There’s a new fox sniffing around the private credit henhouse. Last year, Apollo Global Management Inc. engineered an innovative trade for its insurance arm Athene Holding Ltd., with the help of an obscure Luxembourg-based firm. It’s fascinating and troubling in equal measure.
The deal, named Fox Hedge LP, has repackaged $5 billion of loans and other debts that were already owned by Apollo’s funds and, through clever financial origami, turned them into bonds mainly for Athene to own, Bloomberg News reported this week.
What’s the point? There’s a lot going on in this trade, but it seems to have two main motivations: To create long-dated assets to match Athene’s long liabilities, and to give the insurer capital relief. In some ways, it’s similar to the synthetic risk transfers that banks have been increasingly using to cut capital requirements on their loan books. But Fox Hedge is significantly more complex than those — and it’s unclear how the loss-absorbing slice of this deal is funded.
Apollo is very reluctant to discuss its details, which may be because the asset manager doesn’t want competitors to easily copy it, although imitators are very likely to sprout quickly. Regardless, the lack of disclosure makes it hard to assess the risks involved. The obvious worry is that this trade could be too clever by half.
To put the transaction in context, Apollo has been the leading light in linking insurance and pensions businesses with private credit for years. It’s a marriage that makes a lot of sense: Illiquid, hard-to-sell assets are much better funded by hard-to-cash-in liabilities. Athene’s retirement-services unit has very long-term liabilities where its obligations to customers stretch decades into the future.
Fox Hedge is essentially a private-credit fund that’s been put into a standalone vehicle, which in turn is financed by bonds with a 40-year term but callable after 25 years, according to securities data compiled by Bloomberg. The fund, unusually, combines a wide variety of corporate, real-estate and asset-backed debt — mostly, but not exclusively, investment grade. This diversification might make it safer than, say, a pool of just corporate debt.
The fund’s assets are more short lived than the minimum 25-year term of the bonds and so will get replaced by Apollo as manager of the fund over time. Athene has a right of approval over future assets that go in, according to a person familiar with the deal who wasn’t authorized to speak publicly.
Like other kinds of securitization, Fox Hedge’s bonds are split into layers that face different likelihoods of suffering a loss – and all of them are protected by a layer of equity that takes the first losses from the pool of assets. The bonds are all investment grade with the most senior getting an AA-minus rating, according to the person, although the ratings aren’t public.
Fox Hedge has issued three tranches of debt, according to Bloomberg data. There’s a $2 billion super-senior slice that pays a fixed coupon of 6.05%, which is the safest part; a $1.25 billion senior bond that pays a floating rate of 3 percentage points over a risk-free rate; and a $750 million junior issue that pays a 4-percentage point spread.
That adds up to $4 billion of bonds, while the fund itself is about $5 billion in size, according to Bloomberg News. So the loss-absorbing equity piece is as much as 20% of the vehicle – which is pretty chunky. In traditional securitizations, such as collateralized loan obligations, the equity slice is typically about half that size.
The point of giving Fox Hedge such long-term funding is to better match the very long duration liabilities of insurers like Athene. This matching makes an insurer’s accounts less volatile and means it’s less likely that shifts in interest rates will create worrying gaps between the value of its investments and the costs of its promises to retirees. Duration matching is very common among annuity writers and pension funds, although things can go wrong when it’s done badly – just look back at the UK gilt market crisis of 2022.
One of the main risks for Fox Hedge is that in a decade or two’s time the prevailing returns on the kinds of assets it can buy won’t be enough to cover the interest it has promised to pay on its bonds. Who knows what credit yields will be that far into the future? But the huge 20% slug of equity and the fact that two of the bonds pay a floating rate will help guard against that problem, as might the variety of assets that can go into the fund.
Another aspect that some will find troubling is that Fox Hedge can invest in tranches of other securitizations, according to Bloomberg News – bits of mortgage bonds or CLOs, for example. That recalls some of the worst excesses of the years before 2008, such as CDO-squared deals.
Ultimately, though, the thing that demands closest attention in my view is that Athene is the dominant owner of this trade. It holds $3.2 billion of the $4 billion bonds, according to its quarterly filings. That’s equal to more than 10% of the value of its shareholders’ equity. This concentrated ownership is why Fox Hedge looks like a trade done for capital relief. It allows Athene to own much the same assets it could anyway, just in a form that demands less of its own shareholder funds.
The size of that roughly $1 billion equity slice may make it an incredibly safe capital-relief trade. But with a 25-to-40-year lifespan, it needs to be. This looks to me like the kind of seminal deal that will spur many copycats. And as with all financial innovation, the more it’s replicated, the more that firms will push the envelope of how much capital relief they can get at the lowest possible cost.
It's a fascinating trade – really, a smart synthesis of ideas. But it needs to be properly discussed and understood by investors and supervisors. Otherwise, some insurers could end up with less capital than they should have — making life riskier for retirees and the financial system.
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