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.