I thought I would kick the year off with two new additions to my alternative funds trading list. I updated readers about progress just before Xmas, with well above benchmark returns although in truth it’s still a very young portfolio and thus probably too early to make any meaningful comments.

My two new additions have been on my watchlist for a while but I think we could see some solid catalysts emerge in 2021 which could narrow their mammoth discounts.

The most obvious candidate is Phoenix Spree Deutschland, a London-listed fund that holds a big portfolio of Berlin apartments.

It recently updated the market – see Numis note below – on some recent transactions. I would concur with the Numis and Liberum views below.

My sense is that the 30% discount to NAV – which has been fairly constantly revised upwards – is a bit excessive. The great uncertainty is the ongoing legislative programme by the Berlin government and subsequent legal challenges. My guess is a great deal will depend on the prevailing political landscape as Chancellor Merkel moves on and is replaced by as yet unknown CDU big wig. This in turn will give us a clue as to the electability of a CSU CDU government either with the Greens or the SPD. Merkel is still riding high from their handling of the virus but that could change suddenly and if the centre left and left looked like they were gaining ground then we could see sentiment towards Phoenix deteriorate. For the record, although I would probably regard myself as a SPD/Green supporter in German terms, I think rent controls and the excitable talk of expropriations is utterly pointless and counterproductive. We have plenty of live experiments all around the world which show that rent controls do not work long term and massively skew housing outcomes against youngsters. Much better to build aggressively and especially social housing to fill the affordability gap rather than throttle the market for new builds.

Anyway, my target is a share price of 400p for Phoenix by year end. The price today is 324p.

Tetragon is a much more difficult, much riskier beast. I have looked at this fund on and off for the last few years, tempted by the discount but slightly horrified by the governance issues. Matt Hose funds analyst at Jefferies has been a very lonely optimist for this asset manager cum hedge fund cum family office and I have added his last research note from July 2020 on Tetragon following their six months numbers.

The final note below from Numis (on the recently announced Ripple legal action,) nicely sums up the challenge any investors faces with Tetragon : “Tetragon is trading at a 61% discount to NAV and has struggled to attract demand, despite a strong record of NAV returns since the global financial crisis. We believe this reflects its complicated strategy with a mix of asset management businesses and direct investments, as well as a lack of voting rights and onerous fee structure.”

In essence, there is a structural discount at play given the governance (no voting rights!) and a performance fee.  On the plus side, there is an annual tender, but it uses a reverse auction format so is conducted at a wide discount. That said there is evident value in the portfolio especially with Equitix and TFG Asset Management, which is likely to see write-ups at 31/12. And there is that big stake in Ripple, but as the Numis note below reminds us this stake (7.5% of NAV) is subject to a SEC investigation and so its value is very uncertain. The finals are just around the corner in February and could bring some good news but even I have to admit that there are no obvious catalysts that might narrow the discount imminently.

As one analyst told me “the real catalysts would be if they gave money back at NAV, enfranchised shareholders, or altered the fee arrangements. All are very unlikely though as the status quo is very lucrative for the managers”. But I do think, all these cautions notwithstanding, there is potential value and I think the note below from Ocean Wall (an alternatives specialist) makes a strong case.

Overall Tetragon is currently trading at 682p and I’d set a 900p share price target.

Numis note on Phoenix Spree from 6th January 2021

Condominium Sales: Phoenix Spree Deutschland has announced that since 30 June a further 30 condominium units have been notarised for sale, for a total of €10.5m. Pricing has remained strong with an average price of €4,276 per sqm achieved, which represents a 20.2% premium to the book value of each property. The volume of sales increased markedly in the second half of the year when compared with the eight residential units and two attic spaces sold in H1 for an aggregate €3.0m. In line with the agreement with Accentro Real Estate the company is guaranteed a further €1.2m of condominium proceeds for the financial year to 31 December 2020 in relation to the three remaining unsold units at the Boxhagenerstrasse building. At 31 December, 70% of the portfolio had been legally split into condominiums with a further 17% in the application process.

Share Buybacks: The company resumed its share buyback programme following the release of its 30 June interim report in September, by which point it had become clear that the Covid-19 pandemic had not had a notable impact on the company’s rent collection and financial position. As at 5 January the company had bought back 4,733,500 shares (4.7% of share capital) for an aggregate consideration of £15.2m, with the average price paid equivalent to a 30% discount to the 30 June EPRA NAV.

Debt refinancing: The company has refinanced €21.4m of existing loans into a new debt facility which is non-amortising and benefits from more flexible terms to allow the sale of assets as condominiums. The new facility releases a further €8.1m of cash and has a maturity profile in line with both the replaced debt and the company’s existing facilities. The replaced debt incurred an amortisation cost of 1.5%.

Outlook: Management maintains its view that the “Mietendeckel” rent-cap is unconstitutional and notes that a final decision from the federal court is expected in the first the half of this year. The company continues to explore all options to “optimise strategic flexibility” within the existing portfolio including further condominium sales and share buybacks as well as continued caution over capex projects and new tenant contracts that provide for the retrospective collection of rent should the Mietendeckel be overturned.

Numis Views: Management had indicated in its interim results condominium sales were expected to accelerate in H2 following Covid-19 restrictions in Berlin being lifted. Reflecting this, as well the strategy to focus on condominium sales, the total of €14.6m notarised for sale in 2020 represents a 65% increase on the prior year. It will be interesting to see if the rate of sales is impacted should the current Covid-19 restrictions in Berlin that were re-introduced last month be extended beyond 31 January. The proactive approach of legally splitting further portions of the Berlin portfolio into condominiums will provide management with even greater flexibility to implement condominium projects if deemed appropriate and the significant premiums to book value that continue to be achieved on sales give comfort on the valuations. The company is expected to release its 31 December portfolio valuation in early February.

Phoenix Spree Deutchland delivered share price total returns of 2.2% in 2020 and the shares currently trade at a 31% discount to our estimated NAV (allowing for currency movements). The federal court’s final decision on the legality of the Mietendeckel is due in the first half of this year and could prove to be a meaningful catalyst for the company’s shares to rerate. Following the first announcement of the proposed rent caps in June 2019 the discount widened to 32% having traded at an average of c.7% over the preceding 12 months. In our view, it is positive for shareholders that the company continues to undertake share buybacks while the discount is wide, and we believe that the disposals at significant uplifts demonstrate the value in the portfolio. A number of other property ICs started share buyback programmes in the second half of 2020, including Schroder Real Estate and Standard Life Investment Property Income.

Liberum View on Phoenix Spree

PSDL has implemented a range of initiatives to maximise flexibility following the introduction of the Mietendeckel. The proportion of the portfolio that can be sold as condominiums has steadily increased and debt refinancing has been agreed to provide enhanced flexibility. Furthermore, new leases allow retrospective collection of market rents in the event that the Mietendeckel is found to be unconstitutional. New tenancy agreements specify the rent payable while the Mietendeckel is in place and contracted rents (free market rent in the absence of Mietendeckel).The company remains confident on the potential for the Mietendeckel to be challenged. The decision now rests with the Federal Court after a German constitutional court dismissed a motion to suspend the law in October.

Phoenix Spree is well-positioned relative to its peer group as the company’s size and strategy offer greater flexibility to adjust its business model. The price level achieved on the condominium sales gives comfort over the level of downside protection. We estimate the upside from the achieved condominium sale price in 2020 to the value of the portfolio implied by the market capitalisation to be 41%. Despite the impact of the rent freeze and Covid-19, PSDL has continued to deliver attractive NAV returns (+3.9% in H1 2020). Rent collection is high and strong demand remains for condominiums in an undersupplied market.  

Ocean Wall note on Tetragon

Tetragon is a closed-ended investment company that invests in a broad range of assets; public & private equities and credit (including distressed securities and structured credit), convertible bonds, real estate, venture capital, infrastructure, bank loans and TFG Asset Management, a diversified alternative asset management business. It is isn’t for everyone as the lack of voting rights on the ordinary shares keep management in control. As well as that above-market charges have deterred investors (1.5%/25%). Nonetheless, the discount to NAV is chronically wide at 54%. This is unchanged from March when JPMorgan Cazenove described the discount as ‘unprecedented’ for a company that had grown net asset value by 294% since flotation in 2007, or 11.7% a year. The portfolio is an interesting mix of funds and private equity.

Tetragon portfolio

Tetragon has high insider ownership of over 32% so is essentially a quoted family office investing in multiple asset classes which makes it comparable with similar more highly rated vehicles such as RIT Capital Partners which trades close to its NAV. With a dividend yield of 5.2% and dividend cover of 2.2x it looks a compelling Holdco trade.

Jefferies note from July 2020  on Tetragon half yearly numbers

NAV: TFG announced a 30/06/20 fully diluted NAV per share of $24.00, reflecting a total return of -1.9% for the six months. The shares currently trade on a 62.6% discount to this.

Performance: The portfolio was relatively bifurcated overt the six months, with TFG Asset Management, private equity/venture capital, and the other equities and credit bucket producing positive returns, against losses from event-driven equities, bank loans, and real estate. When comparing the May and June factsheets for the Q2 marks being incorporated into the latter valuation, we can see a $19m increase in the value of Equitix and a $10m increase for LCM. As expected, private equity and venture capital marks have continued to bounce back, but the bank loan (i.e. CLO equity) bucket has dragged over recent months due to credit quality erosion, also noting that a couple of LCM transactions have breached interest diversion tests. Real estate investments posted a small negative performance during June, but there are still likely to be some 31/03/20 marks applied here, so with a positive lag effect to come through. The same effect may also apply to third-party funds within the private equity/venture capital bucket.

Portfolio: The high-level portfolio allocation was little changed over the period, but the QT (quantitative) fund was largely redeemed during the half, while Equitix repaid £25.7m of loan notes to TFG.

TFG Asset Management: Aggregate AuM was $27.9bn at the half-year, up from $27.4bn at the prior year-end, remembering that TFG now reports its pro-rata share of BentallGreenOak’s assets. EBITDA was $37.8m for the half-year, against $25.1m in H1 2019. The strong increase was largely driven by higher management fee income from Equitix as its AuM continues to grow. If we adjust the overall valuation of TFG AM for BentallGreenOak due to its minority investment status, and TFG’s share of the estimated £140m of Equitix debt, the business was held at 12.1x EV/EBITDA as at 30/06/20. We still see this as a relatively conservative valuation, cognisant of the discount rate increases applied to Equitix, LCM, and Polygon (as well as BentallGreenOak) as part of the latest valuation.

Balance sheet: Net cash was $105.5m, or 4.7% of NAV, at 30/06/20 with the $150m RCF fully drawn. However, post the period-end, TFG secured a 10-year $250m RCF, to replace the existing facility, thereby providing an extra $100m of liquidity. There was no further detail in the report on the terms or counterparty to this RCF. TFG’s commitments total $206.7m, with a mix of hard (i.e. third-party) and soft (i.e. controlled) commitments.

Dividend: Following the reduction in its dividend from $0.1875 per quarter to $0.10 in Q1, TFG has declared a Q2 dividend of $0.10 (going ex on 03/08/20), leaving the shares trading on a 4.5% dividend yield

Numis note on 6th January 2021 on Ripple Action

According to press reports, Tetragon has sued its portfolio company Ripple Labs, as it seeks to “enforce its contractual right to require Ripple to redeem” the Series C preferred stock held by Tetragon and to block Ripple from using any cash or other liquid assets until the payment is made. Ripple Labs is the American technology company which developed the Ripple payment protocol and exchange network and is behind XRP, the world’s third-largest cryptocurrency.

Ripple responded to the filing on their website: “In Ripple’s Series C investment agreement, there is a provision that if XRP is deemed to be a security on a go forward basis, then Tetragon has the option of having Ripple redeem their Ripple equity. Since there has been no such determination, this lawsuit has no merit. We are disappointed that Tetragon is seeking to unfairly take advantage of the lack of regulatory clarity here in the U.S. The courts will provide this clarity and we are very confident in our position.”

Last week Coinbase, the biggest cryptocurrency exchange in the US, said it would stop selling XRP to the public after the SEC sued Ripple, alleging it misled investors by selling more than $1bn of the cryptocurrency without registering with the agency. Coinbase is the target of a proposed class-action lawsuit seeking to recover commissions paid on XRP trades, alleging the company knew the tokens qualified as securities.

Numis Views: This is an interesting development as Tetragon’s stake in Ripple is significant, representing $172.5m (7.5% of net assets) and is a top five holding. Tetragon is trading at a 61% discount to NAV and has struggled to attract demand, despite a strong record of NAV returns since the global financial crisis. We believe this reflects its complicated strategy with a mix of asset management businesses and direct investments, as well as a lack of voting rights and onerous fee structure.