow-rich companies), they extract most of the cash from the companies to pay down their own debts. They also streamline the operations of the companies and load them with debts, such that the companies become more conscious about cutting costs and direct most of their cashflows to paring down the debts loaded onto them. Thus, the high returns of buyout funds are partly due to making the companies more efficient and partly due to the leverage employed. As an example, when 3G Capital teamed up with Berkshire Hathaway to buy Heinz for USD23.3B in 2013, they only forked out USD4.4B in capital each. The remaining was borrowed. (Note: Berkshire Hathaway also bought USD8B of preferred stocks paying 9% interest. I will leave it to readers to decide whether to classify this USD8B as equity or debt.)


Thus, in conclusion, Astrea IV is essentially a fund of leveraged buyout funds. I will not be investing in these bonds, even if its 4.35% coupon looks attractive.




See related blog posts:

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Possibly The Worst Time to Invest – 5 Years On
- Original Post from (The) Boring Investor

US-China trade wars, Hong Kong protests, US yield curve inversion, etc. You probably would be thinking now is a bad time to invest. I had the same feelings 5.5 years ago in Dec 2013, when the Dow Jones Industrial Average was then near an all-time high and interest rates near an all-time low. You can read more about it in Possibly The Worst Time to Invest. Nevertheless, I still went ahead to initiate a plain vanilla passive portfolio comprising 70% in global equities and 30% in global bonds. In 2015, I also added a more spicy passive portfolio comprising 70% in US equities and 30% in Asian bonds.


Each year, I would blog about whether that decision in Dec 2013 turned out to be correct or not. Each year, the blog post would say the passive portfolios were up and there is inherent defence mechanism to manage the fearsome stock market crashes through portfolio rebalancing. These once-a-year blog posts on this series almost sound like a broken record.


This year, the plain vanilla portfolio is up by 39.5% since inception 5.5 years ago, while the spicy portfolio is up by 34.7% since inception 4 years ago. You can read about last year's figures in Possibly The Worst Time to Invest – 4 Years On.


Each year, there are bound to be events that worry us and stop us from investing. But each year, the stock market would somehow manage to shrug off the worrisome events and continue its upwards march, reaching new highs which previously seemed unimaginable along the way. A couple of years later, would you still remember the events that stopped you from investing? Do you still remember the taper tantrum in 2013, the threat of Grexit and yuan devaluation in 2015, the shock Brexit vote and US presidential election in 2016? Some of these events have faded from memory, and some people might wonder what was the fuss that stopped anyone from investing in 2013/ 2015/ 2016, etc. But when these events were playing out, the mood was cautious and the stock markets were falling. A couple of years from now, would most people still remember the US-China trade wars, Hong Kong protests and US yield curve inversion that are causing the stock markets to drop currently?


There will be a time when the stock market crash really arrives. But no one can predict reliably when it will arrive. The best way to deal with it is not to stop investing, but to have a good defence mechanism in place while investing.




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Astrea V 3.85% Bonds – Understanding What You Are Buying Into
- Original Post from (The) Boring Investor

It has been exactly a year since I last blogged. My last blog post was on Astrea IV 4.35% bonds. Coincidentally, Astrea's management, Azalea, has recently launched the IPO for Astrea V 3.85% bonds. One year has passed. What do I think about Astrea bonds?


If you read last year's blog post onWould I Invest in Astrea IV 4.35% Bonds?, you would know that I was not too keen on Astrea IV 4.35% bonds. A large part of the reasons had to do with Private Equity (PE) bonds being a new asset class and there was too little time to properly analyse whether it would be a good investment. Given the time constraint, I relied on whatever understanding I had about fund of funds and leveraged buyout funds and concluded that I would not be applying for the IPO.

A week later, after the IPO had closed, I had more time to look at the structure of the Astrea IV bond and acknowledged that it could be a safe one, but only because of all the credit enhancement safeguards put in place. See Understanding the Safeguards of Astrea IV 4.35% Bonds for more info.

Thus, when the IPO for Astrea V 3.85% bonds was launched this week, the first thing I checked was whether it has similar safeguards as Astrea IV 4.35% bonds. It has. Still, it is necessary to re-iterate that being PE bonds, Astrea bonds are not traditional bonds and it is important to understand the risks of the underlying assets. Below is a summary of the risks that I am aware of.

Understated Loan-to-Value Ratio in Fund of Funds


Astrea V bonds invest in 38 PE funds run by independent PE fund managers. Its stated Loan-to-Value (LTV) ratio for the Class A bonds (comprising Class A-1 and Class A-2 bonds which have equal seniority) is 34.8%. This means that for Class A bonds to start losing money, the value of the underlying investments has to drop by 65.2%. However, the underlying PE funds have their own debts and these debts are not considered when computing the LTV ratio of 34.8% for Astrea V bonds. The true LTV ratio after considering the debts in the underlying PE funds (i.e. look-though basis) is likely to be much higher. This ratio matters. See Would I Invest in Astrea IV 4.35% Bonds? for an example.

High Leverage Used by Buyout Funds

80% of the Astrea V investments are in buyout funds. As discussed in Would I Invest in Astrea IV 4.35% Bonds?, buyout funds use a lot of debts when acquiring companies. Typical debts is in the region of 6-7 times Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA). High debts at the underlying PE funds, couple with a Fund of Fund structure, underestimates the true, look-through LTV ratio of the Astrea bonds.

Assurance of Net Asset Value

Astrea V has a portfolio value of USD1,342M. This is an important figure that is used to compute the LTV ratio. After the debacle of the Hyflux preference shares and perpetual securities, it became clear that asset values should not be taken at face value. Hyflux's main asset, Tuaspring Integrated Water and Power Project, which has a stated Net Asset Value (NAV) of $902M as at end of Financial Year 2017, could not be sold at close to book value. Given that PE investments are illiquid assets, what is the assurance that the portfolio value of Astrea V is really as stated?

This question was posted during the Astrea Investor Day in Jan 2019 and during the public roadshow on Astrea V bonds conducted with SGX Academy on Saturday. Azalea's management replied that the NAV of PE funds is checked by reputable auditors. In addition, there are secondary markets where PE funds are traded. The value at which they are traded is close to the NAV reported by the PE fund managers. Furthermore, when the PE investments are disposed of, Azalea cross-checks the sale value against the reported NAV. In most cases, the sale value exceeds the reported NAV.

PE in a Potential Bubble

PE investments have generated better returns than public equities in the last 20 years. This has resulted in a lot of funds flowing into PE investments, and increased competition between PE fund managers to find good deals. This has led to assets being purchased at higher prices. At the same time, the debts used by buyout funds to acquire companies has been on the rise. At some point in time, the PE boom will probably end, potentially leading to falls in NAV. See Bain & Company's report on Private Equity: Still Booming, but Is the Cycle Near Its End? for more info.

At Saturday's roadshow, Azalea replied that this is also a good time for selling assets in the PE funds that Astrea V has already invested in, which will result in cashflows coming back to the Astrea bonds. Furthermore, as most of the PE fund managers have a lot of experience running PE funds, they believe that the PE fund managers will be able to navigate the environment.

While I agree that this is a good time for selling assets in PE funds, this also means that the high asset prices are reflected in the portfolio value of Astrea's investments. In the event that asset prices correct, Astrea's portfolio value will also decline. This will lead to a rise in the LTV ratio, but there is a safeguard in place if the LTV ratio exceeds 50%.

Conclusion

Although I believe Astrea IV and V bonds to be fairly safe for retail investors, I cannot emphasize enough that the reason this is so is because of the credit enhancement safeguards that Azalea painstakingly put in place. Also, for investors interested to buy Astrea bonds, please understand what you are buying into.


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Understanding the Safeguards of Astrea IV 4.35% Bonds
- Original Post from (The) Boring Investor

Astrea IV 4.35% bonds are unusual retail bonds as they are backed by Private Equity (PE). There are 5 safeguards put in place by the issuer to ensure that cashflows from PE investments are adequate to meet the obligations of the bond. These are:



  • Reserves Accounts

  • Sponsor Sharing

  • Maximum Loan-to-Value (LTV) Ratio

  • Liquidity Facilities

  • Capital Call Facilities



To understand why these safeguards are important and necessary, let us consider a hypothetical scenario in which I wish to issue Boring Investor bonds to retail investors to raise capital to invest in public equities listed on the SGX. Cashflows for the bonds would come from sale of equity investments and dividends from investee companies.



Generally, the Straits Times Index (STI) generates annualised returns of 7% in capital appreciation and 3% in dividends on average. To entice investors to my Boring Investor bonds, I would probably have to pay interest rate of 5% on the bonds. The first question that comes to mind is how do I ensure that I could meet the 5% interest obligations on the Boring Investor bonds on a sustainable basis when I could only receive 3% dividends from the equity investments? There are several things I can do, as described below.



Maximum Loan-to-Value (LTV) Ratio



Supposed I intend to invest $1M in the SGX equities. At a dividend rate of 3%, the maximum dividends I could get from the equities annually is only $30K. Based on the bond interest rate of 5%, the maximum amount of Boring Investor bonds I could issue is $30K / 5%, or $600K. The maximum Loan-to-Value (LTV) ratio that can be supported by dividends on a sustainable basis is only 60%. Thus, by setting a maximum cap on the LTV ratio, I can better ensure that bond holders are paid on time.



Liquidity Facilities



There will be times when the economy is not doing well and the investee companies have to cut dividends. When this happens, I might not get sufficient dividends from the equity investments to pay interest to bond holders. I will need to borrow money temporarily from the banks to pay the bond interest.



Capital Call Facilities



There will also be times when some companies need to issue rights issues to raise money. Given that most the funds raised from the Boring Investor bonds have been invested in the SGX equities, I might not have sufficient funds to subscribe to the rights issues and buy additional shares in the companies at a bargain. To guard against this, I can set up a credit line with the banks to temporarily borrow money to subscribe to the rights issues.



Reserves Accounts



Given the unpredictable nature of the cashflows from dividends and sale of equity investments, it is prudent to set up a sinking fund to save some excess cashflows after paying the bond interest and other necessary expenses. The amount to be set aside for the sinking fund each year is a pre-determined amount, but it is only set aside if excess cashflows are available. The sinking fund will be topped up until there are sufficient funds to redeem the Boring Investor bonds in full. This would increase the likelihood that the bonds could be redeemed in full when they mature.



Sponsor Sharing



Generally, after meeting all the obligations mentioned above, any remaining cashflows would belong to the sponsor shareholder. However, as an additional gesture of goodwill, I can share the remaining cashflows 50:50 with bond holders if certain performance threshold is met by a certain date. The cashflows shared with bond holders would be used to top up the sinking fund mentioned above, if it is not full yet.



Conclusion



As you can see above, cashflows from equity investments (more so for PE investments and PE funds) are unpredictable, irregular and discretionary whereas interest and principal repayment obligations of bonds are fixed and mandatory. There is a need for some of the above-mentioned safeguards (known as credit enhancements) to ensure that bond obligations can be met when they fall due. If there were no credit enhancements, and the fixed and mandatory bond obligations were solely funded by the irregular and discretionary cashflows from equity investments, defaults on the bonds would likely happen at some point in time.



Thus, the Astrea IV 4.35% bonds are safe mainly because of the safeguards put in place. It is not a bond, but a structured bond. The credit ratings for Astrea IV 4.35% bonds are expected to be "A(sf)", with "sf" denoting structured finance. To avoid confusion with traditional bonds, it is best to refer to the Astrea IV 4.35% bonds as structured bonds, just like we differentiate structured deposits from fixed deposits.



Did I invest in Astrea IV 4.35% bonds? No, I did not. I prefer to invest in traditional bonds in which the underlying cashflows are sufficient to meet the bond obligations without any credit enhancements.





See related blog posts:



$Astrea IV4.35%B280614(RMRB.SI)

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Understanding the Safeguards of Astrea IV 4.35% Bonds
- Original Post from (The) Boring Investor

Astrea IV 4.35% bonds are unusual retail bonds as they are backed by Private Equity (PE). There are 5 safeguards put in place by the issuer to ensure that cashflows from PE investments are adequate to meet the obligations of the bond. These are:


  • Reserves Accounts

  • Sponsor Sharing

  • Maximum Loan-to-Value (LTV) Ratio

  • Liquidity Facilities

  • Capital Call Facilities



To understand why these safeguards are important and necessary, let us consider a hypothetical scenario in which I wish to issue Boring Investor bonds to retail investors to raise capital to invest in public equities listed on the SGX. Cashflows for the bonds would come from sale of equity investments and dividends from investee companies.


Generally, the Straits Times Index (STI) generates annualised returns of 7% in capital appreciation and 3% in dividends on average. To entice investors to my Boring Investor bonds, I would probably have to pay interest rate of 5% on the bonds. The first question that comes to mind is how do I ensure that I could meet the 5% interest obligations on the Boring Investor bonds on a sustainable basis when I could only receive 3% dividends from the equity investments? There are several things I can do, as described below.


Maximum Loan-to-Value (LTV) Ratio


Supposed I intend to invest $1M in the SGX equities. At a dividend rate of 3%, the maximum dividends I could get from the equities annually is only $30K. Based on the bond interest rate of 5%, the maximum amount of Boring Investor bonds I could issue is $30K / 5%, or $600K. The maximum Loan-to-Value (LTV) ratio that can be supported by dividends on a sustainable basis is only 60%. Thus, by setting a maximum cap on the LTV ratio, I can better ensure that bond holders are paid on time.


Liquidity Facilities


There will be times when the economy is not doing well and the investee companies have to cut dividends. When this happens, I might not get sufficient dividends from the equity investments to pay interest to bond holders. I will need to borrow money temporarily from the banks to pay the bond interest.


Capital Call Facilities


There will also be times when some companies need to issue rights issues to raise money. Given that most the funds raised from the Boring Investor bonds have been invested in the SGX equities, I might not have sufficient funds to subscribe to the rights issues and buy additional shares in the companies at a bargain. To guard against this, I can set up a credit line with the banks to temporarily borrow money to subscribe to the rights issues.


Reserves Accounts


Given the unpredictable nature of the cashflows from dividends and sale of equity investments, it is prudent to set up a sinking fund to save some excess cashflows after paying the bond interest and other necessary expenses. The amount to be set aside for the sinking fund each year is a pre-determined amount, but it is only set aside if excess cashflows are available. The sinking fund will be topped up until there are sufficient funds to redeem the Boring Investor bonds in full. This would increase the likelihood that the bonds could be redeemed in full when they mature.


Sponsor Sharing


Generally, after meeting all the obligations mentioned above, any remaining cashflows would belong to the sponsor shareholder. However, as an additional gesture of goodwill, I can share the remaining cashflows 50:50 with bond holders if certain performance threshold is met by a certain date. The cashflows shared with bond holders would be used to top up the sinking fund mentioned above, if it is not full yet.


Conclusion


As you can see above, cashflows from equity investments (more so for PE investments and PE funds) are unpredictable, irregular and discretionary whereas interest and principal repayment obligations of bonds are fixed and mandatory. There is a need for some of the above-mentioned safeguards (known as credit enhancements) to ensure that bond obligations can be met when they fall due. If there were no credit enhancements, and the fixed and mandatory bond obligations were solely funded by the irregular and discretionary cashflows from equity investments, defaults on the bonds would likely happen at some point in time.


Thus, the Astrea IV 4.35% bonds are safe mainly because of the safeguards put in place. It is not a bond, but a structured bond. The credit ratings for Astrea IV 4.35% bonds are expected to be "A(sf)", with "sf" denoting structured finance. To avoid confusion with traditional bonds, it is best to refer to the Astrea IV 4.35% bonds as structured bonds, just like we differentiate structured deposits from fixed deposits.


Did I invest in Astrea IV 4.35% bonds? No, I did not. I prefer to invest in traditional bonds in which the underlying cashflows are sufficient to meet the bond obligations without any credit enhancements.




See related blog posts:

$Astrea IV4.35%B280614(RMRB.SI)

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Would I Invest in Astrea IV 4.35% Bonds?
- Original Post from (The) Boring Investor

Recently, Temasek launched a Private Equity (PE) bond for retail investors known as Astrea IV 4.35% bond. It is the first PE bond open to retail investors. Would I invest my money in this bond?



First of all, let us understand what this bond is all about. This bond is issued by Astrea IV Pte Ltd, an indirect wholly owned subsidiary of Temasek, to hold a portfolio of PE investments. The investments are managed by 27 General Partners in 36 PE funds and invested in 596 companies. 86.1% of these funds are invested in buyouts, with 12.3% in growth equity and 1.6% in private debt.



Buyout funds are funds that privatise publicly listed companies, cut the excesses in the companies and streamline their operations to make them more efficient, and seek to exit the companies by selling them or listing them again. An example is Amtek Engineering, which was delisted from SGX in 2007 after being bought out by a PE fund, and was relisted as Interplex Holdings in 2010. And the story did not end there. Interplex Holdings itself was delisted in 2016 after being bought out by another PE fund.



The issuer, Astrea IV, has 3 classes of bonds, as follow:



  • Class A-1 - SGD242M 4.35% senior bonds that are open to retail investors and which are the subject of this post.

  • Class A-2 - USD210M senior bonds open only to Institutional and/or Accredited Investors. Class A-2 bonds have the same seniority as Class A-1 bonds.

  • Class B - USD110M bonds junior bonds open only toInstitutional and/orAccredited Investors.



The structure of the bonds is such that Class A bonds have priority to interest payments and bond redemption. In addition, it can borrow money from banks to make interest payments in the event that there are insufficient cashflows to do so. Moreover, its Loan-to-Value (LTV) ratio is capped at 50% of the portfolio value. If this threshold is crossed, it will have to cut debt levels. Furthermore, Class A bonds are senior to Class B bonds and shareholder equity. For Class A bonds to lose money, the portfolio that Astrea IV invests in must lose at least 64.4% of its value. So, it is quite safe, isn't it?



First of all, you need to recognise that Astrea IV, the company that you are investing into by buying the retail bond, is essentially a fund of funds. Although its LTV is capped at 50%, this is only at the Astrea IV level. The funds that Astrea IV invests into could have their own borrowings and these are not counted in the 50% LTV cap. After accounting for these borrowings at the lower levels (i.e. look-through basis), the leverage could be much higher. As a hypothetical example, Company A could have shareholder equity of $50M and bonds of $50M. Using this $100M, Company A invests into Company B. Company B borrows another $100M. Company B invests the $200M into a property. How much of the investment in the property is funded by equity and borrowings? The answer is $50M in equity and $150M in borrowings. Thus, even though the LTV at Company A's level is only 50%, on a look-through basis, the LTV is 75%! Does LTV on a look-through basis matter? For Company A's equity to be wiped out completely and its bonds to start losing money, the property's value only need to fall by 25% ($50M equity out of $200M asset value). So, LTV on a look-through basis does matter!



Secondly, most of the money are invested in buyout funds. Buyouts are usually highly leveraged operations. In the process of buying out companies, they take on large debts and usually pay a premium to acquire a 100% stake in the companies. After successfully acquiring the companies (which are usually cashflow-rich companies), they extract most of the cash from the companies to pay down their own debts. They also streamline the operations of the companies and load them with debts, such that the companies become more conscious about cutting costs and direct most of their cashflows to paring down the debts loaded onto them. Thus, the high returns of buyout funds are partly due to making the companies more efficient and partly due to the leverage employed. As an example, when 3G Capital teamed up with Berkshire Hathaway to buy Heinz for USD23.3B in 2013, they only forked out USD4.4B in capital each. The remaining was borrowed. (Note: Berkshire Hathaway also bought USD8B of preferred stocks paying 9% interest. I will leave it to readers to decide whether to classify this USD8B as equity or debt.)



Thus, in conclusion, Astrea IV is essentially a fund of leveraged buyout funds. I will not be investing in these bonds, even if its 4.35% coupon looks attractive.





See related blog posts:



$Inv Beve Biz EURO S(J0T.SI) $Astrea IV4.35%B280614(RMRB.SI)

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