Tetragon Financial Group Limited

Good afternoon. Thank you for joining Tetragon's investor call. You are all in listen-only mode. And as a reminder, this call is being recorded. I will now turn you over to your speaker to commence the presentation.

As one of the principals and founders of the investment manager of Tetragon Financial Group Limited, I'd like to welcome you to our investor call. I'll cover an update on the business and a brief review of our first quarter results, which were released this morning. I'll also respond to questions that were submitted by shareholders over the last weeks. I'd like to remind everyone that the following may contain forward-looking comments, including statements regarding the intentions, beliefs, or current expectations concerning performance and financial condition on the products and markets in which Tetragon invests. Our performance may change materially as a result of various possible events or factors. I'd like to start with the business continuity. To the extent practical in the circumstances, Tetragon and TFG Asset Management are continuing to operate the business as usual, with personnel of Tetragon's Investment Manager and those of TFG Asset Management telecommuting. Our main offices in London and New York remain closed, And we await guidance from the respective authorities as to when and how we can start to return to those offices. But as you can imagine, we're enthusiastic to do so. Moving on to the first quarter results that's released this morning. Return on equity, i.e. the investment performance, was down 5.1% for March. So that leaves our first quarter down 7.5% for the quarter. The NAV per share was down 5.8% for March, and that leaves us down 7.6% for the quarter. So the NAV at the end of March was $2.18 billion, and the NAV per share at the end of March was $22.69 per share. And you can see the breakdown of the quarterly P&L on page two of the March fact sheet. As you might expect, most of the losses are concentrated in event-driven equities, other equities and credit, bank loans, private equity and venture capital. In other words, the equity and credit market related activities. Our asset management businesses were only a small negative for the quarter. Real estate was also a small negative, having benefited from the sale of a large portfolio of European logistics assets in Q4 of 2019, which benefited the Q1, both in terms of valuation and in terms of cash. I'll move on to answering questions in a moment, but before that, I'd like to give some color on the dividend and the proposed tender offer to buy back shares, both of which were announced this morning. As at last night's close, Tetragon's share price stood at approximately a 60% discount to the NAV per share at the end of March of $22.69 per share. We see this as an excellent opportunity for the company to buy back shares and would like to take advantage of that. However, the company's cash position has been at the lower end of its historical range, and furthermore, Tetragon has committed capital to investments, as well as there being an increasing amount of attractive investment opportunities. Thus, it was decided to reduce the quarterly dividend to $0.10 a share, and at the same time, we announced our intention to purchase up to $25 million of Tetragon's shares, in part as we believe them to be particularly underpriced versus the NAVs. We believe that this use of cash is good for shareholders as it allows us to maintain a healthy dividend, and we know that dividends are important to many investors. It allows us to reinvest in the NAV, showing our underlying confidence in the portfolio. It allows liquidity for any sellers in what is a volatile and illiquid market, and it enhances the NAV per share for the benefit of all shareholders. As you know, Tetragon seeks to return value to its shareholders, including through dividends and share repurchases. And indeed, since our IPO in 2007, we've returned approximately $1.4 billion to investors in this manner. Over the last 10 years, we've steadily increased our dividends and were recognized in March of this year by the Association of Investment Companies, the AIC, in a list of the next generation of dividend heroes for having done precisely that. But in the current and indeed anticipated economic and operating environment, however, and based on such other factors, sustainability of cash generation, the company's current and anticipated performance, other potential uses of cash ranging from preservation of the company's investments, and the financial position of investors, other investment opportunities, and finally, Tetragon's share price, we feel that the announced dividend and proposed share buyback is the best way to return value to our shareholders. Finally, in light of market conditions, Tetragon is determined to modify its dividend and capital return policy to remove any particular dividend target payout ratio reference to the normalized earnings. And please note that the exact wording is in the quarterly fact sheet and it's also on our website. Now what I'd like to do is move to answer some questions that we've been asked over the last few days and weeks. And to assist me, Yuko Thomas is going to ask the questions that have been submitted to us.

Thanks very much, Paddy, and thanks to all of you who submitted questions to the call. So first of all, how would you describe first quarter performance versus expectations given the backdrop in global markets?

Well, To start with, here are some data points that we're all well aware of. The end of March, the MSCI all share was down 20%. That's a global equities index. Bank loans on a total return basis were down 13%. High yields on a total return basis was down 13%. And then gold was up 3%-ish, and U.S. Treasuries on a 10-year basis. duration were up about 10%. So that was the backdrop. So the very rough math with us down 7.5% shows that we had relatively low correlation to the fall in asset prices as of the end of March. But I must emphasize that's a very rough observation. And most importantly, it's a single day data point at the 31st of March during what was and still remains a very volatile period. And as always, much depends on what happens in the future. However, having said that, if we just take that snapshot, we're pleased with the way the portfolio performed over that period and pleased how it's performed during the crisis so far. And I think it does show that we're generating alpha, which is obviously our goal.

Thanks. Secondly, how has APOL performance been?

Well, we can't comment on performance other than what we say in our public disclosures. So we won't be able to comment on the April performance until that date is released, which will be later in May.

Okay. Moving on, how is today's Tetragons portfolio different to in the past, and how do you think it's likely to fare in the current environment?

Well, in 2008, the portfolio was nearly all U.S. subinvestment-grade bank loans held via CLO equity. So a very concentrated portfolio in one asset class. If we look now as to where we are here in 2020, our exposure to CLO equity is 14% of the portfolio. So we have a very different asset mix. In fact, Tetragon now owns a very broad range of diversified investments, and you can see that in the pie chart or the disk chart that's shown in the fact sheet. Our intention is is to generate alpha in our investments and hopefully for those investments to have relatively low correlations to markets and indeed to each other. Another big differentiation is the type of crisis. In 2009, it was a financial crisis that then created economic problems. This crisis is primarily a health crisis. That in turn is creating economic problems And those may or may not, in turn, create or trigger severe financial problems. So it's certainly a very different type of crisis.

Okay. Next question reads, please comment on the outlook for your CLO portfolio in particular.

Okay. So as I've just said, the CLO part of the portfolio is about 14%. That's 1.4% of the total portfolio. And I think most of you are aware that Tetragon invests in bank loans primarily through these majority or control stakes in the equity tranches of CLOs. And remember, these CLOs are made up of a diverse number of predominantly first lien loans to corporate America in the sub-investment grade universe. The CLOs have secure long-duration funding and are cash flow CLOs. and thus their performance is based on the actual cash received and not on any mark-to-market of the underlying loans. Senior secured loan prices obviously did drop significantly in March and have shown some recovery in April, but being cash flow CLOs, I would reiterate their ultimate value is determined by how those companies perform over the duration of the CLO. So whilst prices have been volatile, what we're focused on is whether the issuers continue to pay their coupons or not. It is currently very difficult to forecast future performance for CLOs, as this depends on not only defaults, but also recovery rates on those defaults, reinvestment spreads, LIBOR, the one-month, three-month LIBOR curve, etc. A couple of other things I would note. Firstly, as a control equity holder, we do have the option to put in cash to buy extra collateral, should we deem that to be a good investment. Secondly, As I mentioned, this economic crisis is very different to others. While there's certainly a higher correlation across the types of companies suffering, many of them are actually good businesses that will thrive in a more normal environment, or if a more normal environment returns, I guess. Thus, if they do default and the senior debt holders end up owning the business, that need not be a negative for the loan holders. And thirdly, or lastly... We do try to invest with managers whose style is conservative, i.e. focused on minimizing portfolio defaults. And many of our investments have structural protections in place, which may indeed prove helpful.

Thanks. Next, please comment on the status of your real estate investments.

So Tetragon's real estate investments are predominantly through Bentle Green Oak funds. And these are mainly opportunistic funds, And they are geographically split between the US, Asia, and Europe. In each region, there are several funds and several different vintages of funds. It's worth noting that the performance data for LPs in these funds, such as Tetragon, are generally one or two quarters in arrears. So our NAVs are based generally off the Q4 2019 data. And we won't see the Q1 NAVs for a few months yet. While real estate in general is likely to suffer in line with the drop-off in economic activity, we do actually have some real reasons to be optimistic about the Bentall Green Oak funds. So a couple of points. The first is that these funds have relatively low exposures to the hardest-hit sectors, so very few exposure to hotels and retail. Secondly, the funds in all three regions the active funds are relatively uninvested, so thus hopefully can take advantage with their dry powder of some of the current dislocations. And lastly, in particular in Europe, the manager sold a substantial portfolio of assets at the end of last year, which I mentioned earlier, and that was completed in Q1. So not only did we get the markup in Q1, but we've also received the cash from that distribution as well.

Okay, thanks. Next question, Ruth. What changes were made to the assumptions used to value the TFG asset management business in the first quarter?

Okay. With every quarterly valuation, we have a third-party valuation specialist engaged to provide a point valuation for TFG asset management. That then feeds into the Tetragon NAS calculation. That quarterly valuation usually incorporates, where relevant, an update of the fund performance by the manager, as well as the net income generated by the manager for that period. Future projections are also reviewed and refreshed, although for most of the managers, a full year forecast is usually only updated on an annual basis. So what the third-party valuation specialist does is review and update its own models, including making adjustments to reflect its own assumptions, and then applies the updated market metrics and discount rates to arrive at a valuation. The key assumption changes that they applied for March were firstly discount rate changes. So the discount rates they used to discount projected future cash flows were increased by between 1% and 2.25%, so between 100 basis points and 225 basis points. Valuation multiples utilized in the LCM valuation And for some elements of the bent or green note valuation declined by approximately 10%. So that was a decline in P multiples or EBITDA multiple. And the short-term capital raising assumptions were adjusted for some of the managers were relevant. But for note, given the uncertainty and significant range of unknowns, an exercise to adjust the model cash flow for any long-term impacts of coronavirus have not been undertaken.

Okay. The next question is regarding Ripple. The recent Ripple Labs private equity investment of $150 million is sizable relative to net assets, but there's precious little background on this investment provided. Any reason?

Yes, there is a reason, and the primary reason is because we don't tend to discuss in detail live investments that are in the portfolio. I mean, certainly if and when things leave the portfolio, we're happy to talk in more detail. But I would note that we've been following Ripple Labs for some time, and we're not in a position to comment on various aspects of this investment. But we are pleased with Ripple Labs' progress and with the investment as a whole to date.

Okay. Next question is regarding Polygon. Is it right that TFD is pretty much the only investor in terms of the percentage of the assets in that fund, the European Equity Opportunity Fund? So wouldn't it make sense to bring that in-house onto Tescon's direct assets?

Okay, so this is with reference to Polygon's European Equity Opportunity Fund. And currently, as you can probably see from the disclosed information, Tescon is the largest investor in this fund. However, there are a number of external investors. Many have been long-term investors. Plus, we have a large managed account in the strategy, and it has excellent historic performance, though we think the current strategy is as it should be.

Okay. Next question. What are the main investments on the balance sheet?

Well, I think as many people know, Tetragon occasionally makes investments directly on its balance sheet, reflecting single strategy ideas, either co-investing with some of its underlying managers or or simply idiosyncratic investments, which it believes are attractive, but may be unsuitable for an investment via TFG asset management vehicles. There are currently two types of investments in this category. One is other equities and credit, and the second is direct private equity and venture capital. So the first of these, other equities and credit, these are liquid U.S. and or European equity investments. And they're currently approximately 10 positions with a focus on biotechnology and growth equity. In the second group, which is direct private equity and venture capital, by far the largest position is our investment in Ripple Labs.

Okay, next question reads, how reflective is the current NAV for the real estate, private equity, and venture capital segment? given the valuations in these segments are based with a three- to six-month lag?

Important question, and obviously we've touched on this a little bit already. But the assets referred to represent approximately 20% of Tetragon's NAV. So to be clear, each of the other asset classes, representing 80% of the NAV, are valued at March 31st using pricing refresh as of that date. But of this remaining 20%, approximately 12.5% or $270 million of the NAV is in private equity and venture capital, and the remaining 7.5% or $163 million is in real estate. So if we tack on that first bucket first, of that $270 million that's in private equity and venture capital, approximately $210 million is valued utilizing March 31st pricing. And so only the remaining $60 million has been valued utilizing the latest available LP statements, which are typically dated December 2019. So to reiterate, about $60 million is based on Q4 pricing. In real estate, all of the valuations are with a lag, and that's traditionally the case. So the real estate fund values are valued using the latest available LP statements in each case, all of which are dated end of Q4, or in a couple of cases, actually Q3. So based on usual reporting cycles from these investments, we'd expect that for most investments, Q1 2020 reports would have been received and incorporated into TESCON's NAV by the end of Q2. But in summary, yes, we are subject to lag reporting, as is everyone else for private equity and real estate. But as of March 31st, that represents about $223 million of NAV. So approximately 10% of the March 31st NAV is with a time lag.

Thank you. Next question. How much of your cash balance is currently earmarked or committed to fund investments?

Okay, so I might just broaden this out and talk about cash flows in more general to give you some data points. Cash at month end, as you can see, was $87 million, and this is net of the $150 million liability on our revolver. Of that, we have hard commitments of $85 million, of which $55 million is to rental green real estate fund, and $30 million committed to private equity funds. We also have commitments to our own in-house asset management businesses of $30 million to Hawkes Point and $85 million to Banyan Square, although of note those do have discretionary elements to them. In addition, we are obviously looking for ideas on a regular basis. We're committed to the usual fees and expenses within the company. We have the quarterly dividend of approximately $10 million and the announced proposed tender offer of $25 million. On the inflow side, we do have the normal cycle, albeit it is particularly hard. I mean, it's always hard, but particularly hard to forecast in the current environment.

Okay, thanks. For the next question, I've grouped together a couple of questions which are similar, and I think you can answer them together. Firstly, what is the range of investment opportunities that you're seeing or evaluating, and how can we take advantage of the dislocation at this time? Next, could we get an update on where we see the asset allocation mix changing? I know it was pointed out where it was likely to move a couple of months ago, but the world is a very different place, and it would be interesting to get an update if the position has changed. And then also, in light of the recent turmoil in the markets, have the managers made any material changes to the portfolio?

Thank you. As everyone might imagine, a major priority over the last few weeks has been to preserve energy, conserve cash. We've also focused on understanding the extent to which we have investments in businesses already that are directly affected by COVID-19, and that would be hotels, travel, retail, leisure, etc., And very luckily, as noted, there are very few exposures in those areas. Third, we've then been looking for opportunities of mispricing across the current portfolio, i.e., in things that we currently own and looking to add where applicable. And then, as always, striving for new ideas, and that is across all asset classes. But as to asset allocation, I think as many of you are aware, the portfolio of assets we own are, for the most part, illiquid and long duration by their nature, and thus our asset allocations change slowly over time as we direct new investments. So we're not anticipating any large changes in allocations. In terms of new investments, as you might imagine, equities, credit, real estate investment teams all see some interesting new opportunities in their specialist fields. I think it's fair to say infrastructure is probably closer to business as usual than those others. And we're evaluating several new opportunities and allocations across credit, convertibles, equities, and real estate.

Thank you. Next question. How will asset raising be affected for your businesses by the crisis?

Well, I don't think I can be specific on this topic. As TFG asset management businesses are currently active in the market with multiple products, and our business development teams are talking to multiple LPs across multiple products and geographies covering existing and new funds. And also, I guess I would note that these are very uncertain and volatile times, and it would probably be unwise to predict the behavior of our LPs in various businesses. But I would note, in terms of new businesses, On May the 1st, our Tetragon credit partner business expects to launch a new fund that would be investing in U.S. CLO debt tranches. So that would be an exciting new product.

Great. Thanks. I've got one last question for you. With the current dislocation in the stock price and the NAV of the company, does there come a point where shareholders would benefit more from a return of capital than continued reinvestment of capital into new opportunities? Or are the opportunities for investment so much better now with global asset prices down that you feel like you need to invest as much as you can while certain asset classes are more reasonably valued?

Thank you. Well, I think the answer is a balance of both. Hence our announcement of a tender offer to buy back shares as well as making new investments in the portfolio. So hopefully we're getting that balance right. I think that sort of concludes our questions. So I will say goodbye for myself and thank you very much for joining us and leave you with Yuka.

Thanks very much. That concludes the call. Thanks, everyone, for dialing in. And we'll have the replay up on the website soon. Thank you.