Willis beats, with stronger revenues as well.? Probably goes up tomorrow.? Brooke Corporation beats, but who can really tell, their press release reveals few details.? Personally, I believe every company that reports earnings should provide an income statement, balance sheet and statement of cash flows at minimum.? I shouldn’t have to wait for the 10Q, or go to their website for a supplementary packet.
Title
Landamerica and Fidelity National both stronger than expected.? LFG went higher yesterday; FNF goes higher tomorrow.? If housing continues to sag, I would expect earnings to flatline, despite business from foreclosure sales and default processing.
Personal Lines
Commerce Group misses, blames weather and some technical items.? Would expect it to fall tomorrow, despite the enhanced buyback.? Personally, I distrust companies that announce expanded buybacks when earnings are poor.
Life
Still no core life companies have reported. National Financial Partners preannounces a miss.? Stancorp misses; looks like the Street just got ahead of the trend.? SFG still reaffirms annual guidance, so the damage should be limited.? I like SFG management a lot so if the price falls dramatically, it should be bought.
The Bermudans
Montpelier beats.? I suspect that the sell side got too pessimistic about MRH’s business prospects given the changes in Florida law.? As Pat Thiele of PartnerRe put it on his conference call, there is more business to be done by private reinsurers in Florida than one might expect.? It will be interesting to hear what Tony Taylor says on his conference call tomorrow.? Perhaps he will grace us with another quote from the Bible? 😉
That’s all for now.? Earnings season is in full swing, and we are 25% through.
Some securities I own are illiquid. A few are very illiquid. When I wrote for theStreet.com, we had a warning that we posted for every security mentioned where the market cap was less than half a billion dollars, because what we wrote could budge the market, and sometimes it did. I remember when I wrote a post about personal lines P&C insurers, and I mentioned Safety Insurance [SAFT], which was definitely small, as one of the companies that I thought was worth owning, and we did own it at the firm that I worked for. The stock popped about 5% before settling down.
But frenzies to buy are usually tame compared with frenzies to sell. There is an urgency to preserving value that makes the seller particularly zealous in getting out rapidly.
In the last three weeks, I’ve experienced this twice with two securities that I own. In both cases I bought moreas the seller got aggressive. Let me show you what happened.
Image Credit: Aleph Blog
This is a graph of National Western Life Insurance over the last three weeks. It’s my largest holding in one of my strategies. On September 23rd, near the close, an aggressive seller, on no news, sold a large block of stock, driving down the price temporarily. I was one of those buying from him, but by no means the biggest buyer.
Image Credit: Aleph Blog
Then there is TCW Strategic Income Fund [TSI], which is the second-largest holding as bond funds go for my clients, behind PIMCO Enhanced Short Maturity Active ETF [MINT] which I use for liquidity. Yesterday, someone was aggressively selling until 2PM or so, and then they seemed to be done. They may have been selling for three days prior to that. In this case also, I was buying as they were selling, and in this case I caught the bottom tick. Again, there was no news, but when is there ever news for a bond fund?
My main point is this: be willing to be a buyer on days when there is no news, an it is not a sector effect, when a security that you know well is getting thrown out the window for no good reason. Occasionally mad bombers show up and they have to sell down to the last share. Having known some institutional traders, that last sale can be quite aggressive because they want to be DONE!
THere was a guy at theStreet.com, I think his name was Ken Wolff who often talked about “dumpers.” Stocks where a bad event happens, and everyone runs to sell, and there is a climax of volatility where the aggressive sellers have sold their last shares. You see the spike up in volume, and the spike down in the price. His idea was that it was simple to buy then, and close out the trade at the end of the day. On that front, I thought he was pretty clever.
Panic never leads to good results. Understand what you own very well, and be willing to buy when other market participants are irrational.
Kevin Dowd -?Professor of Finance and Economics, Durham University
Tyler Goodspeed -?Junior Fellow in Economics, University of Oxford
==========================
O’Driscoll — What CBs can’t do? They aren’t prescient. ?Policy discretion — results aren’t measured, and politicians blame the Fed when things go wrong, and take credit when things go right.
Politicians and Central bankers engage in “symbiotic rent-seeking.”
Fed reform would involve reducing the Fed’s scope, improving its performance and enhance?its accountability.
Fed should let assets roll off the balance sheet and even sell off securities on the long.
Eliminate Fed 13.3 powers to eliminate lender of last resort powers. ?Can’t implement a policy rule without that.
Wants to keep the regional Fed banks.
Dowd: “Money often costs too much” Ralph Waldo Emerson
John Law and money printing. ?Sir Robert Giffen: “Governments, when they meddle with money, are so apt to make blunders.”
Allowing people to use their money freely is often viewed with scepticism.
ZIRP is not stimulative. ?It is a trap.
QE/LSAP
QE — greatest Wall Street bailout of all time.
Argues that ZIRP causes productivity to drop. ?Real Private Non-residential investment has only now come back.
Can’t calibrate hedges because markets are too stable. ?In a crisis, that would shift.
QE has not worked in Japan. ?Policy is increasingly delusional.
NIRP [negative rates] — doesn’t make sense. ?If it makes your brain hurt you are sane.
Must abolish cash to do NIRP. ?The most vulnerable people depend on cash. ?Loss of cash is a loss of civil liberty. ?Bad guys use every amenity, including?cash.
Helicopter money is a form of redistribution, which should belong to Congress. ?End of sound money. Hyperinflation.
The most costly money is the money that is free.
Goodspeed: We all ought to read more financial history: Those sympathetic to the elimination of large institutions today will learn. ?Aids imagination. ?Gives you kind of a “control group” to work with.
Prior to 1863, the US states had a wide number of approaches. ?There was public, mutual, and no insurance for deposits. ?He looks at contiguous counties in different states with different insurance regimes.
They had no effect on bank failure initially. ?Over the long run, though, the more double liability resulted in less defaults. Public insurance — ?More exposure to real estate and interbank lending, and other types of opaque lending. ?Double liability took less risk prior to crises, but took more risk after crises, adding to system stability.
Seems to be that growth was the same across the counties with public vs double liability.
Scottish banks with unlimited liability. ?During a balance of payments crisis — uses an extension option against British speculators.
Upshot: Socializing losses does not work well in the long-term.
Q&A
1) Benefit of QE?
Banking system bailout, nothing else
2) Ed Teryakin — what should Congress do to change the mandate of the central bank to get a better outcome?
O’Driscoll — long weak recovery; U-3 unemployment low?because of people who have left the labor force
3) Walker Todd — lend in a panic only on collateral of recognizable value for lender of last resort powers?
O’Driscoll: Texas S&L crisis — collateral rules get fuddled.
4) Real purpose of stress tests?
To calm the public. ?The tests are bad, particularly in Europe.
5) John Flanders, Central Methodist University — Canadian experience many fewer defaults. ?Weren’t US banks over-regulated?
Unit banks less stable. ?Law of small numbers in Canada. ?But are fewer bank failures a good thing?
6) How did we end up with a central bank? ?George and Martha Washington owned shares in the Bank of England.
Goodspeed: US banking has always had more failures. MD & VA tobacco planters defaulting on Scottish banks in 1772.
Dueling notions on the need for central banks with the Founding Fathers. ?George Selgin tossed in a comment.
7) CPA — aren’t buybacks a waste of funds. ?Bernanke said there would be a wealth effect, and then spending will rise. ?Spending did not rise. ?Wealth effect is not big.
8 ) Isn’t it a bad thing that there were no Canadian bank failures — not enough risk taking? ?Morphed into a question on risk-based capital:
O’Driscoll: RBC is a disaster.
Goodspeed: Canada was not starved of capital. ?Banks regulations can lead to their own set of problems. (DM: RBC creates its own weaknesses, but the one covering insurance in the US is pretty good.)
Before I start tonight, I just wanted to mention that I was on South Korean radio a few days ago, on the main English-speaking station, talking about Helicopter Money. ?If you want listen to it or download it as a podcast, you can get it here. ?It’s a little less than 11 minutes long.
The bravery of Steve Kandarian and the executives at MetLife is a testimony to something I have grown to believe. ?Frequently the government acts without a significant legal basis, and bullies companies into compliance. ?If a company is willing to spend the resources, often the government will lose, when the laws are unduly vague or even wrongheaded.
This was true also in a number of the allegations made by Eliot Spitzer. ?Lots of parties gave in because the press was negative, but those that fought him generally won. ?Another tough-minded man, Maurice Raymond “Hank” Greenberg pushed back and won. ?So did some?others that were unfairly charged.
The FSOC’s case largely relies on the false idea that being big is enough to be a systemic risk.
Systemic risk is a mix of liquidity of liabilities, illiquidity of assets, credit risk, leverage, contagion, and lack of diversity of profit sources.
Liquidity of liabilities is the most important factor — in order to get a “run on the bank” there has to be a call on cash. ?Life insurers have long liability structures, and it is very difficult for there to be a run. ?People would have to forfeit a lot of value to run.
Contrast that with banks that use repo markets, and have short liability structures (w/deposit insurance, which is a help). ?Add in margining at the investment banks…
The only life insurers that suffered “runs” in the last 30 years wrote lots of short-term GICs. ?No one does that anymore.
Life insurers invest a lot of their money in relatively liquid corporates, and lesser amounts in illiquid mortgages. ?Banks are the reverse.
Leverage at life insurers is typically lower than that of banks.
Insurers make money off of non-financial factors like mortality & morbidity. ?Banks run a monoculture of purely financial risk. ?(Okay, increasingly many of them make money off of “free” checking, and then kill their sloppy depositors who overdraw their accounts… as I said to one of my kids, “Hey, your best friend “XXX bank” sent you a love note thanking you for the generous gift you gave them.”)
That makes contagion risk larger for banks than life insurers — banks often have more investments across the financial sector than insurers do.
Life insurers tend to be simpler institutions than banks. ?There is less too-clever-for-your-own-good risk.
State regulators are less co-opted than Federal regulators. ?They also employ actuaries to analyze actuaries. ?(At least the better and larger states do.)
Finally, life insurers do more strenuous tests of solvency and risk. ?They test solvency for decades, not years. ?They have actuaries who are bound by an ethics code — the quants at the banks have no such codes, and no responsibility to the regulators. ?The actuaries with regulatory responsibility serve two masters, and though I had my doubts when the appointed actuary statutes came into being, it has worked well. ?The problems of the early ’90s did not recur. ?The insurance industry generally eschewed non-senior RMBS, CMBS and ABS?in the mid-2000s, while the banks loved the yieldy illiquid beasties, and lost as a result.
Anyway, that’s my summary case. ?I haven’t always been a fan of the industry that I was raised in, but the life insurers learned from their past errors, and as a result, made it through the financial crisis very well, unlike the banks.
PS — there are some things I worry about at life insurers, like LTC and secondary guarantees, but I doubt the FSOC could figure out how big those are as an issue. ?A few companies are affected, and I’m not invested in them. ?Also, those risks aren’t systemic.
Full disclosure: long ENH NWLI BRK/B GTS RGA AIZ KCLI and MET
In some ways, this is a boring time in insurance investing. ?A lot of companies seem cheap on a book and/or earnings basis, but they have a lot of capital to deploy as a group, so there aren’t a lot of opportunities to underwrite or invest wisely, at least in the US.
As I have also pointed out before AIG’s reserving was liberal, and recently AIG took a $3.6 billion charge to strengthen reserves. ?Thus I am not surprised at the rating actions of Moody’s, S&P, ?and AM Best. ?Add in the aggressive plans to use $25 billion to buy back stock and pay more dividends?over the next two years, and you could see the ratings sink further, and possibly, the stock also. ?The $25 billion requires earning considerably more than what was earned over the last four years, and more than is forecast by sell-side analysts, unless AIG can find ways to release capital and excess reserves (if any) trapped in their complex holding company structure.
Improving?the Commercial P&C accident year loss ratio by 6 points
Targeted divestitures (United Guaranty, and what else gets you to $6 billion?)
Reinsurance (mostly life)
Borrowing $3-5B (maybe more after the $3.6B writedown)
Selling off some hedge fund assets to reduce capital use. (smart, hedge funds earn less than advertised, and the capital charges are high.)
Okay, this could work, but when you are done, you will have reduced the earnings capacity of the remaining company. ?Reinsurance that provides additional surplus strips future earnings out the the company, and leaves the subsidiaries inflexible. ?Trust me, I’ve worked at too many companies that did it. ?It’s a lousy way to manage a life company.
Expense reduction can always be done, but business quality can suffer. ?Improving the Commercial lines loss ratio will mean writing less business in an already overcompetitive market — can’t see how that will help much.
I don’t think the numbers add up to $25 billion, particularly not in a competitive market like we have right now. ?This is part of what I meant when I said:
…it would pay Carl Icahn and all of the others who would be interested in breaking up AIG to hire some insurance expertise. ?Insurance is a set of complex businesses, and few understand most of them, much less all of them. ?It would be easy to naively overestimate the ability to improve profitability at AIG if you don?t know the business,? the accounting, and how free cash flow emerges, if it ever does.
They might also want to have a frank talk with Standard and Poors as to how they would structure a breakup if the operating subsidiaries were to maintain all of their current ratings. ?Icahn and his friends might be surprised at how little value could initially be released, if any.
Thus I don’t see a lot of value at AIG right now. ?I see better opportunities in MetLife.
MetLife is spinning off their domestic individual life lines, which is the core business. ?I would estimate that it is worth around 15% of the whole company. ?In the process, they will be spinning off most of their ugliest liabilities as far as life insurance goes — the various living benefits and secondary guarantees that are impossible to value in a scientific way.
The main company remaining will retain some of the most stable life liabilities, the P&C operation, and the Group Insurance, Corporate Benefit Funding, and the International operations.
I look at it this way: the company they are spinning off will retain the most capital intensive businesses, with the greatest degree of reserving uncertainty. ?The main company will be relatively clean, with free cash flow being a high percentage of earnings.
I will be interested in the main company post-spin. ?At some point, I will buy some MetLife so that I can own some of that company. ?The only tough question in my mind is what the spinoff company will trade at.? Most people don’t get insurance accounting, so they will look at the earnings and think it looks cheap, but a lot of capital and cash flow will be trapped in the insurance subsidiaries.
There is no stated date for the spinoff, but if the plan is to spin of the company, a registration statement might be filed with the SEC in six months, so, you have plenty of time to think about this.
Get MET, it pays.
One Final Note
I sometimes get asked what insurance companies I own shares in. ?Here’s the current list:
Long RGA, AIZ, NWLI (note: illiquid), ENH, BRK/B, GTS, and KCLI (note: very illiquid)
Here is a recent question that I got from a reader:
I have a question for you that I don?t think you?ve addressed in your blog. Do you ever double down on something that has dropped significantly beyond portfolio rule VII?s rebalancing requirements and you see no reason to doubt your original thesis? Or do you almost always stick to rule VII? Just curious.
Rebalance the portfolio whenever a stock gets more than 20% away from its target weight. Run a largely equal-weighted portfolio because it is genuinely difficult to tell what idea is the best. Keep about 30-40 names for diversification purposes.
This rule is meant to control arrogance and encourage patience. ?I learned this lesson the hard way when I was younger, and I would double down on investments that had fallen significantly in value. ?It was never in hope of getting the whole position back to even, but that the incremental money had better odds of succeeding than other potential uses of the money.
Well, that would be true if your thesis is right, against a market that genuinely does not understand. ?It also requires that you have the patience to hold the position through the decline.
When I was younger, I was less cautious, and so by doubling down in situations where I did not do my homework well enough, I lost a decent amount of money. ?If you want to read those stories, they are found in my Learning from the Past series.
Now, since I set up the eight rules, I have doubled down maybe 5-6 times over the last 15 years. ?In other words, I haven’t done it often. ?I?turn a single-weight stock into a double-weight stock if I know:
The position is utterly safe, it can’t go broke
The valuation is stupid cheap
I have a distinct edge in understanding the company, and after significant review I conclude that I can’t lose
Each of those 5-6 times I have made significant money, with no losers. ?You might ask, “Well, why not do that only, and all the time?” ?I would be in cash most of the time, then. ?I make decent money on the rest of my stocks as well on average.
The distinct edge usually falls into the bucket of the market sells off an entire industry, not realizing there are some stocks in the industry that aren’t subject to much of the risk in question. ?It could be as simple as refiners getting sold off when oil prices fall, even though they aren’t affected much by oil prices. ?Or, it could be knowing which insurance companies are safe in the midst of a crisis. ?Regardless, it has to be a big edge, and a big valuation gap, and safe.
The Sense of Rule Seven
Rule Seven has been the rule that has most protected the downside of my portfolio while enhancing the upside. ?The two major reasons for this is that a falling stock triggers a thorough review, and that if I do add to my position, I do so in a moderate and measured way, and not out of any emotion. ?It’s a business, it is not a gamble per se.
As a result I have had very few major losses since implementing the portfolio rules. ?I probably have one more article to add to the “Learning from the Past Series,” and the number of severe losses over the past 15 years is around a?half dozen out of 200+ stocks that I invested in.
Summary
Doubling down is too bold of a strategy, and too prone for abuse. ?It should only be done when the investor has a large edge, cheap valuation, and safety. ?Rule Seven allows for moderate?purchases under ordinary conditions, and leads to risk reductions when position reviews highlight errors. ?If errors are eliminated, Rule Seven will boost returns over time in a modest way, and reduce risk as well.
Recently I ran across an academic journal article where they posited one dozen or so risk premiums that were durable, could be taken advantage of in the markets. ?In the past, if you had done so, you could have earned incredible returns.
What were some of the risk premiums? ?I don’t have the article in front of me but I’ll toss out a few.
Many were Credit-oriented. ?Lend and make money.
Some were volatility-oriented. ?Sell options on high volatility assets and make money.
Some were currency-oriented. ?Buy government bonds where they yield more, and short those that yield less.
Some had you act like a bank. ?Borrow short, lend long.
Some were like value investors. ?Buy cheap assets and hold.
Some were akin to arbitrage. ?Take illiquidity risk or deal/credit risk.
Others were akin to momentum investing. ?Ride the fastest pony you can find.
After I glanced through the paper, I said a few things to myself:
Someone will start a hedge fund off this.
Many of these are correlated; with enough leverage behind it, the hedge fund?could leave a very large hole when it blows up.
Yes, who wouldn’t want to be a bank without regulations?
What an exercise in data-mining and overfitting. ?The data only existed for a short time, and most of these are well-recognized now, but few do all of them, and no one does them all well.
Hubris, and not sufficiently skeptical of the limits of quantitative finance.
Risk premiums aren’t free money — eggs from a chicken, a cow to be milked, etc. ?(Even those are not truly free; animals have to be fed and cared for.) ?They exist because there comes a point in each risk cycle when bad investments are revealed to not be “money good,” and even good investments are revealed to be overpriced.
Risk premiums exist to compensate good investors for bearing risk on “money good” investments through the risk cycle, and occasionally taking a loss on an investment that proves to not be “money good.”
(Note: “money good” is a bond market term for a bond that?pays all of its interest and principal. ?Usage: “Is it ‘money good?'” ?”Yes, it is ‘money good.'”)
In general, it is best to take advantage of wide risk premiums during times of panic, if you have the free cash or a strong balance sheet behind you. ?There are a few problems though:
Typically, few have free cash at that time, because people make bad investment commitments near the end of booms.
Many come late to the party, when risk premiums dwindle, because the past performance looks so good, and they would like some “free money.”
These are the same problems experienced by almost all institutional investors in one form or another. ?What bank wouldn’t want to sell off their highest risk loan book prior to the end of the credit cycle? ?What insurance company wouldn’t want to sell off its junk bonds at that time as well? ?And what lemmings will buy then, and run over the cliff?
This is just a more sophisticated form of market timing. ?Also, like many quantitative studies, I’m not sure it takes into account the market impact of trying to move into and out of the risk premiums, which could be significant, and change the nature of the markets.
One more note: I have seen a number of investment books take these approaches — the track records look phenomenal, but implementation will be more difficult than the books make it out to be. ?Just be wary, as an intelligent businessman should, ask what could go wrong, and how risk could be mitigated, if at all.
About 1 1/2 years ago, I wrote a seven-part series on investing in insurance stocks. ?It is still a good series, and worthy of your time, because there aren’t *that* many writers freely available on the topic.
This particular article deals expands on part 4 of that series, which deals with insurance reserving. ?I wanted to do this at the time, but I was short on time, and wrote out the general theory there, while not actually doing the time-consuming job of ranking the conservativeness of P&C insurers reserving practices.
Let me quote the two most important sections from part 4:
When an insurance policy is written, the insurer does not know the true cost of the liability that it has incurred; that will only be known over time.
Now the actuaries inside the firm most of the time have a better idea than outsiders as to where reserve should be set to pay future claims from existing business, but even they don?t know for sure.? Some lines of insurance do not have a strong method of calculating reserves.? This was/is true of most financial insurance, title insurance, etc., and as such, many such insurers got wiped out in the collapse of the housing bubble, because they did not realize that they were taking one big nondiversifiable risk.? The law of large numbers did not apply, because the results were highly correlated with housing prices, financial asset prices, etc.
Even with a long-tailed P&C insurance coverage, setting the reserves can be more of an art than science.? That is why I try to underwrite insurance management teams to understand whether they are conservative or not.? I would rather get a string of positive surprises than negative surprises, and you tend to one or the other.
and
What is the company?s attitude on reserving?? How often do they report significant additional claims incurred from business written more than a year ago?? Good companies establish strong reserves on current year business, which depress current year profits, but gain reserve releases from prior year strongly set reserves.
So get out the 10K, and look for ?Increase (decrease) in net losses and loss expenses incurred in respect of losses occurring in: prior years.?? That value should be consistently negative.? That is a sign that he management team does not care about maximizing current period profits but is conservative in its reserving practices.
One final note: point 2 does not work with life insurers.? They don?t have to give that disclosure.? My concern with life insurers is different at present because I don?t trust the reserving of secondary guarantees, which are promises made where the liability cannot easily be calculated, and where the regulators are behind the curve.
As such, I am leery of life insurers that write a lot of variable business, among other hard-to-value practices.? Simplicity of product design is a plus to investors.
Today’s post analyzes Property & Casualty Insurers, and looks at their history of whether they consistently reserve conservatively each year. ? Repeating from above, management teams that reserve conservatively?establish strong reserves on current year business, which depress current year profits, but gain reserve releases from prior year strongly set reserves. ?This should give greater confidence that the accounting is fair, if not conservative.
So, I went and got the figures for “Increase (decrease) in net losses and loss expenses incurred in respect of losses occurring in: prior years,” for?67 companies over the past 12 years from the EDGAR database. ?Today I share that with you.
When you look at the column “Reserving by Year,” that tells you how the reserving for business in prior years went over time. ?A company that was consistently conservative of the past twelve?years would have “12N’ written there for twelve negative adjustments to reserves. ?Using Allstate as an example, the text is “5N, 1P. 3N, 3P” which means for the last 5 years [2013-2009], Allstate had negative adjustments to prior year reserves. ?In 2008, it had to strengthen prior year reserves. ?2007-2005, negative adjustments. ?2004-3,?it had to strengthen prior year reserves.
Now, in reserving, current results are more important than results in the past. ?Thus, in order to come up with a score, I discounted each successive year by 25%. ?That is, 2013 was worth 100 points, 2012 was worth 75, 2011 was worth 56, 2010 was worth 42 points, etc. ?Since not all of the companies were around for the full 12 years, I normalized their scores by dividing by the score of a hypothetical company that was around as long as they were that had a perfect score.
Now, is this the only measure for evaluating an insurance company? ?Of course not. ?All this measures?in a rough way is the willingness of a management team to reduce income in the short-run in order to be more certain about the accounting. ?Consult my 7-part series for more ways to analyze insurance companies.
As an example, imagine an insurance company that consistently writes insurance business at an 80% combined ratio. ?[I.e. 20% of the premium emerges as profit.] ?I wouldn’t care much about minor reserve understatement. ?Trouble is, few companies are regularly that profitable, and companies that understate reserves tend to get into trouble more frequently.
Comments and Surprises
1) Now, it is possible for a company to game this measure in the short run, where the management aims to always release some reserves from prior year business whether it is warranted or not. ?That may have happened with Tower Group. ?Very aggressive in growth, after their initial periods, they consistently released reserves for eight years, before delivering huge reserve increases for two years.
Now, someone watching carefully might have noticed a reserve strengthening for their non-reciprocal business in 2011, and then strengthenings in mid-2012, before the whole world realized the trouble they were in.
2) Notice in the red zone (scores of 40% and lower) the number of companies that did subprime auto insurance — Infinity, Kingsway, and Affirmative. ?That business is very hard to underwrite. ?In the short run, it is hard to not want to be aggressive with reserves.
3) Also notice the red zone is loaded with companies with much recent strengthening of reserves. ?Many of these companies are smaller, with a few exceptions — the law of large numbers doesn’t apply so well with smaller companies, so they mis-estimate more frequently. ?I won’t put companies with less than $1 billion of market cap into the Hall of Shame. ?It’s hard to get reserving right as a smaller company.
4) As for larger companies, they can be admitted to the Hall of Shame, and here they are:
Hall of Shame
AIG
The Hartford
AmTrust Financial Services
Mercury General, and?
National General Holdings
AIG is no surprise. ?I am a little surprised at the Hartford and Mercury General. ?National General Holdings and Amtrust are controlled by the Karfunkels, who are aggressive in managing their companies. ?Maiden Holdings, another of their companies is in the yellow zone.
Final Notes
I would encourage insurance investors to stick to the green zone for their investing, and maybe the yellow zone if the company has compensating strengths. ?Stay out of the red zone.
This analysis could be improved by using prior year reserve releases as a fraction of beginning of year reserves, and then discounting by 25% each year. ?Next time I run the analysis, that is how I will update it. ?Until then!
I’m not an advocate for smart beta. ?There are several reasons for that:
I don’t pay attention to beta in the stocks that I buy; it is not stable.
The ability to choose the right brand of enhanced indexing in the short-run is difficult to easily achieve.
I’m a value investor, a bottom-up stock picker that doesn’t care much about what the index does in the short-run. ?I aim for safety, and cheapness.
But today I read an interesting piece called?Slugging It Out in the Equity Arena. ?It talks about an issue I have been writing about for a long time — the difference between what a buy-and-hold investor receives and what the average investor receives. ?The average investor chases performance, and loses 2%+ per year in total returns as a result. ?As the market relative to the index is a zero-sum game, who wins then?
The authors argue smart beta wins. They say:
To us, the smart beta moniker refers to rules-based investment strategies that use non-price-related weighting methods to construct and maintain a portfolio of stocks.1?The research literature shows that smart beta strategies earn long-term returns around 2% higher than market capitalization-weighted indices. Moreover, smart beta strategies do not require any insight into the weighting mechanism. One can build a smart beta strategy with any stock ranking methodology that is not related to prices, from a strategy as na?ve and transaction-intensive as equal weighting to a more efficient approach such as weighting on the basis of fundamental economic scale. For example, a low volatility portfolio and its inverse, a high volatility portfolio, both outperform the market by roughly 2%?as long as they are systematically rebalanced.2??It is not the weighting method but the rebalancing operation that creates most of smart beta?s excess return. Acting in a countercyclical or contrarian fashion, smart beta strategies buy stocks that have fallen in price and sell stocks that have risen.
When I read that, I said to myself, “That is a more intense version of my portfolio rule seven:
Rebalance the portfolio whenever a stock gets more than 20% away from its target weight. Run a largely equal-weighted portfolio because it is genuinely difficult to tell what idea is the best. Keep about 30-40 names for diversification purposes.
I learned this rule from three good managers — one growth, one core, one value. ?They were all fairly rigorous in their quantitative analyses, but they all agreed, a 20% filter on target weight added ~2%/year to performance on average. ?But unlike the current “smart beta” discussion, I have been using this idea for the last 15-20 years.
The mostly equal-weighting also induces a smallcap and value tilt, which is an additional aid to performance. ?Since I concentrate by industry, the 30-40 stocks?requirement does not lead to over-diversification, as a great deal of my returns comes from choosing the right industries.
In one sense, portfolio rule seven is an acknowledgement of mental limitations, and is an exercise in humility. ?So things have been great? ?They will eventually not be so. ?As prices go up, so does fundamental risk. ?Take a little off the table. ?Raise a bit of cash.
Things have been bad? ?Look at the fundamentals. ?How badly have they deteriorated? This can take three paths:
a) Fundamentals?have deteriorated badly, or I made an initial error in judgment. ?I would not own it now, even at the current price there are much better stocks to be owned. ?Sell the position.
b) Fundamentals are the same, a little better, or haven’t deteriorated much. ?Rebalance to target weight.
c) Fundamentals are better and people are just running scared from a class of companies — not only rebalance, but make it a double-weight. ?I only do this in crises, for high-quality misunderstood companies like RGA and NWLI in the last financial crisis. ?Some of that is my insurance knowledge, but I have done it with companies in other industries.
For fundamental investors, who think like businessmen, there is value in resisting trends. ?Having an orderly way to do it is wise. ?Don’t slavishly follow me, but ask whether this fits your management style. ?This fits me, and my full set of rules. ?Modify it as you need, it is not as if there is one optimal answer.
I’ll close with an excerpt from the first article that I cited, which was its summary:
KEY POINTS
1.?????Smart beta strategies are countercyclical, periodically rebalancing out of winning stocks and into losers. They may underperform for extended periods but they ultimately tend to prevail.
2.?????Investors? procyclical behavior, selling recent losers and buying recent winners, pays for the estimated 2% per year in long-term value added by smart beta strategies.
3.?????Smart beta investing can be reasonably expected to have an edge as long as investors persist in following trends and chasing performance.
Are you willing to take the long-term view, meaning more than 3 years? ?These ideas will work. ?Focus on longer-term value, and do your analytical work. ?And if you outsource your investing, be willing to allocate more to stocks during bad times. ?To avoid really ugly scenarios, wait until the 200-day moving average has broken to the upside, of look at the 13Fs of value managers.
Do that and prosper. ?Resisting trends intelligently can make money.
Q&A w/Bill White – former chief economist of the Bank for International Settlements?http://t.co/EoDdKnoD4x?Worth a read, still bearish $$?Jun 07, 2014
China City Crash-Lands to Zero Growth on Coal Bust?http://t.co/sROcEjLThJ?For Taiyaun, it is a coaled, cruel world $$ $KOL $FXI?Jun 06, 2014
Welcome to Baku, the Fiercely Modern, Millennia-Old, Capitalist-Socialist, Filthy-Rich Capital of Azerbaijan?http://t.co/SCr1Yyb1o5?LONG $$?Jun 06, 2014
Swiss Garbage Police Irk Foreigners Reeling After Vote?http://t.co/a2Nul3KysI?Picky, piddly, part of what makes Swizerland unique $$ $SZE?Jun 06, 2014
China Central Bank Calls for More-Targeted Loosening Measures?http://t.co/fwKv9QQcTa?Central banks r not good @ micromanaging an economy $$?Jun 06, 2014
China?s Rare Earth Toxic Time Bomb to Spur Mining Boom?http://t.co/XWrbnSKptk?That’s a boom outside of China, as econ policy raises costs $$?Jun 05, 2014
Obama Pledges to Bolster Europe’s Security?http://t.co/XYVI5Bi9p1?I’m not 4 entangling alliances, but really only $1B 4 E. Europe?! $$ $SPY?Jun 05, 2014
Dai-ichi to Buy Protective Life?http://t.co/rxdOapKZth?When Japanese life cos buy American life cos they overpay; this 1 is colossal $$ $PL?Jun 04, 2014
Cameron Threatened as ?People?s Army? Marches on Newark?http://t.co/GZQ4fIdnWR?UK independence Party: anit-EU, anti-immigrant, anti-Tory $$?Jun 04, 2014
Putin Pausing as Russia Volatility Kills Trade-to-Invest?http://t.co/jZhiKnR8t1?Whaddaya know? Maybe the sanctions do have some bite $$?Jun 04, 2014
China Builds Sulawesi Smelters as Ore Ban Cuts Jobs?http://t.co/yXCVATdl5l?Unemploy a lot of miners 2 create inefficient smelting jobs $$?Jun 03, 2014
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Companies & Industries
It’s Watershed v Pipeline in Latest Fracking Battle?http://t.co/D9kHxY9Xmf?High-Profile Spills Prompt Water Utilities to Fight Pipelines $$?Jun 06, 2014
Amazon Feud With Publishers to Escalate as Contracts End?http://t.co/KRe3cWvSw8?Dominance of $AMZN especially in e-books vexes publishers $$?Jun 06, 2014
Buffett?s $26B Power Bet in West Seen Paying Off?http://t.co/CZkw7nlZwB?Needed infrastructure financed by insurance premiums: brilliant $$?Jun 06, 2014
Wells Fargo Requires Principal With Home-Equity Payments?http://t.co/zeNbOeBGhg?Good practice 2 require principal amortization $$ FD: + $WFC?Jun 05, 2014
US refiners struggle with too much light crude?http://t.co/PcA1I4gymX?Light crude is more volatile; difficult to separate the light stuff $$?Jun 04, 2014
Abbott CFO: How and Why to Spin Off?http://t.co/ZLgszwAgRM?Explanation of how & why the spinoff unlocked a lot of value $ABT $ABBV $$?Jun 02, 2014
US Politics & Policy?
U.S. Workers’ Productivity Falters?http://t.co/XKmjss5R6o?First-Quarter Decline, Worst in 6 Years, Comes as Job Market Heals $$ $MACRO $SPY?Jun 06, 2014
Service Industries Propel Broad Rebound in US Growth?http://t.co/Sx8JzPi28F?Let’s see how well this persists $$ $MACRO?Jun 05, 2014
Smoke and Mirrors Hide the Collapse in Corporate Profits?http://t.co/tKzMwwAKF8?Economy-wide profits take a hit in the revision of GDP $$?Jun 05, 2014
Obama’s Next Fed Fight?http://t.co/wMrsvbkqA2?Why Michael Barr will be just as unacceptable to progressives as Larry Summers $$ $TLT $SPY?Jun 05, 2014
Now Who Wants to Change the Constitution?http://t.co/tD35tVeQTj?@CassSunstein I would prefer my anti-gerrymandering amendment $$ $TLT $SPY?Jun 05, 2014
Fed Officials Growing Wary of Market Complacency?http://t.co/tv1RsY2LLP?Go ahead, Fed: Raise Fed Funds by 0.1% & c how mkt reacts $$ #blammo?Jun 04, 2014
Growing Student Debt Focus of Senate Hearings Today?http://t.co/4rUJrpv7LY?Expensive colleges extract more $$ from students, parents, govt?Jun 04, 2014
Waiting game: Why small businesses won’t hire?http://t.co/8LZXP8YqUg?Workforces r not overloaded; if demand really picks up then hire $$?Jun 04, 2014
Market Impact
Morgan Stanley Is Said to Cut London Fixed-Income Traders?http://t.co/W29BnWm9nU?Not enough action for $MS 2 pay in an illiquid market $$?Jun 06, 2014
Hedge Funds Betting on Calm as Volatility Shorts Increase?http://t.co/vmUQXsSdbB?I get worried when I c exotic side bets grow $$ $SPY $VIX?Jun 06, 2014
Wall Street Adjusts to the New Trading Normal?http://t.co/41Lzn1AJFA?Transaction Volume in May Fell 2 Lowest Level Since Financial Crisis $$?Jun 06, 2014
Dueling Indexes: A Big Name Is # 2 in Returns?http://t.co/dltXFxHPeU?Russell 2000 trails enhanced index S&P600. $IWM $IJR Earnings/float $$?Jun 06, 2014
different this time?http://t.co/BGJ7SSKS3D?@researchpuzzler on the delusions of chasing returns late in this current bull market $$ $SPY?Jun 06, 2014
Kass: Prepare for a Minsky Moment?http://t.co/fP2m7jtyJk?@DougKass tells us 2b concerned about the low volume accompanying the new highs $$?Jun 06, 2014
Hedge-Fund Wolfpack Stalks Financials as Alpha Pangs Grow?http://t.co/B28wHitYlQ?Got utilities & other yield sensitive sectors? NO? $$ $XLU?Jun 06, 2014
The unglamorous life of hedge fund startups?http://t.co/g2rjcehsT3) @JesseSolomonCNN meets w/ @allstarcharts -> lots of work to do $$ $SPY?Jun 06, 2014
Value Funds Are Beating Growth-Stock Funds This Year?http://t.co/D1yoMyPN8U?This is true most years, nice 2feel the wind @ my back $$ $SPY?Jun 05, 2014
Fresh Records Get Stale With S&P 500 Volume at 6-Year Low?http://t.co/oeu4OnFmkK?Volume is low & few stocks are reaching new highs $$ $SPY?Jun 05, 2014
Word Power: A New Approach for Content Analysis?http://t.co/DAd7cyppAF?10K filed, language sounds cautious 2 the computer which sells $$?Jun 05, 2014
Unstoppable $100T Bond Market Renders Models Useless?http://t.co/GAU74xkHdt?Many bonds forced into being via QE, spread relationship hurt $$?Jun 04, 2014
Bond Bankers Have 144 Reasons to Fret Over Underwriting Frenzy?http://t.co/66VsCIy8ct?Top 9 banks have lower mkt share & fees then past $$?Jun 04, 2014
Fortress Tries ?Nuclear Option? for Trups CDOs?http://t.co/RkavoJkPYW?American Back hasn’t paid in 5 years; Fortress takes it to BK court $$?Jun 03, 2014
Are Stocks Expensive? The 2 Perspectives?http://t.co/uVHaq4Tlsu?On an intrinsic basis, yes. Can the market go up anyway? Yes. Safely? No $$?Jun 03, 2014
Icahn won?t be joining the Mount Rushmore of insider trading?http://t.co/HJOOM0ez3Y?This one is overblown in terms of facts & size $$ $IEP?Jun 03, 2014
What investors must know about new accounting rules?http://t.co/Mx6FONELtv?It still doesn’t eliminate uncertainty from earnings accruals $$?Jun 03, 2014
Investors Rewarded for Trek Into Little Known Markets?http://t.co/VW6N768dUz?I wouldn’t put much trust in the low vol argument; looks odd $$?Jun 02, 2014
Other
With His Eye on the World Cup, Soccer Coach Jurgen Klinsmann Overhauls Team USA?http://t.co/GKnao1ZmtR?New attacking style fits Americans $$?Jun 06, 2014
In Search of America’s Best Burrito?http://t.co/RaCIa2nXBc?via @fivethirtyeight Visit “The Well Dressed Burrito” in Washington, DC #cult?Jun 06, 2014
New Chip to Bring Holograms to Smartphones?http://t.co/KaWS9b8T5H?Ostendo’s Tiny Projectors r Made 2Display Video, Glasses-Free 3D Images $$?Jun 05, 2014
No Pain, No Gain, as Tattoo Regret Fueling Laser Removals?http://t.co/GHS89tzV4A?New pico-second lasers remove tattoos w/moderate pain $$?Jun 04, 2014
Wrong
Maybe not: This Time, Russia-China Alliance Will Last?@BloombergView?http://t.co/NYNTGV1mH3?Cultural alignment is lacking; econ not enuf $$?Jun 06, 2014
Wrong: Hydrogen Fuel Finally Graduating From Lab to City Streets?http://t.co/lkboflU5Sr??I usually call them ?fool cells.?? – Elon Musk $$?Jun 06, 2014
What New College Grads Need To Know About Money?http://t.co/mJpL4ckJoa?Disagree. If renter’s insurance optional, take the risk, don’t buy $$?Jun 04, 2014
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Comments, Replies, and Retweets
RT @derekhernquist: bookmarked “Investment Mgmt: A Science to Teach or an Art to Learn” via @cfainvestored HT @alephblog?http://t.co/ozoStZ??Jun 05, 2014
RT @susanweiner: Financial #blogging insights from David Merkel of @AlephBlog?http://t.co/PVhL3tX9yq?Jun 05, 2014
