There were once good rea­sons for this trust’s 34pc dis­count – but not any more

The Daily Telegraph - Business - - Business -

A RE­CUR­RING theme in this col­umn in­volves trusts that trade at a dis­count be­cause of per­cep­tions formed in in­vestors’ minds many years ago – per­cep­tions that no longer re­flect re­al­ity.

This week’s tip, Te­tragon Fi­nan­cial, which yields a gen­er­ous 5.5pc, trades at a dis­count of 34pc and there are sev­eral rea­sons to ex­pect that dis­count to nar­row.

First is that the port­fo­lio owns a di­ver­si­fied range of as­sets that should move in­de­pen­dently of the stock mar­ket. It has 21pc of its money in hedge funds, 8pc in prop­erty funds, 8pc in di­rect investments, 23pc in cash await­ing in­vest­ment op­por­tu­ni­ties and 19pc in var­i­ous as­set man­age­ment firms in­volved in run­ning some of Te­tragon’s own port­fo­lio. The re­main­ing 21pc is in highly es­o­teric as­sets called “CLO eq­uity”.

Some in­vestors will as­so­ciate the ab­bre­vi­a­tion CLO (col­lat­er­alised loan obli­ga­tion) with the ex­cesses seen be­fore the fi­nan­cial cri­sis, although Questor un­der­stands that these par­tic­u­lar as­sets per­formed well dur­ing and af­ter the cri­sis.

When Te­tragon floated (in Am­s­ter­dam) in 2007 the fund was much less di­ver­si­fied, with a much larger hold­ing in this CLO eq­uity. In the years that fol­lowed there were a cou­ple of de­vel­op­ments that left a bad taste in in­vestors’ mouths, the mem­ory of which prob­a­bly weighs on the shares to­day, even though things have now changed for the bet­ter.

The first was a write-down in the value of CLOs at the time of the cri­sis, fol­lowed by a strong re­cov­ery over the fol­low­ing years. This in it­self was un­ex­cep­tional, but the up­wards reval­u­a­tion trig­gered the pay­ment of a large per­for­mance fee to the man­agers. Per­for­mance fees are of­ten struc­tured to avoid this kind of seem­ingly un­de­served pay­ment but in this case the fee was con­trac­tu­ally due.

The se­cond con­tro­ver­sial as­pect of Te­tragon’s his­tory was its pur­chase, in 2012, of Poly­gon, the firm from which Te­tragon orig­i­nated. Poly­gon was owned by Reade Grif­fith and Paddy Dear, the man­agers of Te­tragon, and share­hold­ers in the trust could not vote on the deal as their shares were (and are) non-vot­ing.

Tom Tre­anor of As­set Value In­vestors, which runs the British Em­pire in­vest­ment trust, a share­holder in Te­tragon, said: “As a ‘re­lated-party’ trans­ac­tion on which share­hold­ers could not vote, and with pay­ment made in deeply dis­counted shares in Te­tragon, sus­pi­cions were un­der­stand­ably height­ened.”

But he added: “Sub­se­quent growth makes the trans­ac­tion price ap­pear rea­son­able to­day, if not ob­vi­ously cheap. More im­por­tantly, the deal sowed the seeds of Te­tragon as it stands to­day, lead­ing to a more di­ver­si­fied in­vest­ment port­fo­lio, an as­set man­age­ment plat­form and – cru­cially – a much greater align­ment of in­ter­est given man­age­ment’s greatly in­creased stake in Te­tragon.”

That stake arose be­cause Grif­fith and Dear were paid for their Poly­gon hold­ings in Te­tragon shares.

The pair, and other mem­bers of the man­age­ment team, now own about 25pc of the trust be­tween them.

“Their in­creas­ing stake has been ac­com­pa­nied by a per­haps un­sur­pris­ing new in­ter­est in tack­ling the com­pany’s wide dis­count,” Tre­anor added. “Man­age­ment has ap­pointed two new spe­cial­ist in­vest­ment trust bro­kers and joined the As­so­ci­a­tion of In­vest­ment Com­pa­nies.

“They have mar­keted the com­pany much more ex­ten­sively and, in late 2015, added a sec­ondary list­ing in Lon­don.

“More tan­gi­bly, ex­cess cap­i­tal has been re­turned to share­hold­ers via five sep­a­rate ten­der of­fers over the past five years, and the div­i­dend has grown by 52pc over that pe­riod.”

Tre­anor con­cluded: “While the lack of vot­ing rights and fee struc­ture mean that Te­tragon should trade on a dis­count, we con­tend that the cur­rent level is too wide and re­flects the mar­ket’s per­cep­tion, hav­ing failed to keep pace with the changes in align­ment of in­ter­est and man­age­ment be­hav­iour. While to­day’s dis­count of 34pc is ma­te­ri­ally less than the near50pc of mid-2016, it is sig­nif­i­cantly wider than the five-year low of 20pc.

“Te­tragon of­fers low cor­re­la­tion to el­e­vated eq­uity mar­kets and a strong track record, while in­vestors are be­ing paid to wait (via the 5.5pc yield) for a re-rat­ing which should be helped over the long term by a flota­tion of the as­set man­age­ment busi­ness.” Questor says: buy Ticker: TFG Share price at close: 12.75p

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