Tetragon Financial is a unique investment trust that generates exceptional profits

According to James Mackreides, Tetragon Financial has done exceptionally well, but most investors won't find it appealing There are obvious reasons for the significant discount

One of the most unusual investment trusts on the London Stock Exchange, Tetragon Financial (LSE: TFGS) has a distinctive approach to corporate governance and investing. Regardless of whether the latter will deter someone, it is intriguing to review because its total returns are essentially unmatched. It has generated a total return on a net asset value (NAV) basis of 568 percent since listing in April 2007, while the MSCI All Country World index has produced a total return of 276 percent.

Hedge-fund managers Reade Griffith and Paddy Dear initially co-founded Tetragon to invest in the then-burgeoning collateralized debt obligation (CDO) market. It changed its approach following the global financial crisis and now makes investments in a variety of asset classes. It is easiest to begin with a breakdown of the portfolio because it is much more complicated than most vehicles of this type, which are typically just listed feeder funds into a main hedge fund.

Tetragon's gross assets at the end of September were slightly less than £4.5 billion, with net assets of £3.9 billion plus roughly £600 million in debt. Through a company called TFG Asset Management, the majority of the portfolio (£2 billion, or 44 percent) was made up of full or partial ownership of specialized asset managers. The largest asset, accounting for over 25% of the total portfolio, is a controlling interest in Equitix, an infrastructure investor.

Since Tetragon's investment in 2015, Equitix's assets under management have increased tenfold since the company's founding in 2007. Recently, Tetragon sold a 16% stake at a significant markup over its carrying value. TFG Asset Management owns or co-owns a total of £41.5 billion in capital. Most of this amount is made up of LCM (leveraged loans), BGO (real estate), and Equitix.

The remaining £1.33 billion in private equity and venture capital, £570 million in hedge funds, £310 million in stocks and credit, £120 million in real estate, £100 million in bank loans, and £60 million in "legal assets" (litigation finance-related investments) make up the portfolio's various investment strategies. Direct investments account for 22% of the entire portfolio, while external funds make up the remaining 6%. Nonetheless, the majority (31%) is invested in funds managed by Tetragon's own managers.

Tetragon's primary approach, then, is to locate appealing asset classes, find managers who generate high returns in them, and then invest in the development of these managers by making direct investments in their strategies.

The governance gap at Tetragon Financial.

If you need some time to understand that, the governance does as well. Tetragon offers both dollar-priced and sterling-priced shares, with a primary listing in Amsterdam and a secondary listing in London. The founders have all the power because these are non-voting shares and the only voting shares are owned by a business under Griffith and Dear's control.

Tetragon has an external manager named Tetragon Financial Management, which is also under Griffith and Dear's control, despite the fact that Tetragon owns investment managers. This arrangement's fee structure, which consists of an annual management fee of 1.5 percent plus a quarterly performance fee of 25 percent over its hurdle rate (three-month US interest rates plus 2.75 percent) without any high-water marks, is far from ideal.

Tetragon trades at a consistent discount to NAV (currently 55 percent), most likely due to these flaws. The sole mitigating factor is that Tetragon and its shareholders are still aligned due to insider ownership. As of June, Griffith, Dear, and employees held over 38 percent of the shares. This offers some motivation to attain optimal outcomes for all investors.

Since its launch, the shares have returned 385 percent, which is still very strong but less than the NAV return due to the widening discount. Although there is a small yearly dividend of £0.44 per share, or 2.3 percent, the number of outstanding shares has decreased by 13 percent over the last ten years due to £570 million in share buybacks.

The majority of investors will not find this trust appealing. Anyone who is tempted to purchase will need to think about it for much longer than there is room for. Even so, its historic performance is difficult to dispute.