Saturday, June 09, 2018

A deeper analysis of the Astrea IV Private Equity Bond Offerings.

There seems to be quite a bit of excitement on the Astrea IV Private Equity Bond Offerings.  These bonds have been described in great detail by other bloggers such as Investment Moats and Financial Horse.

I just wish to write a small article to plug the gaps in the analysis I find in the blogosphere. Compared to most investors, my personal interest lies in the Class B rather than the Class A offerings.

Here I am detailing the reasons why this is the case.

[ Feel free to critique my analysis. In practice, I do not have the money to move into this asset class this year but I expect some leveraged positions to be take place a few years later after more of such offerings start appearing in the market. This is definitely going to be a successful new asset class that retirees and income investors to flock to moving forward. ]

a) Class B offering actually has lower interest rate risk

Here's where some bond investing fundamentals taught in CFA class may come in useful. The biggest issue investing in bonds is rising interest rates over the next few years. This makes interest rates the primary consideration when you think about buying Astrea IV bonds.

A lot of bloggers miss out on a discussion about bond duration, which measures how sensitive the bond prices are to slight changes in interest rates. I used my spreadsheet and did a simple calculation of the Macaulay duration for the Class A1 and Class B bond offering.

For the Class A1 bonds, I estimated the bond duration to be around 8.31 years.

For the Class B bonds, I estimated the bond duration to be around 7.59 years.

What this means is that for every 1% rise in interest rates, your Class A1 bonds will lose about 8.31% in market value, but the Class B bonds will lose only 7.59%. This is because Class B bonds give out a higher coupon rate allowing you to recoup your costs at an earlier date resulting in a less swingy experience.

b) Class B bonds can achieve this lower interest rate risk at a higher risk of default

The other aspect of bond investing is credit risk. The Class A-1 bonds are rated A by Fitch. For this  A credit rating, I can't seem to find a default rate on Wikipedia, but I think it is reasonable estimate it at a cumulative 1% over 5 years or close to 2% over 10 years. For the Class B bonds, the rating is lower at BBB that gives it a default probability of around 2.11% over 5 years, we can round it up to 5% over 10 years.

After performing this analysis, I am actually a lot more attracted to the idea of buying Class B bonds for their higher coupons using 200%leverage. Kim Eng brokers are offering me at a financing rate of 2.5%, so at 200% leverage, I'm looking at a delicious 11% yield every year that offsets the rising interest rates that will affect the market price of these bonds. The downside is a 5% chance of busting out over the next decade and fluctuations in USD currency (which I have yet to quantify).

Anyway, my hands are still full trying to build my leveraged REIT portfolio. At a much later date, I will come back to to my duration calculations when I get an indicative price of how much these bonds will trade in the secondary markets.

My calculations also reveal that perhaps in future PE bond offerings, retail investors get exposure to the riskier tranches because the credit default risks are often offset by lower interest rate risk. The Class B bonds may require a position size of $100,000 for a 200% leveraged position which is an amount of money that most retail investors do not have.

Anyway, let me know what you think of my analysis.


Retireby35.SgStyle said...

Hi Chris - I haven't had the time to do deep analysis into this offering, but from what I read and hear from friends, this is non-recourse to Temasek / SG Govt and is deeply subordinated debt to underlying cashflows - when PE funds acquire investments they will normally take on leverage at the investment SPV level to juice returns. Please correct if I am wrong.

Just on pricing perspective, this doesn't seem right.

Be very very careful, especially if you are deploying leverage to juice your returns.

Christopher Ng Wai Chung said...

Thanks for the reminder !

I had to sit this out anyway because I lack funds.

INTJ said...

Hi Christopher,

It is dangerous to buy the bonds merely on the premise that it has a better rating from the credit rating agencies. It is undisclosed whether what kind of risk the underlying assets are Exposed to and if they are sufficiently diversified.

Understand how the cash flows from the originator and how it flows down to the bondholders. If your premise of buying bonds is to diversify your risk or lower the risk of your portfolio, be sure you are using the right Instruments


INTJ said...

Credit rating can deterioritae and be downgraded when underlying assets start to present problems. Ultimately it is all about caveat emptor - let the buyer beware.

Unknown said...

If you look at the financing structure, class B bonds will do better if SHTF and the cashflows from the investee companies stop or drastically reduced. Coz covenants will kick in to mantain LTV, and 1 major action is to start redeeming class B bonds first.

So if you think we're gonna get worse recession in the next 5 yrs than GFC, then you should get class B ... Not only will you get the higher yield, but good chance of getting repaid quickly & bonus of strengthened USD as whole world collapses.

Otherwise if you think the next recession will be meh, then class A bonds will be almost guaranteed to be repaid by year 5.

Christopher Ng Wai Chung said...

Wow ! Thanks for sharing, Unknown.

Too bad, class B is just not available for retail investors.

Unknown said...

Yeah, very likely the institutionals will have gotten both classes ... The proportion will be dependent on their views on how bad the next recession will be. Something like a bond version of risk parity long/short.