Tetragon Financial: An exotic investment trust producing stellar returns

Tetragon Financial (LSE: TFGS) is one of the most exotic investment trusts on the London Stock Exchange, with a unique approach both to investing and corporate governance. Its total returns are virtually unmatched, which makes it interesting to review regardless of whether the latter will put one off. Since listing in April 2007, it has produced a total return on a net asset value (NAV) basis of 568%, compared to 276% for the MSCI All Country World index.

Tetragon was originally co-founded by hedge-fund managers Reade Griffith and Paddy Dear to invest in the then-booming collateralised debt obligation (CDO) market. In the aftermath of the global financial crisis, it reinvented its strategy and today invests across a wide range of asset classes. It is far more complex than most vehicles of this kind (which tend to be just a listed feeder fund into a main hedge fund) and so it is simplest to start with a breakdown of the portfolio.

At the end of September, Tetragon had net assets of $3.9 billion, plus about $600 million of debt, resulting in gross assets of just under $4.5 billion. The largest part of the portfolio ($2 billion or 44%) consisted of full- or part-ownership of specialist asset managers through a business called TFG Asset Management. A controlling stake in Equitix, an infrastructure investor, is the single biggest asset, at more than 25% of the entire portfolio.

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Equitix was founded in 2007 and Tetragon invested in 2015, since when assets under management have grown tenfold. Tetragon recently sold a 16% stake at a large mark-up to its carrying value. In total, managers owned or co-owned by TFG Asset Management run $41.5 billion in capital. Equitix, BGO (real estate) and LCM (leveraged loans) account for the majority of this sum.

The rest of the portfolio is in a range of different investment strategies: $1.33 billion in private equity and venture capital, $570 million in hedge funds, $310 million in equities and credit, $120 million in real estate, $100 million in bank loans and $60 million in “legal assets” (investments related to litigation finance). Some of this (22% of the total portfolio) is direct investments and some (6%) is in external funds. However, the largest share (31%) is invested in funds run by the same managers that Tetragon owns.

So in essence, Tetragon’s core strategy is to find attractive asset classes, identify managers who deliver strong returns in them, and then invest in the growth of these managers as well investing directly in their strategies.

Tetragon Financial's governance shortfall

If that takes some time to get your head around, so does the governance. Tetragon has a primary listing in Amsterdam and a secondary listing in London, with both dollar-priced and sterling-priced shares. These are non-voting shares and the only voting shares are held by a company controlled by Griffith and Dear, so the founders hold all the cards.

Even though Tetragon owns investment managers, it has an external manager called Tetragon Financial Management, which is also controlled by Griffith and Dear. The fee structure under this arrangement leaves much to be desired: an annual management fee of 1.5% plus a quarterly performance fee of 25% over its hurdle rate (three-month US interest rates plus 2.75%) with no high-water marks.

These shortcomings are probably why Tetragon trades at a persistent discount to NAV (currently 55%). The only mitigating factor is that insider ownership still creates alignment between Tetragon and its shareholders. As of June, more than 38% of the shares were owned by Griffith, Dear and employees. That provides some incentive to achieve the best results for all shareholders.

The shares have returned 385% since inception, which is less than the NAV return (because the discount has widened since it floated), but still very strong. There’s a modest annual dividend of $0.44 per share (yielding 2.3%), but $570m of share buybacks over the past 10 years has reduced the number of shares outstanding by 13%.

This is not an trust that will appeal to most investors. Anybody tempted to buy will need consider it at far greater length than there is space to do here. Still, it is hard to argue with its historic performance.

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