Why we are less keen on the Astrea 7 bonds

TL;DR

• The Astrea 7 bonds offer investors diversified exposure to private equity funds, and have safeguards in place to offer investors some form of protection.
• The Class A-1 bonds offer a yield 4.125% and carry lower risk, as you will be paid first before other bondholders. The Class B bonds offer a yield of 6% and have much higher risks, as you may not be repaid fully in the event of a deep and long recession.
• With rising interest rates, we think the yield on the Astrea 7 bonds looks less attractive compared to previous issuances. We would consider putting our spare cash in Singapore Savings Bonds (SSB) for a short period of time and await potentially better yields.
• If you prefer to sleep soundly at night, we highlight that the SSBs have lower risk and offer an average return per year of 2.37% over 5 years.

One thing I have learnt since starting Beansprout, is that Singaporeans love investing in assets that give them a high and steady yield.  

It is no wonder that the buzz amongst investors recently is the Astrea 7 bonds.

What are the Astrea 7 bonds?

If you are a fan of fixed income investments, then the Astrea series of bonds would not be new to you.

This is the fourth in a series of Astrea bonds issued since 2018. The last time the Astrea 6 bond was issued in 2021, the retail portion amounting to S$250 million was 3.1x subscribed by more than 25,000 applicants.

However, if you are new to this, let's do a quick summary.

The Astrea 7 bonds are issued by an entity of Azalea Asset Management, which is a subsidiary of Temasek.

The bonds are backed by cash flows from a US$1.9 billion portfolio of investments in 38 private equity funds.

In other words, when you invest in the Astrea 7 bond, you are lending money to this Azalea entity. Your interest and principal payment will be coming from the cash flow generated from the portfolio.

In this case, there are two Astrea 7 bonds that are available to us as retail investors.

• Class A-1 that offers a fixed interest rate of 4.125% per annum
• Class B that offers a fixed interest rate of 6% per annum

I thought it’s interesting to see that it’s the first time the Class B bonds are available to retail investors.

You might see a Class A-2 in some offer documents but that is not available to us as retail investors, so we will not spend too much time talking about it.

You must be wondering if the Class B bonds are giving a higher interest rate compared to the Class A-1 bonds, they must be better right?

As with everything in investments, a higher return usually comes with higher risks.

Here, it is important to note that the Class A-1 bond ranks as the most senior of bonds. This means that if Azalea has difficulties repaying all debt holders, the holders of the Class A-1 bond would be paid before other bond holders.

In short, it comes with lower risks.

The Class B bond ranks junior to Class A-1 and Class A-2, which means that bondholders will be paid last should there be any payment difficulties. 

The other feature to note is that the maturity date of the bonds is in 2032. This means that your principal investment amount will only be repaid in 10 years time.

However, the Class A-1 bond is calleable by Azalea in 5 years time in 2027, while the Class B bond is calleable in 6 years time in 2028.

In fact, it is mandatory for Azalea to repay your principle investment on the call date if certain conditions are met. If the bonds are not called, you will get a 1.00% higher interest rate after that.

Given the higher interest rate that they will have to pay, there is a likelihood that the issuer will call the bonds early. This depends on the prevailing interest rates at that time. If interest rates are 10% in 2027, then maybe the bonds will not be redeemed early.  

How risky are private equity funds?

You’re probably wondering we can assess the risk of a debt issuer if it is a company. Like SIA. Or Hyflux.

But how do we assess the ability of this portfolio of private equity funds to repay the borrowing?

In evaluating the portfolio, what we like is how it is diversified. What we have been saying about not putting all your eggs in one basket.

What makes it diversified?

• Investments in 38 private equity funds
• 29 reputable fund managers
• 982 investee companies
• Split in geographical exposure of US (55%), Europe (27%) and Asia (18%)

If you don’t understand how these make the portfolio diversified, we’ll explain in just abit.

By having 29 reputable fund managers and 982 investee companies, we will not be overly worried if one company or one fund manager were to face financial difficulties due to specific challenges faced.

If it’s not a global economic crisis, the other 28 fund managers and 981 investee companies will probably still be able to generate good returns. This will help with the payment to bondholders.  

In fact, an analysis done by Azalea found that even in the event of a global financial crisis, the issuer will be able to meet 100% of its obligations to holders of the Class A-1 bond by both  the scheduled call date (2027) and maturity date (2032).

Things may not be as rosy if you are a holder of the Class B bonds. The issuer will only be able to meet 39% of its obligations by the scheduled call date (2028) and 99.7% of its obligations by the maturity date (2032).

The other thing that we like, is the weighted average vintage of 2017 for the private equity funds. What this means is that on average, the private equity investments were made in 2017.

These were investments made prior to the Covid-19 pandemic, when we have not seen US monetary easing led to sky-high valuations in the public and private equity markets as yet.

According to a study by Cambridge Associates, the average returns for US private equity fund investments made in 2016 to 2018 were at about 25% to 27% as of June 2021.

This means that there is some buffer for the issuer to meet its obligations even if we were to see private equity returns come off in the next few years.

What are the safeguards in place?

If you are still not assured by how the issuer has tried to diversify its portfolio, there are also certain structural safeguards in place to offer bondholders more protection.

These would include reserves accounts, maximum loan-to-value (LTV) ratio and credit facility.

The maximum loan-to-value means that there is a limit to how much borrowing the funds can take on. They will be required to reduce their borrowing if the loan-to-value exceeds 50%.

What we want to do is through the reserves accounts in more detail, as it could affect your choice of subscribing to the Class 1A or Class B bonds.

The Reserves Account sets aside cash every 6 months for repayment of holders of Class 1A and Class B bonds on the callable date (2027 and 2028 respectively).

This means that after paying key expenses and bondholders’ interest every 6 months, cash will also be reserved to repay the principal of bondholders.

It is important to note here that Class B will begin reserving only after Class A has been fully redeemed or reserved.

Would we subscribe to the Astrea 7 bonds?

There are a few things we like about the Astrea bonds.

Its portfolio is diversified across private equity funds. This helps to spread out risks across fund managers, companies, geographies, and year of investment.

We also like the safeguards in place. In particular, the cash put aside regularly in the reserve account would offer some protection on the principal repayment.

What we do not like as much, is the interest rate we are getting on the bonds.

The US Federal Reserve has raised its benchmark interest rates twice so far this year. Most economists expect the Fed to continue raising interest rates for the rest of the year.

In fact, the general view is that the Fed funds rate will reach 3% by early next year. From 0.25% at the start of 2022. That’s a very significant increase within one year.

The question we would be asking is – would you want to lock up the interest rate you are getting over the next 5 years, when you could be getting a higher interest rate 6 or 12 months down the road?

To put it into numbers, the Class 1A Bond is offering you an interest rate of 4.125%. The 5-year government bond is now offering you 2.57%.

When the Astrea 4 bond was launched in 2018, it was offering an interest rate of 4.35%. The 5-year government bond at that point was offering you 2.3%.

In other words, interest rates have gone up in general, but the interest rate for the Astrea bond has come down.

Here’s another example – the Astrea 6 bond issued in March 2021 was offering an interest rate of 3.00%. The yield on the 5-year Singapore government bond then was below 1%.

With the 5-year Singapore government bond now at 2.6%, we would have expected the Astrea 7 bond to be offering an interest rate of at least 4.5%.

Of course, this is assuming that the ability to repay is the same for the entire series of Astrea bonds. We do not know for sure since we do not have data on the underlying private equity funds held.

But you would have seen more people talking about a potential recession these days. And this means that the risks for the private equity funds would have risen.

We would expect a higher interest rate after taking into consideration the higher economic risks today compared to even 12 months ago. 

If I want to subscribe to the Astrea 7 bond, is the Class A-1 or Class B bond better?

The Class A-1 bonds carry lower risk, as you will be paid first before other bondholders. The reserve account will also offer you additional safeguards as a Class A1 bondholder. 

The Class B bonds carry significantly higher risks. Remember that the Astrea 7 may not be able to meet all its obligations to Class B bondholders at the first call date in the event of a global economic crisis.

It is also worth noting that the Class B bonds are in US Dollars, so there may be some currency risk involved.

Here, we can’t emphasise enough the various risks that come with bond investing.

As with all investments, your capital is not guaranteed. Even if the issuer is a subsidiary of Temasek.

Bond prices can also be affected by market conditions, and you might suffer losses if you choose to sell your bonds before maturity.

For example, the prices of some of the previous Astrea issues fell by more than 10% during the Covid-19 sell-off in March 2020.

We’ve all read about how interest rates are going up. What is also important to know is that bond prices would decline when interest rates are rising.

This explains why the Astrea 6 bonds are trading below par, which means that you will be making a capital loss if you were to sell the bond in the market today.

What are the alternatives?

For those who prefer to sleep well at night and not worry about a recession, what we want to highlight is that the 5-year Singapore Savings Bond is now offering an average return per year of 2.37%.

This is issued by the Singapore government, which is lower risk than Astrea’s portfolio of private equity funds.

Putting your money in the Singapore Savings Bond for one year gives a return of 1.43% (refer to table below). If I have some spare cash, I would consider putting my money into this for the short term.

With interest rates going up, I may be able to earn a higher interest rate in 12 months’ time than what I am able to earn by fixing my interest rates now.

How to subscribe to the Astrea 7 bonds?

Pro-tip: You have a higher chance of getting an allocation if you apply for less than S$50,000 of the Class A-1 bonds and US$50,000 of the Class B bonds. This is due to the issuer’s desire to favour smaller retail investors. In the previous Astrea 6 issuance, all 21,220 valid applicants of less than $50,000 received some allocation in full or in part.

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