Some friends of mine asked me if I could create an insurance-centric hedge fund. I said that it was unlikely because I’m not good at shorting. They pressed me on it, because they knew if I had good longs, with my quantitative skills, I could create a credible short position that might hedge the longs.
Ugh. I don’t want to do it, but maybe I could make this work. I certainly could use the revenue. So what would I focus on in such a fund?
- Relative valuations
- Management quality
- Reserve releases/strengthening from prior year claims
- Momentum — yeh, momentum.
- Long-term underwriting profitability
My goal is to make money for average people, not the wealthy, but if that is the only way that my firm can survive, I will set up a hedge fund in the insurance space. I love insurance; I know it intuitively, but I know that once I begin to take big bets, I may fail badly.
If you know me well, you know that I only take prudent risks. I’m not risk-averse, I like taking risks when the odds are in my favor.
So I am puzzled at this point. I have done better in evaluating the broad markets than the narrow insurance markets, but if I have to be a narrow investor in order to survive, I can do that.
If you have advice for me here, I will receive it with thanks.
Hi David,
Focus on where you have an edge (it might even be all of the above at various times) and if you don’t have a good short idea, there are always ETF’s and options available for hedging.
Kapil
David,
You don’t sound very enthusiastic about the idea. If you are not passionate about it, walk away. Sooner or later you will get whacked making big bets.
yours, woolybear1
In terms of what you should focus on… focus on the exact thing you would focus on when you manage any portfolio. Hedge funds aren’t a different strategy (ignoring that they provide more flexibility… both with regards to areas of focus and less liquidity buffering for clients), they are simply a pricing structure.
As far as hedging, while hedge funds were originally meant to “hedge” against the broader market, there are plenty of hedge funds that simply attempt to significantly outperform the broader market, but not in absolute terms. If you aren’t comfortable shorting, you really don’t need to if you can knock the socks off with the longs in a levered manner.
“Ugh” says it all. If you are only doing this for the money, you are not likely to be happier. In fact, you are more likely to be unhappy as you may feel additional resentment on account of doing something you clearly don’t enjoy.
Then, too, if you feel like you are not good at shorting, you are likely to be feeling additional stress doing something outside your skill set. The psychology of investing is difficult enough without complicating it by trying to move away from your area of expertise. On top of that, having other people’s money on the line sounds like it would make for some potentially sleepless nights.
That said, if you need to put food on the table, and this is the only way…
Perhaps before trying to launch a hedge fund, you could add shorting to your own portfolio, or a trial portfolio, and see how it goes. Maybe the experience will let you know whether this will or won’t work for you (and your clients).
Good luck.
Randolph
David,
You might attract more investors if you posted a concise, quantitative summary of your past performance.
Jim
This is a people business and your skills will never be fully appreciated; so I’m not sure a specialty approach (even as I believe it will be well executed on your part) can open quickly enough doors with the “average” client in mind. If you have some good opportunities for some blocks of assets that gets your revenue to where it needs to be you should do this; especially as i believe you can differentiate yourself in the market in this regard.
Regulations prevent that Jim.
The correlations between insurance stocks seem very tight. PL,HIG, and LNC all seem to go up and down together as if they’re tethered. If machines are making most of the decisions about trading relationships, then there is an opportunity to trade against them with a longer-term outlook.
What is critical about whether this works is your judgment about whether you’ve picked more winners vs. losers in the space. Not better companies; stocks that performed!
I spent a few years looking intensely at utilities – going to conferences, reading Public Utilities fortnightly, and being diligent. What I found was that my preference for better operators was a disadvantage- the dopes who screwed up got taken over at premiums, and the good firms got pasted in rate reviews by their regulators. I dropped the sector, because I became convinced that I couldn’t add value.
Rich, I really appreciate this comment. Very well thought out, and applicable to me also. We all need to understand our “circles of competence,” and stick to them.