I Don’t Get It

1) Liberty Mutual buys Safeco?  Pays 1.75x book, and 11x estimated earnings?  Mutual companies have limited access to the credit markets, and have no equity to pay with, so it is mainly a cash deal.  They must have had a lot of cash lying around — might we wonder why they might not have enhanced policyholder dividends instead?  This is not an economic use of capital in my opinion. Kudos to those who owned Safeco — it was cheap, though in the negative part of the underwriting cycle.

I know this diversifies Liberty Mutual geographically and from a line of business standpoint, but I don’t expect there are a lot of costs to take out here. Intellectually, it is harder to grow organically, but at this point in the underwriting cycle, it is definitely preferred to acquisitions.  There are no equity investors in Liberty Mutual, but I would not lend them money on a trust preferred or a surplus note at present.  There are better places to put money at interest — remember, acquirers usually underperform.

But for those with a RM subscription, check out Cramer.  Off of Safeco, he likes Chubb.  Okay, I like Chubb too.  Great company, and cheap.   I prefer Allstate, HCC, or Safety, and if I wanted to speculate, maybe Affirmative.  Lots of cheap P&C names out there, but it is the wrong side of the underwriting cycle — premiums falling, losses coming in unabated.

2) I don’t get fundamental weighting on bonds.  With bonds, the best one can do is get paid interest and principal, if one is buy-and-hold.  With stocks, a buy-and hold investor can do better in the long run by buying better earnings streams (value), rather than accepting market value weightings.  With bonds, there is no such upside, so I don’t get the fundamental weighting, except perhaps in foreign currency denominated bonds, and using purchasing power parity, which is still a weak tool.  I wouldn’t go there.

3) I don’t get Bill Miller.  I’m a value investor.  I like companies that trade at modest multiples of book and earnings.  I agree in principle with the concept of deferred performance that he mentioned in his quarterly letter:

My friend Jeremy Hosking, who has delivered around 400 basis points per year of excess return over two decades at Marathon (in London), corrected me recently when I spoke about our underperformance. “You mean, your deferred outperformance,” he said. I thought it a clever line, but it contains an important point. For investors who are trend followers, or theme driven, or who primarily build portfolios around forecasts, or who employ momentum strategies, price is dispositive. When they do badly, it is because prices moved in a direction different from what they thought. For value investors, price is one thing, and value is another. When prices move against us, it usually means that the gap between price and value is growing, and our future expected rates of return are higher.

With stable, cheap businesses, this definitely applies, but as you step out onto the growth spectrum, it no longer applies.  Check out the beginning of the letter, he is only 41 basis points ahead of the S&P 500 on a ten-year basis.  At this rate next year, he might be behind the S&P over ten years.  Quite a flameout for one who was so lionized.  Could he be fired?  Yes, but not by Chip Mason.  They are too close.  If one succeeds unconventionally, there is less tolerance for failure, because they weren’t sure why it worked in the first place.

4) I’ll take the opposite side of this tradeFinancial literacy is a good thing, and most people would be better off knowing more about finances, so long as they can mix it with humility.  I’m a professional, and I think humility is a key virtue in handling money.  As I say in my disclaimer:

David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent “due diligence” on any idea that he talks about, because he could be wrong. Nothing written here, or in my writings at RealMoney is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, “The markets always find a new way to make a fool out of you,” and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves.

People who are educated will still make mistakes with their money, but they will make fewer mistakes on net.  Hey, I’ve paid market tuition, and it is painful.  But boy, I learned a lot, and I don’t repeat mistakes often.  (Repeating mistakes sometimes is bad enough… 😉 )

Full disclosure: long SAFT (not SAF)