Recently, Azalea Group has just released its Astrea IV Class A-1 bonds. It was widely marketed as the debt instrument which provides access to private equity investments. This was definitely confusing (at least for me) and here are the reasons.
Bonds and equities have different long-term investing objectives
Bonds are predominantly debt instruments while equity, regardless private or public, are stake holdings in companies. Debt is primarily raised externally with the purpose of investing in the company’s operations for higher future returns. Interest and loan repayment is required. Debt is classed higher than equity for repayment in the event of a default. While the risk of failure of loan repayment can be mitigated by securing the loan with collaterals (where the collateral can be sold in the event of default), the investment returns are still from the interest payments. Hence, simple judgement of attractiveness of a bond is based on the underlying company’s ability to pay (risk) and the interest rate it is offering (reward). Investors should look for cash flow stability for company’s ability to pay.
Equity funding can be raised internally or externally with the similar purpose of investing in the company’s operations for higher future returns. However, the principal amount invested is not required to be repaid. Investors get their returns from the performance of the company through dividends issued or sales of its shares. As such, the attractiveness of a company’s equity is based on its probability of default (risk) and its business potential and performance (reward).
Why I am confused
While Azalea Group is a Private Equity firm, Astrea IV is a debt instrument which relies on Azalea Group’s cash flow for interest repayment. The attractiveness of this bond should be based on its relative interest rate offered and ifs underlying ability to pay the interest and principal loan amount. If the underlying private equity investments do perform better, the bond investors does not receive further benefits from the interest rate offered. In addition to this, even though Azalea Group is indirectly wholly-owned by Temasek Holdings, the bonds are not guaranteed by Temasek.
While I understand that the rarity of these private-equity-backed bonds may be the reason of its attractiveness, getting exposure to Private Equity via debt instruments does not resonate well unless the debt instrument has an option to convert into equities or equity-related benefits. A better gauge of bond attractiveness will be to compare its relative default risk and interest rate among other bonds offered in the market.
The Astrea IV bonds have definitely performed well in the light of the positive marketing and its early performance (heavily oversubscribed). The purpose of this post is also not to discount its merits but to offer my 2-cents thoughts of how investors should differentiate the investment perspectives of an equity and debt instrument.
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