Search Results for: "Flavors of INsuraNCE"

Flavors of Insurance, Part II (Life)

Flavors of Insurance, Part II (Life)

Posted on by David Merkel

Life insurance probably has the most complex accounting of any of the sub-industries. Part of this comes from the complexity of the contingencies underwritten, and most of the rest from producer compensation and the length of the contracts underwritten.

Life insurance and annuities are sold, not bought. In general, people have a mental bias toward thinking that they aren’t going to die in the immediate future. Annuities are often sold to people who won’t otherwise plan for their retirement. To overcome those biases, life insurance companies pay agents handsomely to originate policies. The commission is large enough that if the company expensed it, it would lose money on a GAAP basis every time it issued a policy. That’s why policy acquisition costs are deferred, set up as an asset, and amortized in proportion to the gross profitability of the business over the life of the business.

Reserving for term policies isn’t very complex, but reserves for cash value policies are set as the expected present value of future benefits less future premiums. Small changes in interest, mortality, and lapse rates can make large changes to reserve values. Other contingencies can affect different classes of policies as well; variable and indexed contracts rely on returns of the stock and bond markets. Higher assets under management mean higher fees.

There is a second business that most life insurance companies engage in. Since the companies would not be profitable if they invested in Treasury securities, they typically invest in corporate bonds, mortgage-backed securities, and other risky forms of debt. Some also invest in commercial mortgages and real estate. When there is stress in the credit and mortgage markets, life insurance companies do poorly.

In reviewing the performance of life companies as group from March 1994 through March 2004, one can see the effect of the major drivers of profitability. Underwriting was typically profitable for companies throughout the entire decade, so that was not a differentiating factor. Most of the shifts in profitability came from investment results. The credit cycle was generally positive to the beginning of 1999, negative 1999-2002, and positive after that. The equity market supported variable life and annuity writers until the bull market peak in March 2000, punished them until March 2003, and has rewarded them since then. The only period that deviated from this description was after the bubble popped in March 2000; life companies temporarily did better as equity investors fled technology stocks for the safety of stodgy sectors like life insurance.

The outlook for life insurance is no different than the past; it is tied to the outlook for the asset markets. If the credit and equity markets do well, so will life companies.

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Bringing it to the Present

Many of the things that I wrote back in 2004 regarding life insurers have proved prescient.? Life insurers have prospered as the asset markets have prospered, and suffered during the bear markets. On average, life insurers have done better than other financials, and better than the market as a whole since 2004.

One advantage the life insurers had 1999-2003 was that they got burned on CDOs and did not get caught in the bubble.? Even with other types of structured lending, life? insurers got more conservative 2003-2005, unlike most of the rest of the financial sector.? Life insurers noticed the poor underwriting, and stayed away.

It should be noted that there are life insurers that do a lot of variable business, and those that don’t.? Those that write a lot of variable life and annuities will be more sensitive to the stock market than those that don’t write a lot of variable business.

One final squishy spot: secondary guarantees.? With Universal Life and Variable Annuities, there are secondary guarantees where the reserving is questionable.? Also true of long-dated term policies… be aware that there might be some bombs lurking there, that will manifest in severe economic scenarios.

At present, I don’t own any pure life insurers.

Flavors of Insurance, Part I

Flavors of Insurance, Part I

Posted on by David Merkel

I view the insurance industry as a loosely related group of sub-industries, where knowing something about one sub-industry tells little about any other sub-industry. Even within each sub-industry, companies can be very different from each other. This article will attempt to go through the vast wasteland that is the insurance industry, and attempt to point out some of the more interesting aspects of it.

There are three major risk factors with insurers: the underwriting cycle, investment returns, and expense control.

The Underwriting Cycle

The property/casualty insurance industry, like all mature industries, is a cyclical business. Cyclical businesses revolve around pricing, which involves the relative degree of capacity available in the industry.

The P/C industry derives its capacity to write business from the amount of surplus available to support business. This creates a four-phase cycle for the industry.

1.????? When surplus is abundant, rate-cutting is prevalent, and generally poorer-quality business gets written in an effort to retain market share. Terms and conditions for insurance are loose. During this period, the prices of P/C companies fall relatively hard, as prospective estimates of profitability fall.

2.????? After enough poor quality business gets written, and premium rates decrease meaningfully, high quality companies exit lines of business, or buy reinsurance, and low quality companies begin to look impaired. At these times, the stock prices of high quality firms fall a little, and low quality firms fall more.

3.????? As the results of bad business become evident, reserves get raised, sometimes drastically, and surplus declines. When surplus is deficient, premium rates rise, and the stocks of companies that have survived the cycle rise dramatically. The best business from both a profit and risk control standpoint, gets written in this phase of the cycle Terms and conditions for insurance are tight.

4.????? When surplus becomes adequate, premium growth rate slows, and stock prices rise slowly, at roughly the rate of retained earnings. This continues until surplus is abundant.

Catastrophes, when they happen, temporarily reduce surplus, and improve pricing. The companies least affected by the cat rally, and those most affected, tend to fall, or rise little. Major catastrophes can cause the cycle to bottom, or extend the positive side of the cycle, because surplus is diminished.

The rating agencies tend to cut ratings near phase 2, and raise them near phase 4. Diminished ratings decrease the amount of business that an insurer can write, and further limit the willingness of prospective purchasers of insurance, particularly long-tailed coverages, who want to be sure that the company that they buy insurance from will be around to pay claims.

Investment Returns

Strong investment returns increase surplus. In a bull market, some companies become more aggressive about writing business so that they can earn money from investments. This is particularly true of companies that sell coverages that result in long-tailed liabilities. Strong investment returns prolong phases 1 and 4 of the cycle. Investment returns were so strong throughout the 1990s that insurers often compromised underwriting standards, leading to much of the troubles that occurred in the industry from late 2000 to early 2003. Not only were investment returns low or negative, but the results of prior poor underwriting were realized through reserve adjustments that diminished surplus.

Expense Control

Every time a premium gets calculated, there is an estimate embedded in the premium for expense. Expenses typically take three forms: policy acquisition, claims adjustment, and operational. There is a tendency for expenses to drift higher when investment returns are strong, and when the market is softening due to greater competition.

Now I will discuss each sub-industry separately. Included in each discussion is a description of products, risks, and industry performance over the last ten years. The graphs show the performance of each sub-industry over the last ten years, derived from my own proprietary indexes. At the end, I give my outlook for each sub-industry.

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Bringing it to the Present

This series was written seven years ago in an all-nighter for my new boss.? The piece never saw the light of day, which annoyed me, though I liked my boss, and I never complained about it.

As I publish the ten-or-so pieces of it, because it was long, at the end of each installment, I will try to update the insurance subindustries to the present.? But it would be useful for anyone reading this to look at my presentation to the Southeastern Actuaries Conference on the Amazing Decade for Insurance Stocks.? Aside from that, I have lost the graphs of the original presentation.? My apologies.

Insurance is an amazing business.? Insurers make promises.? Many of the promises are uncertain with respect to amount and/or timing.? That makes the accounting complex.? This is one of the reasons why examining the qualitative aspects of an insurance company to understand how a management team makes decisions is so valuable.

Anyway, more to come here, and I hope you all enjoy this series.

On Understanding and Valuing Financial Companies

On Understanding and Valuing Financial Companies

Posted on by David Merkel

I have readers all over the world.? Here is an example:

Hi Dave

I am a 25 year old from Pretoria, South Africa. I have been reading your blog for around 2 years and I thoroughly enjoy it (especially the book reviews). I might not agree with a few things you say, but it is rare that I don’t learn something while reading your work. I love how your personality shines through in your writing…a personality based on God.

I have had this fascination with finance and investing since I ran into a popular finance magazine here in South Africa around 2008 while stile in university. Since then I have been reading everything I could on business, investing and finance. I am also about to start training with a large wealth management firm in south africa to be 1 of their financial advisors. Training I am wholeheartedly looking forward to.

In all my reading, there is something I still struggle to wrap my head around, and that’s how to value Financial companies. You are undoubtedly the most informed person on financial company investing nd financials that I read. Hence my email: I was wondering if you could suggest a few readings for me to tuck into (preferably books) as I have found most of the things I have read only scratch the surface. Reading with maths that is not too elaborate.

I hope I am not asking too much.? Thank you in advance for any suggestions you might have, and I hope you keep up the good work on your blog.

Financial companies are difficult for several reasons:

1) The cash flow statement has almost no meaning.

2) It is very hard to know how much capital is needed to keep things going.? That data gets disclosed to the regulators, and not directly to stockholders.

3) It is difficult to know the riskiness of the assets that a financial company holds.

4) With complex financials, it is difficult to tell what the “run on the bank” risk is.

I will be reviewing a book on banks this month, but I have run into few books in my life analyzing financials.? It is a real hole in the investment literature.

Financial companies are valued off of their net worth, and their expected path of earnings.? Earnings retained, rather than paid out in dividends, or used to buy back stock, adds to net worth, and is new capital that can be used for growth.

The capital of financial companies can be divided in two: that which is required by the regulators for solvency purposes, and that which is free for deployment into new business.? With banks, look at the call reports to analyze the capital needs of subsidiaries.? With insurers, get the statutory reports.

To the extent you can, analyze the quality of assets owned.? Also analyze when liabilities may require cash, particularly if assets are financed by repurchase agreements.

Now over the last seven years, I have written a lot on financials, particularly insurers.? Here are the articles at my blog that would deserve attention:

A Summary of my Writings on Analyzing Insurance Stocks

A compendium of the best articles written prior to mid-2010.

Then there was the Flavors of Insurance Series.? In 12 parts, it went through the entire insurance space, explaining what make each area different.

Thinking about the Insurance Industry

Describes the changes that have happened since the financial crisis.? Bad financial models have been destroyed.

On Life Insurance and Life Reinsurance

Explains how life insurance is saturated but reinsurance is not.

On Complexity in Financials, and Insurers Specifically

Explains why complex financials are usually a bad investment.

Investing In P&C Insurers

Once you understand the model, many are simple companies, and easy to invest in.

Evaluating Regulated Financials

An attempt to explain to college students why financials are different from other companies.

On Insurance Investing

This seven-part series explained a wide number of factors in analyzing insurance stock investing.

Penny Wise, Pound Foolish

On some of the pathologies inside badly-run insurance firms.

Two Insurance Questions

On reserving and valuation questions.

On the Designation of Systemically Important Financial Institutions

Why Insurers, no matter how large, should not be considered a threat to systemic risk.? (Please ignore AIG — no other insurer was a major party in derivatives.)? Also see: On Risk-Based Liquidity, and Financial Regulation

On Captive Insurers

Explains some of the nuances of statutory reserving/capital, and why some insurers want to fuddle it.

Classic: Financials are Different

A piece from 2006 at RealMoney, describing how financials are different from industrial stocks.

That should give you a start.? There aren’t many books dealing with the intricacies of financial companies, and of what few there are they are written by the big four auditors, or the rating agencies, for their own purposes.? I don’t own any of them.

But what I have written, from that you can benefit.

Six Years at the Aleph Blog!

Six Years at the Aleph Blog!

Posted on by David Merkel

Thanks to all of my readers, whether you read me via RSS, e-mail, twitter, or natively at the website.? But I have a favor to ask… if you read me elsewhere, drop by the site every now and then, because not all of my commentary gets republished by those that reprint my work.? Also, not that we get a ton of comments at Aleph Blog, but I appreciate the quality of almost all of the comments we get here, even if I may disagree with some of them.? If you read me elsewhere and want to comment, come to Aleph Blog and do so, or, just e-mail me.

Now for a few housekeeping items.? 1) People sometimes ask me for books to help explain insurance stocks, and in the past I have pointed to my own writings, especially this one.? My flavors of insurance series helps also.? I’ve also pointed to works from the Society of Actuaries, Casualty Actuarial Society, LOMA, CPCU, and others.? But now, I think this piece could be useful to some readers.? It’s relatively comprehensive, and not that long.? It’s not the way I do it, but it is well thought out.? It suffers from the same problem as one using the models of Aswath Damodaran; it’s too detailed.? I can’t think of anyone that uses such a model — it is overkill.? But maybe readers could what I would do with such a model: boil it down into something simpler.

That is what I am trying to do with my current series on analyzing insurance stocks.? There are three or so more parts left to write, and I should get them out in coming months.

2) Some people ask me how they can read the articles in my Major Article List, and I wish I could read them too.? Trouble is, TheStreet.com has lost them.? They are there, maybe, somewhere in their computer systems, but since they changed the way that they named files, the links to most pre-2008 posts has been lost.

Now, if any of you think you have a way to find those posts, let me know.? There are pieces on that list that are gold, silver, and bronze.? I would at least like to get the gold ones back.

3) Sometime soon, I will create a small website for my business.? It will explain what I do for a living for those that might want me to manage money for them.? I will not link to it here; I try to keep a separation between the blog and my business.

4) I write about a lot of topics, and I tend to go in streaks on given topics.? It’s not what I intended when I started this, but I can understand why I have readers follow me and leave me.? My blog is consistent over a long period, but over intermediate periods it concentrates on one area, then another.

5) I’m not out of things to write about.? Here’s what I am planning for the future:

  • Completion of my work on a new asset pricing model
  • Completion of my “On Insurance Investing” series
  • More posts on the idiocy of US & Global macroeconomic policy
  • Buffett’s Shareholder Letter and Annual Report.? (Note: the letter gets more press, but the Annual Report has more substance.)
  • Commentary on new ideas from the CFA Institute… some good, some bad…
  • More commentary on investments that rip people off.
  • And more, I have a long list of ideas to write about, and many book reviews to publish

6) I would have never expected? it, but February 2013 was my highest readership level at the blog directly, despite the short month.? Thanks to all who read what I wrote.? I try to write good stuff; I do not aim to be controversial, though I know that some of my views are controversial.

7) When I started this six years ago, I would have never dreamed how much I would end up writing.? I thought I wrote a lot for RealMoney.? If anything, I have written four times as much per unit time, which means that as prolific as I was at RealMoney, I have written 4-10x as much here.? And it all started with an extended conversation with readers on Jim Cramer’s “blog,” which led me to do what I had resisted for two years — start my own blog.

As I have developed this blog, I now earn more than I did writing for RealMoney.? That’s not much, but every little bit helps.

8 ) You can’t believe how many people write me asking to do a guest post at my blog.? It happens about 15 times per month.? Then there are the scummy advertisers, who don’t want their advertisements to be labeled as such.? I have a strict policy that all advertising should be identified as such.? Why?? Because I never want to scam my readers.? When you come here, I want you to be comfortable that I am saying what I say for reasons of truth, not profit.? Profit is incidental here.? Truth is paramount.? I know how I could make this place more profitable, and I reject it because I would compromise my message.

9) I began with thanks to readers; I end there as well.? Truth, I treasure all of the emails giving me praise, but my internal response is “Wow, you’ve all been so great to me over the years.? It really gets to me, you know.? I hope I always make you proud.? That’s all.”? (What the Flash said to the citizens of Center City… yeah I know, a little dumb, but you had to see it.? Start it at 8 minutes.)

My main focus is on ethics in investing, and secondarily explaining how things work.? I hate seeing people ripped off by investment firms, or their dishonest governments.

I have no idea how long I will continue this blog, but I would love to do it as long as I live.

Sincerely your friend,

David

Post 2000

Post 2000

Posted on by David Merkel

This has been a lot of fun.? This has been a lot of work.? This has been a “labor of love.”

When I wrote for RealMoney, I would sometimes say to my editor Gretchen, “Here’s another labor of love piece,” to which she would give a hearty response, because she liked editing me.? She told me she always learned a lot from me.? I liked working with her a lot.

Unlike some writers at RealMoney, I would sometimes troll through the comments on Cramer’s blog.? Sometimes I would defend him, at minimum I would try to explain him.

At the time, there were some financial blogs that I liked a lot — Jeff Miller, Barry Ritholtz, Roger Nusbaum, Steven Randy Waldman, Eddy Elfenbein, Alea… I know there are more, but I can’t remember now.? I resisted starting a blog for 1-2 years, because I felt RealMoney was my blog.? I especially liked participating in the Columnist’s Conversation.? (Note: if RealMoney would like to invite me back, I am open to the idea.? That said, the CFA Institute has encouraged me to blog for them as well — just don’t know how much content I can produce, because everyone wants original content.)

But I realized that RealMoney and I had different goals, and in talking with some of those that commented at Cramer’s blog, I decided to launch Aleph Blog.? Why call it Aleph Blog?? Many reasons, as noted in the link, but part of the fun was getting to read Borges, who I had not previously read.

When I launched Aleph Blog, I had no idea what I was getting into, and I did not intend on leaving RealMoney.? I liked the editorial freedom, though, and liked the broader interaction with many voices across the internet, rather than only RealMoney columnists, good as they were.? I did research when I started, and so I created my own domain, signed up with Seeking Alpha, and launched just prior to the mini-crisis where the Chinese stock market crashed in Shanghai.? When that happened, I wrote a popular piece that Seeking Alpha picked up that my friend Cody Willard promoted as well.

And off we went!? A grand experiment, allowing me to spread my wings more wide than at RealMoney.? My goal was to do a brain dump of areas where I thought I had competence.? I didn’t want to be like many bloggers where over 50% of their post is quoting others — I wanted to write from my heart, expressing my views on a wide number of topics relating to economics, finance and investment, from my unusual framework, which is Evangelical Christian, mostly libertarian (but not for financials), actuarial, value investor, doubting neoclassical economics and modern portfolio theory.

I was recently at a Baltimore CFA Society meeting, when a few people came up to me telling me how much they liked my blog.? Some quoted to me recent pieces I had written.? This was new; I was surprised.? I have never had local people come to me and say that.? Yes, stats for Maryland on my blog are above average, but my work helping the local CFA Society always seemed to be detached from other things that I do.? My worlds are merging, maybe.

My worlds are also merging from the many evangelical Christians who write to me.? This is a blog written by a Christian, not a Christian blog.? I’m here to serve everyone, but my views on ethics will color all that I write.

At the beginning, I tried focused linkfests, where I drew together posts on a hot topic, and narrated them to give my thoughts.? Those were a lot of work.? Today, my linkfests occur through Twitter.

Twitter: it took me even more pain to decide to do Twitter.? Given that my blogging is more long-form than most — why should I do Twitter?!? My answer for today is simple: to have good conversations, and push good content to readers.? And, for those who don’t do Twitter, they can read my weekly sorted tweets.? I got the idea from History Squared, a newer blog that I like.? Sorting the tweets makes them more useful to readers, so if it takes half an hour to do so each week, it is worth it.

But now I have more followers on Twitter than on RSS.? 6000 vs 5300.? I prefer RSS because people see the whole post, but I understand how the lower bandwidth on Twitter allows people to choose what attracts them.? Twitter makes us all epigram writers in AOL-ese.? It is challenging to do, but I like a good challenge.

I’ve written a number of series that have been significant:

I’m sure there are more, but I can’t think of them now.? At the same Baltimore CFA Society meeting as mentioned before, one person asked me, “How do you write about the wide variety of topics that you do?”

Part of it is my varied career, and educational background.? I have worked in a large number of areas, and have not been afraid to branch out and try things slightly outside my grasp.? You only learn when you fail.? I’ve learned a lot. I’ve failed a lot.

If you don’t take reasonable chances, you won’t grow.? Look for opportunities to expand your abilities — who can tell where you will go?!? Opportunities go to those who are there, grab hold of them, and win.? If you don’t try, you won’t win.

I know that my blog is an acquired taste, and best for professionals and advanced amateurs.? If you are a beginner, best you should focus on my personal finance category.

My goal has been to give something back to my readers.? I’ve had an interesting career, with many unusual and entertaining experiences.? I don’t have to have more fame or clients.? I enjoy relating the truths of the markets to others, whether they are beautiful or ugly.

To my readers: I don’t know if I will last another thousand posts, but I appreciate that you read me, eclectic as I am.? The one thing I promise: I will do my best for you, poor as that may be.

Your Servant,

David

PS — I know that my views on Fed policy and economics will win me few friends, but someone has to point out that the paradigm is broken.? Same for Modern Portfolio Theory….

 

The Best of the Aleph Blog, Part 16

The Best of the Aleph Blog, Part 16

Posted on by David Merkel

I try to do “The Best of the? Aleph Blog” pieces between 1-2 years after original publication.? Why?? It gives time for reflection, time for series to complete, time for me to be proven wrong/right, etc.? I would have preferred that readers do this job for me, so that I could be neutral, but I realized that I am the one that has the most concentrated interest in doing this, so that is why I do this.? The main benefit for me in doing this is when I submit free content to “Wall Street All Stars,” I know what I think is good stuff, and I utter a few words to explain how my wisdom has proven right, or fell on its face.

This episode covers the era of November 2010 through January 2011.

On Investment Modeling, Part 1

On Investment Modeling, Part 2

On Investment Modeling, Part 3

On Investment Modeling, Part 4

Investment modeling is tough, you omit some bits of reality, and deny other bits of reality.? In this four-part series, I try to explain how difficult good modeling is, and how to make it better.

Flavors of Insurance, Part I

Flavors of Insurance, Part II (Life)

Flavors of Insurance, Part III (Personal Lines)

Flavors of Insurance, Part IV (Commercial)

Flavors of Insurance, Part V (Reinsurance)

Flavors of Insurance, Part VI (Brokers)

Flavors of Insurance, Part VII (Health)

Flavors of Insurance, Part VIII (Financial)

Flavors of Insurance, Part IX (Title)

Flavors of Insurance, Part X (Conglomerates)

Flavors of Insurance, Part XI (Banks and the Insurance Business)

Flavors of Insurance, Part XII (Summary ? The End)

This was a unique series where I tried to bring my expertise to bear on a complex industry.? I wrote the original piece in 2003, and it never got published.? I used OCR to scan it and one of my brighter children to edit it, so you have my original text, plus my commentary in 2010, pointing out where I was right and wrong.

Time to Grow Up

I am an advocate for a brainy libertarianism that reflects the intelligence embedded in the Bible, coming form the Creator Himself.? I do not back what the t-party has to say, whose positions reflect personal selfishness.

Nonidentical Twins: Solvency and Liquidity (III)

Now, when a government is overleveraged, but interest rates are low, the situation is potentially unstable.? A rise in rates could tip the scales.? Market actors would conclude that they can?t survive at rates high than a certain threshold, so sell the debt now, in case rates would get so high.? That action forces rates higher, leading to a self-reinforcing panic.

Sometimes this happens in advance of a debt refinancing, leading some politicians and bureaucrats to say the forever bogus phrase, ?This is not a solvency crisis, this is a liquidity crisis.?? Sorry, if you play near the cliff, don?t complain if you happen to fall off.

Liquidity crises do not happen to governments with low debt levels.? Liquidity crises are solvency crises during the panic phase, before they are revealed to be solvency crises alone.

The Value of Fair Accounting

Why fair value accounting has value to investors.? This should be a “duh” moment, because everyone should understand this.

2010 Financial Report of the US Government

My annual post on the topic, describing the deterioration of the situation.

A Portrait of Maryland?s Public Companies

I explain why Maryland, my adopted homestate, has the mix of publicly traded companies that it does.

Why We Don?t Need the Fed

We would do better with a commodity standard, and even a gold standard.? The Fed hoodwinks us with its pretended efforts to maintain value.? I genuinely mean that we could do better without the Fed.? Put James Grant and Steven Hanke in charge of our monetary policy, and we will do well

On Human Fertility

A controversial topic, but fertility rates are falling more rapidly than the demographers expect. Why? It is politically correct to say that the planet is running out of resources, a bogus idea, but often stated.? As it is, because of changes in the way that women and men view their roles, fewer children will be born.

And as for a guy who has sired three children, and adopted five (far more difficult), I would simply say that we are better off with more children in homes that care about the results of how children turn out.

Five Years at the Aleph Blog!

Five Years at the Aleph Blog!

Posted on by David Merkel

When Jim Cramer asked me to write for RealMoney, it was a dream come true, and I didn’t ask for it.? After year of writing him on bond issues, he told me I wrote better than most he knew.? Trouble was, in 2003, I had a new job at a hedge fund, and was doing well at it.? It took some doing, but eventually my boss (a good guy, generally) agreed that I could do it, and my public writing on investing began.

Writing for RealMoney, I always felt a little odd.? As I do at Aleph Blog, it is my goal to help you think better, not shovel “buy this now” ideas at you.? I wrote more comments relative to articles than any other writer; I was told that I was RealMoney’s most profitable writer, because people re-read my articles & comments.? Oddly, I had less feedback from Cramer than when I was an e-mailer.? That said, if I ever e-mailed him, which I did rarely 1-2 times/year, he would always give me a short gracious response.? Long before I actually did so, he encouraged me to start my own asset management shop, when I asked his advice in the matter.

Roughly one year before I left RealMoney (which I did unceremoniously, never said goodbye), I started Aleph Blog.? I did it for greater freedom of expression.? I also never read RealMoney anymore, and as such, did not feel the compulsion to contribute to a publication that I had loved.

I wanted to write more article-length pieces about issues that were deeper to investing, and not simple buy/sell this asset pieces.? So, beginning with the Shanghai Market crisis in February 2007, we were off and running.? Most of my initial pieces were shorter; I would write two per evening, six days a week.? That morphed into one longer piece once an evening.

It was my goal to try to take my generalist experiences and turn them into something valuable for the general public.? I did not want to be an “all crisis, all the time” blog.? When the crisis was hot, or promising to be so, I would write.? And though I have distinct views on how economic policy should be done, that is not what defines me.? We have to act and live in the face of suboptimal policies.

There are many pieces and series that I could never have done at RealMoney that I have done at Aleph Blog.? As a sampler:

  • Education of a Corporate Bond Manager (12 parts)
  • Flavors of Insurance (12 parts)
  • The Rules (30 parts so far, and may go to 60 if I do them all)
  • A Day in the Life of John Davidson (my one attempt at fiction, 8 parts)
  • Most of my articles dealing with flaws in institutional investment strategies, accounting rules, etc.
  • My occasional rants on how I thank neoclassical economics is wrong, and sometimes, very wrong.
  • Articles on accounting rules and the effect on investing.? In some circles, this is (wide eyes here) an accounting blog. (I’ve never taken an accounting course in my life.? I’ve had to create accounting statements for 12-18 years of my life corporately.? I have read through accounting standards, and theories on accounting polices repeatedly.)
  • Many of my quantitative posts they would have blinked at, and said, “Uh, who will benefit from that?”? My view is, you may not get any initial benefit from such a piece, but if you get some idea into how the markets interact, you may be better prepared when things get weird.
  • All of the book reviews. That was not an early goal of the blog, but has become 10% of what I do.
  • The interactions I have had with agencies of the US Government.
  • The (7 part) first blogger summit at the US Treasury.? It was a pleasure to meet Steven Randy Waldman, Yves Smith, Kid Dynamite, Accrued Interest, John Jansen, Michael Panzner, and Tyler Cowen.

That said, RealMoney gave me more room to run than most columnists.? They rarely turned down my ideas, but they did want me to become more “practical,” and crank out more investment ideas.? The hard thing for me was/is, I have no lack of investment ideas/opinions, but the response I get to giving them is far less civil than sharing ideas on how to think about investing.? To that end, I appreciate Tom Brakke, who does that in a very structured way.? We had tea together last June or so, and I started to write about it but could never get it out.

In late summer of last year, Josh Brown came through the area, and we had lunch together.? Great guy; a ton of fun and ideas.? A man like him in some ways is my pal Cody Willard, who is a fountain of ideas and connections.? Add in James Altucher, who is prolific, and has been willing to give me time on two occasions.

Last fall I had a late dinner with Miguel Barbosa of Simoleon Sense.? Very bright guy; great conversation.? During the same trip to Chicago, got to talk with Eric Falkenstein for a few hours.? Wish I could have met up with Tadas Viskanta then; maybe another time.

Yet that reminds me of those I interact with.? Though I have never physically met them, I appreciate Barry Ritholtz, Jeff Miller, Felix Salmon, Bruce Krasting, Howard Simons, Roger Nusbaum, Gonzalo Lira, Michael Pettis, Victor Shih, Carl Walter, jck at Alea, the crew at FT Alphaville, and more.

There was the Aleph Blog lunch in late 2010, and the relationships that engendered.? I am very grateful for all of the relationships that blogging has created for me, whether close or distant.

And, with all of the virtuality of blogging, the relationships are what make it for me.? I am happy to write bits on the sites of others, and give them content.? I appreciate those that I read and comment on.

And to the many who have written me, though I may have never responded, thanks for writing me.? I get fifty+ messages per day and can’t keep up.? So, thanks to all have interacted with me, that’s what has made it valuable to me.

PS — If I forgot you, my apologies, I have so many interactions that it is difficult to keep track of them all.

 

Post 1400 — About to Launch

Post 1400 — About to Launch

Posted on by David Merkel

Every 100 posts, I take a step back, and think about where we have been.? My, I have been a busy bee.? And I have blogged more than usual over the last three months.

In the recent past, I have completed my “Flavors of Insurance” series.? I also wrote a series on investment modeling.? And I wrote a complete series on my eight portfolio rules.? I have created a book review database that I will continually update.? And in this time I have given two talks, one to the Society of Actuaries at their Annual Meeting, and one to the CFA Society of Denver, together with the Leeds School of Business at the University of Colorado.? Add to that my two award winning articles that I mentioned yesterday.? And this is in the midst of this, I have written more than ever.

Now as an aside, do you know who I am happy for?? Trader Mark.? I am glad that he has gotten enough subscriptions that he can start his mutual fund after the SEC okays it..? He seems to be a bright guy, and I wish him all the best.? He has more than $10 million of commitments.? Good for him, and I hope it grows from there.

As for me, by the end of January 2011, I have no idea how much I might be managing, it could be as small as $3 million, or over$10 million.? Many people have indicated interest, but the test is how many commit.? I won’t be disappointed if I hit the low end of the range, but I would not be surprised if I hit the top of the range, or exceed it.

What I am Doing

Because of many questions from readers, I want to give a brief description of what I am doing.? There is some confusion over what I do, because I have been a bond manager, and a lot of my investing is informed by conditions in the bond market.? I follow a lot of markets, because they are related, and knowledge of the whole sharpens understanding of particular markets.

But I invest in stocks.? Mostly stocks in the US, with a value orientation.? I rotate industries, as I have often written about.? I run a concentrated portfolio of 30-40 stocks.? I adapt to market environments.? Markets are very difficult to time, but if you are in stocks that have a margin of safety, a cheap valuation, and the industry is experiencing an increase in pricing power, it is hard not to earn good returns over time.? The rest is summarized in my eight rules.

The ideal here is to give investors a clone of my portfolio through separately managed accounts.? Each account has its own portfolio, which can then be be managed for tax purposes, unlike a mutual fund.

I am offering taxable accounts, IRAs, and other tax-deferred accounts.? I am not afraid of being called a fiduciary under ERISA standards, because I manage all money to those standards.

I am also offering market-neutral management of assets for taxable accounts, at no more cost than long only.? And, my fees are not high — 1% on assets between $100,000 (minimum size) and $1,000,000, 0.5% on assets over $1,000,000.

As it stands, next week I am going to start inviting those that have already contacted me to open an account at Interactive Brokers, and will send them a package of other materials via e-mail to complete the deal.? After that, I manage their money on a discretionary basis, mirroring my own trades.? I get the same execution levels as my clients.? We all trade together.? I will eat my own cooking, and at minimum 50% of my liquid assets will be invested in my strategies. At present, it is 80%+.

Aside from that, I have minimized the cost of trading by using Interactive Brokers.? Particularly for smaller accounts, it is the best solution.? Using Interactive Brokers means investors get cheap trades, while I pay fees to access market data.? Those costs get paid by investors through higher commissions in many other situations.? I bear those costs here, and I do not take soft dollars.

I start my investment management practice in early January.? I am really encouraged by this, and look forward to serving my clients.

What Remains

These are the few things I need to get done before I start:

  1. Compliance Strategy, Including Web Compliance Strategy, CFA Document Retention
  2. Procedures for suitability ? CFA notes on such to guide
  3. Investment Policy Statement

I have the data together for most of these, though I have a question for those that manage equity money for clients through separate accounts.? What do you do on suitability?

What I need to get done will get done next week, and I will start taking client assets in 2011.? I thought of doing this in 1996 and 2003, but did not do it because I did not have enough assets of my own to buffer me if it did not work.? Now I can do it, and last for many years.

Those who inquire of me can see my 10-year track record.? I’ve done well, but that does not mean that I will do well in the future.? But I will do my best for clients.

The Blog

There are some that worry that I will stop blogging.? That is not my plan.? If I could write at RealMoney while working for a hedge fund, I can blog under the same rules with separate accounts.

But some things will change.? I will delete my portfolio at Stockpickr.? Only clients will know my full portfolio.

I don’t have any public stock positions other than what is in my portfolio.

Aside from the market-neutral accounts, there are no derivatives.? And I will let client know whether I am market neutral or long only, or a percentage thereof, before I do it.? Right now I am long only.

I will not write as much about portfolio management, at least on a detailed basis.? I will provide more detailed information on portfolio management issues to clients.

Thanks

One thing I have strongly believed since starting my blog — my readers have alternative uses of their time.? I thank them for taking time to read me.? I am humbled by the large reception I have received over the? years, and thank those that take their precious time to read me.

Soli Deo Gloria

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