Astrea 7 Bonds – Is Class B more attractive than Class A-1? REITs a better buy?

 

After the weekend article on Astrea 7, I received many great questions from readers.

And having had more time to mull over Astrea 7 Bonds, I wanted to share some updated views.

I know not everyone of you will be applying for Astrea 7 Bonds, but even if you don’t the analysis / discussion here will have broader implications, as it can be applied to fixed income (bonds) generally.

This article will assume you already have some understanding of how Astrea 7 works, so if you don’t, just check out the weekend article here.

Note: This is an exclusive Patreon article. Making it available given the massive interest around Astrea 7.

If you found it useful, please support Financial Horse on Patreon and receive more exclusive articles like this.

Is Astrea 7 Class B more attractive than Astrea 7 Class A?

I’ve been thinking about it for quite a while, and a very interesting thought occurred to me that actually – Class B may be more attractive risk-reward wise than Class A-1.

Think about it this way.

Astrea 7 Class A-1 is SGD denominated, and pays a 4.125% yield.

And it is about 30% LTV, which means that there is zero risk as long as the underlying NAV does not default by more than 70%.

Astrea 7 Class B is USD denominated, and pays a 6% yield, which is a whole 1.875% higher than Class A-1.

And it is about 30-40% LTV, which means that there is zero risk as long as the underlying NAV does not default by more than 60%.

In other words, for the 1.875% higher yield, the risk you are taking on is:

1. USD FX risk
2. Default risk of the NAV from 60% (instead of 70%) on a $1.9 billion USD broadly diversified PE portfolio

Let’s discuss each of that.

1. USD FX Risk

To put things in perspective, Class A-2 USD pays a 5.35% yield (vs 4.125% for Class A-1 SGD).

And don’t forget that Class A-1 and Class A-2 rank pari passu in default (which is basically just a fancy way of saying that if Astrea 7 defaults, both Class A-1 and Class A-2 rank equally).

So the higher yield on Class A-2 over Class A-1, is simply USD FX risk, and not default risk.

What this means, is that the market is pricing in a 1.225% spread, simply to take on USD FX risk vs SGD.

Or in other words, of the yield spread of Class B vs Class A-1, 65% of it is due to USD FX risk, and 35% due to increased default risk.

Is USD vs SGD really that scary, over a 5 year horizon?

I mean I don’t know the answer to that, but personally my portfolio will stand to benefit from any USD depreciation.

The commodity positions, gold positions, US stocks, all should technically benefit from a major USD depreciation.

So I think if you view it holistically as part of your overall portfolio, the USD risk can be managed.

2. Default Risk

So the market is pricing in the increased default risk of Class B vs Class A as being 0.65% spread (if you strip out the USD FX risk).

Which indicates that frankly, the market doesn’t see Class B as significantly more risky than Class A.

And the more I think about it, the more I’m inclined to subscribe to that view.

Try to think about it this way.

You assemble a $1.9 billion USD PE portfolio, spread across US, Europe, Asia. All from the biggest names in private equity like Warburg Pincus and KKR. With an average vintage of 5.3 years.

And yet – this broadly diversified portfolio defaults to the point where it loses 60% of its total value.

What does the world look like in this scenario?

Okay let’s leave aside the micro level risk of some freak accident where the securitisation structure fails and Astrea 7 self-destructs. You can argue the same with any other investment in that case.

But leaving this aside – you’re probably already looking at a very deep financial crisis, and devastating global recession.

In such a case, would the 60 – 70% jump in safety for Class B to Class A really make that big a difference?

Frankly not so sure about that.

And for those of you who think that REITs at a 5% yield are a better buy, try to imagine the kind of losses REITs would be nursing in a global recession like this.

 

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Class B Astrea 7 vs REITs – which is the better buy?

Let’s take Ascendas REIT.

It trades at a 5.5% yield today, vs 6% for Class B Astrea 7.

With Ascendas REIT you have capital gains potential on top of the 5.5% yield.

But you also have a chance of capital loss if real estate prices drop, and risk of dividend cut if rentals are impacted.

With Class B Astrea there is very limited capital gains potential given the nature of fixed income.

Chances of capital loss are mainly limited to default risk if you hold to maturity. Risk of dividend cut is basically a default scenario as well.

Which is the better buy?

I think it will be clear based on the analysis above that the two are very different investments.

One gives you upside potential in exchange for the risk of capital loss (REITs), one removes the upside potential (in return for a fixed yield) in exchange for reduced risk of capital loss (Astrea 7).

So the more I think about it, the more I think that this is not a fair comparison.

It really goes back to the whole equity vs fixed income debate.

REITs, like equity, give you upside potential, but comes with higher risk of capital loss.

Astrea 7, like fixed income, has very limited upside potential. But the risk of capital loss is mainly limited to default risk.

Will the coming recession be a problem?

Okay I get it.

Most of these PE assets are valued in 2021, and do not reflect the latest fall in public market valuations.

If you mark them to market today, you may be looking at a 20-30% drop in valuations.

I actually really like this argument, and I think it makes a lot of sense.

But as investors, we are all about taking measured risks.

Knowing what you know today – at a 4.125% or a 6% yield – is the risk-reward attractive for Astrea 7?

If you don’t think so, just skip the investment.

No big deal.

How much of Astrea 7 Class B / Class A-1 would I apply for?

So having thought about it a bit, I’m starting to think that I may actually want to apply for more of Astrea 7 Class B than Astrea 7 Class A-1.

I think both offer decent risk-reward, and I’ll still apply for both.

But I frankly don’t mind taking on the USD risk, and it seems the market is pricing in only a marginal increase in default risk for Class B anyway.

In which case I frankly wouldn’t mind holding more Class B.

I do want to caveat that this is just for me though, and every investor’s personal risk appetite is very different. If you’re not comfortable with USD risk, or if you’re not comfortable with default risk, or if you need liquidity in the next few years, Astrea 7 may not be for you.

But let’s see the balloting results and trading action, I would be very curious to see how the market reacts to and prices Astrea 7.

As always – love to hear what you think!

Note: This is an exclusive Patreon article. Making it available given the massive interest around Astrea 7.

If you found it useful, please support Financial Horse on Patreon and receive more exclusive articles like this.