All asset classes achieved positive returns in H117
Tetragon generated US$70.0m fair value net income in the first half of 2017, equating to an investment return on equity (ROE) of 3.6%, with a slightly lower NAV total return of 2.8% due to share dilution. Annualised ROE of 7.2% is modestly ahead of the 6.3% achieved in 2016 and slightly below the comparable 8.2% ROE in 2015. During the period, all asset classes in Tetragon’s portfolio achieved positive returns, with total investment gains of US$99.5m, which compares with US$68.9m in H116. The largest gains were generated by TFG Asset Management and CLOs, with meaningful contributions also made by hedge fund investments, direct balance sheet investments and real estate. Management and performance fees for the half year totalled US$26.0m, including an incentive fee of US$11.4m, while other operating expenses amounted to US$2.0m.
Exhibit 2: Tetragon’s fully diluted NAV per share progression in H117
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Source: Tetragon Financial Group
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TFG Asset Management, which comprises a diverse portfolio of alternative asset managers, recorded a gain of US$38.7m, with positive contributions from all of the established businesses. Tetragon’s investment in Equitix saw the largest gain of US$23.3m, mainly due to favourable movements in market valuation metrics. The underlying business also continued to perform well, with its fourth fund oversubscribed and closing at its £750m fund-raising cap post the half-year end. Equitix also completed the refinancing of its debt facilities in July 2017, resulting in £63.6m of proceeds to Tetragon. The investment in LCM saw a significant gain of US$9.4m, also as a result of a favourable movement in market multiples as well as the performance of the underlying business.
In May 2017, TCI II had its final close with c US$350m of capital, and this contributed to an increase of US$2.7m in the fair value of TCIP, its general partner. TCICM, the CLO manager and subsidiary of TCI II, now manages c US$1.4bn of US broadly syndicated leveraged loans. The investment in GreenOak also recorded a US$2.7m gain, which reflected the crystallisation and distribution of carried interest from its first Japan fund, while the investment in Polygon recorded an investment gain of US$0.6m as that business added third-party capital to its European Equity fund.
Tetragon’s bank loan investments through CLOs benefited from proactive efforts by the CLO managers to offset the effects of spread tightening across the capital structure and a shift in the Libor curve, which were the main challenges within the asset class during the half year. The managers took advantage of tightening credit spreads and strong demand for leveraged loans to refinance and reset a number of CLO transactions, resulting in a US$28.0m net investment gain.
Hedge fund investments made a US$14.2m contribution, with positive returns from all of the open Polygon funds. The largest gain was US$11.8m from event-driven equities, through the investment in Polygon European Equity Opportunity Fund. Small gains were made in Tetragon’s convertible bonds and distressed opportunities investments, outweighing small losses on the Mining Opportunity Fund (which is being wound up) and the QT Fund (a new quantitative strategies investment initiated in March 2017).
Other equities and credit, which comprises Tetragon’s direct balance sheet investments in single strategy ideas, and real estate investments also generated positive returns. All but one of the direct balance sheet investments, primarily consisting of listed and unlisted equities, made a positive contribution to the overall US$9.5m gain. GreenOak investments generated positive returns totalling US$7.5m across all three investment regions, with more than half of the gains from Asia-based investments, including GreenOak Japan Fund I. Other real estate investments, comprising commercial farmland investments in Paraguay managed by South American farmland specialist Scimitar, recorded a US$0.3m loss reflecting ongoing fees and expenses.
Dividends and share dilution
During the half year, Tetragon’s Q416 and Q117 dividends, both US$0.1725 per share, were payable, with the total dividend distribution amounting to US$30.7m. US$23.2m was paid in cash, with the remaining US$7.5m reinvested under Tetragon’s optional stock dividend plan, resulting in 0.6m shares being issued from treasury. The Q217 dividend, which was increased to US$0.1750 per share, is payable on 23 August 2017.
Tetragon’s fully diluted share count increased from 96.7m to 98.0m during H117. In addition to the issue of 0.6m shares as scrip dividends, fully diluted shares in issue increased due to recognition of an additional 0.5m shares in equity-based compensation and an increase in the intrinsic value of in-the-money options resulting from the 4.5% rise in Tetragon’s share price over the half year. The 2.4m shares issued to settle the exercise of 12.5m options by Tetragon's investment manager TFM were already included in the fully diluted share count at end-2016, as were the 2.0m treasury shares transferred to escrow in relation to the deferred US$25.1m incentive fee payable to TFM (triggered by Tetragon’s adoption of IFRS from end-2016 and the consequent uplift in the NAV of certain TFG Asset Management businesses). Tetragon also issued 0.4m shares to settle options exercised by GreenOak founding partners, representing 67% of their options exercisable in 2017.
With respect to the half year to end-June 2017, Frederic Hervouet has elected to receive shares in lieu of his full compensation as a non-executive director, and William Rogers has elected to receive shares in lieu of half of his compensation as a non-executive director. During the period, Hervouet and Rogers received 4,019 and 1,009 shares, respectively. The number of shares to be issued in lieu of fees for Q217 will be determined as part of the Q217 dividend process.
Tetragon continues to maintain a substantial cash position to cover future commitments and also enable it to capitalise on opportunistic investments and new business opportunities. At end-June 2017, Tetragon held net cash of US$400.0m, representing 20.2% of net assets. All Tetragon’s cash is held at highly rated banking institutions, in on-demand arrangements, to ensure that it is not exposed to any term risk.
During H117, Tetragon deployed US$134.6m of cash in new investments and paid US$23.2m in cash dividends. A new investment was made in the majority of the equity tranche of a new issue LCM-managed CLO in March, and additional investments were made in the equity tranche of an LCM-managed CLO that was ‘reset’ (CLO liabilities refinanced and the reinvestment period, final maturity, and other duration-related terms extended by more than five years) at the end of May.
Tetragon’s outstanding cash commitments at end-June 2017 were c US$275.8m, comprising investment commitments (GreenOak US$129.0m, TCI II US$57.0m), potential investments (Hawke’s Point US$89.8m), ongoing dividends and fees. Tetragon currently has a US$150.0m revolving credit facility in place, of which US$38.0m was drawn at end-June 2017.
Tetragon’s management highlights that the current investment environment remains difficult, with 10-year US government bond yields not far off their historical lows and the effects of quantitative easing and bond buying by central banks continuing to influence financial markets. Against the current backdrop of tightly priced credit and elevated price/earnings ratios, Tetragon’s management emphasises that its focus continues to be on generating returns from investments that generally produce idiosyncratic results, rather than trying to predict the future returns of passive investments.
Tetragon’s management sees near-term potential for several of the asset classes in the portfolio. First, it considers that investing in US CLO equity when funding costs are low remains compelling despite current tight credit spreads, noting that in the event of greater spread volatility, these investments should benefit from their relatively attractive financing costs. Within hedge fund allocations, management is optimistic on the potential for the allocation to European event-driven equities to perform well, given that Europe remains some years behind the US in terms of its economic recovery. Lastly, while Tetragon’s large cash balance may potentially drag on current performance, the cash could be partly used to fund compelling opportunities that may emerge as markets adapt to a shift from quantitative easing to balance sheet reduction by central banks.
In respect of European CLOs, management expects c 40% of the current portfolio to amortise over the next few quarters and does not plan to add any additional exposure, in contrast to US CLOs. The wind-down of the Polygon Mining Opportunity Fund has progressed according to plan and was largely completed at end-June 2017, when it represented only 0.2% of Tetragon’s NAV.
No new businesses have been added to TFG Asset Management recently, but management reports that opportunities are continually being reviewed, and detailed discussions are being held with several businesses that could potentially conclude in an investment within the next 12 months.