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Sunday, June 10, 2018

Astrea IV bonds: What you need to know

Low entry point of $2k, yearly 4.35% coupon payout appeal to retail investors

Lorna Tan
Invest Editor/Senior Correspondent
June 10 2018

Retail investors who want to diversify and try their hand in private equity can now do so via the newly launched Astrea IV private equity bonds.

The features appear attractive at first glance when compared with other bonds. There is a low entry point of $2,000 with a yearly coupon payout of 4.35 per cent.

The holding period can be as short as five years for a full redemption of your principal, or less as the bonds are tradeable on the Singapore Exchange (SGX).

In fact, Astrea IV's Class A-1 bonds will be the first listed retail private equity bonds on SGX.

The launch has made headlines because private equity investments are not usually easily accessible to retail investors, as they require large sums of capital and long holding periods of 10 years or more.

That has meant that private equity is typically accessible only to institutions and wealthy investors.

In recent years, interest in private equity has surged as investors seek higher returns from non-traditional sources.

Information provider Preqin estimates that assets under management in private equity have grown 11 per cent a year since December 2000, and hit US$4 trillion (S$5.3 trillion) as at September last year.

The Sunday Times highlights what you need to know about Astrea IV.

WHAT IS PRIVATE EQUITY?

Private equity refers to investments in private firms or listed companies that may be acquired and privatised. It is largely done via private equity funds managed by professional managers who raise money from investors.


These funds aim to improve the operations and financial performance of the firms they invest in and then exit the investments for a profit.

Historically, private equity has outperformed the public market indices such as the S&P 500 Index and MSCI World Index over an extended period.

WHAT ARE ASTREA IV PRIVATE EQUITY BONDS?

The bonds have been launched by Azalea Asset Management, a Temasek Holdings subsidiary.

There will be three classes of bonds issued under Astrea IV to raise a total of US$500 million.

The least risky Class A-1 bonds will raise $242 million, split equally between retail and institutional investors here.

Class A-2 bonds, which carry an annual interest rate of 5.5 per cent, are expected to raise US$210 million, while Class B bonds (at 6.75 per cent) would raise US$110 million. Both classes are not available to retail investors and offer higher returns to compensate for the relatively higher risks.

Astrea IV's Class A-1 private equity bonds are the first in the market to break down entry barriers for retail investors by lowering the initial investment amount to just $2,000 and reducing the investment period to as short as five years.

The bonds are backed by cash flow from a diversified portfolio of 36 private equity funds invested in 596 firms in a range of industries, including consumer, information technology, healthcare and financial. These funds are valued at about US$1.1 billion in all.

Such diversification helps to minimise the impact of the poor performance of any one fund.

 Note that the funds' average age is seven years, which means that many of them are in the cash-generating stage of a typical private equity fund's 10-year lifespan.

As such, Mr Sam Phoen, co-founder of Wateram Capital, expects cash flow to be positive.

In the initial years, a typical private equity fund tends to exhibit negative net cash flow due to drawdowns to fund new investments, as well as fees and expenses.

However, in the later years (usually after five years), a fund will achieve net positive cash flow when divestments are made.

On a geographical basis, Astrea IV has 62.8 per cent concentrated in United States-focused funds, followed by Europe at 19.1 per cent and the rest in Asia.

Its strategy is largely to focus on private equity buyout funds which purchase controlling stakes in the firms they invest in.

While many retail and some corporate bonds are not rated, the Astrea IV Class A-1 bonds carry an expected rating of Asf, with "sf" denoting the rating for structured finance.

Astrea IV's structure is broadly similar to Astrea III, a private equity bond with an annual 3.9 per cent yield that was issued in 2016 and available only to institutional and accredited investors.

It was eight times subscribed and raised about US$510 million.

INTEREST RATES AND EXIT

In a nutshell, Astrea IV private equity bonds will pay regular interest to bond holders and repay the principal at maturity. However, the interest is not guaranteed and the bonds themselves are not guaranteed by Azalea nor Temasek.

Such income to investors is generated through cash flow from private equity funds, including when firms that the funds invested in are sold.

Class A-1 bonds will pay a non-guaranteed interest of 4.35 per cent a year every six months. For a principal amount of $10,000, the interest payment works out to $217.50 on a half-yearly basis.

In addition, Class A-1 bond holders will receive a bonus payment of 0.5 per cent of principal at redemption if a performance condition is met.

This would be when the sponsor - Astrea Capital IV, wholly owned by Azalea - receives 50 per cent of its equity investment or US$313 million on or before the scheduled call date on June 14, 2023.


This is the earliest date the issuer can redeem the bonds if the cash set aside is sufficient to redeem all Class A-1 Bonds.

If the Class A-1 bonds are not redeemed in 2023, there will be a one-time step-up interest rate of 1 per cent a year.

The final maturity of the bonds is in 10 years or on June 14, 2028.

However, investors can sell their holdings on the SGX when the bonds start trading on June 18.

"As A-1 bonds are traded on the stock exchange, it provides daily liquidity to investors, an uncommon feature for PE (private equity) investments due to the long lock-up period," said Mr Phoen.

TARGET CUSTOMER SEGMENT

Private equity bonds are targeted at investors who want regular income at a fixed rate rather than capital growth. Note that returns are limited to the bond coupon, as returns of higher multiples typically associated with successful private equity investments do not apply here.

Early last week, Temasek Holdings chief executive Ho Ching referred to the Astrea IV offering as a way to help enhance individuals' retirement savings.

Mr Kelvin Goh, head of investments at OCBC Bank, said that as part of an overall diversification strategy, these bonds may be useful for investors looking for income strategies that are different from traditional income sources.

SAFEGUARDS

There are several safeguards in place which help to mitigate against potential risks and to ensure that sufficient funds are available to fulfil interest payment and principal repayment obligations.

Reserve accounts are set up and measures - for example, cash is set aside every six months - are put in place to enable a fast build-up of cash reserves for the redemption of all Class A-1 and A-2 bonds on the scheduled call date in June 2023.

The debt-level limit is set at 50 per cent, which will trigger action to lower the total net debt if crossed.

Besides foreign exchange hedging, there are also bank facilities set up which will cover taxes and administrative expenses, management fees and interest payments to bond holders in the event of cash flow shortfalls.

HOW TO APPLY UNDER THE PUBLIC OFFER

The Astrea IV Class A-1 bonds have been available for public subscription through DBS (including POSB), OCBC and UOB ATMs, Internet banking platforms and DBS mobile banking platform since Wednesday.

Applications close at noon on Tuesday. The bonds can be bought with cash but not with Central Provident Fund savings or Supplementary Retirement Scheme funds.

POTENTIAL RISKS

As with any investment, it is prudent to understand the underlying risks involved before investing.

•Fluctuating interest rates may affect the bond price Changes in market interest rates may adversely affect the value of the bonds. Like all fixed-rate bonds, the market price could fluctuate due to interest rate movements. Generally, a rise in interest rates may cause a fall in the prices of bonds, while a fall in interest rates may lead to a rise in bond prices. There is no assurance that low interest rates will persist.

•Uncertainty on cash flows The ability of the issuer to make payments and the timing and amount of such payments on the bonds are highly dependent on the performance of the Astrea IV fund investments. These can be highly variable and there is no assurance that any fund will achieve its investment objectives.

•Adverse market conditions could impact distributions As with all other investments, an adverse change in market conditions could result in falling asset prices and cash flows, said Mr Kelvin Goh, head of investments at OCBC Bank. This would impact the amount or timing of distributions from the underlying private equity fund investments.

•Limited trading market There may be a limited trading market for the bonds, so prospective investors must be prepared to hold their bonds until the maturity date.

•Illiquidity of private equity investments and reliance on key private equity professionals There are risks associated with the illiquid nature of private equity fund investments, and reliance on key private equity professionals in managing these funds, adds Mr Goh.

•Limited disclosures from underlying private equity funds Bond holders will receive limited information regarding the private equity funds that form the Astrea IV portfolio due to the nature of such fund investments, which usually require investors to keep certain information confidential.