Search Results for “insurers” – Page 8

Asset Value Illusion

Posted on 23 May 2014 by David Merkel

Are some Baby Boomers retiring because the current value of their assets is?high? ?This article from Bloomberg gives an ambivalent answer to the question. ?Personally, I don’t know the answer to that question, but I can answer a related question: In the current market environment, where interest rates are low and stock valuations?are high, should Baby Boomers accelerate their retirements?

The?answer is no. ?Here’s why: in retirement, you aren’t earning income from wages. ?You need income to be able to pay for expenses. ?If?interest rates are low and?stock valuations?are high, you won’t be able to create much income relative to your assets.

It’s like owning a long bond that you intend to buy and hold for the income. ?Do you care that interest rates have fallen, and the value of your bond is above where you bought it? ?No. ?It doesn’t give you any more income. ?If you sold it, where would you reinvest to get more income at equivalent risk?

Let me digress: rather than looking at asset values, look at anticipated cash flow streams. ?Have you grown you anticipated cash flow stream? ?In a bull market, many look like geniuses, but if it is only due to a rise in valuations, it means that the cash flow streams are unchanged.

I realize this is a harder way to look at the markets, but for those that have managed the interest rate risk at life insurers, this is the way the best do it. ?Have you created a higher income rate over the funding horizon? ?That is true improvement of the economic position.

Don’t merely look at the current value of your assets. ?That is an illusion of the true value in terms of income. ?Think of it this way. ?Say that you have surpassed your prior peak assets of 2007 recently in 2014. ?Now look at the income you could have purchased in 2007 (use the long bond as a proxy — 5%), versus what you could buy today — 3.4%. ?The ability to generate income is reduced by 30%+.

You might argue that the long bond is the wrong proxy — too long, too safe. ?I would argue that the safety is necessary. ?If you want to take more risks in fixed income, go ahead, but that is an option. ?As for length, the length?is close to what is needed, but if you used 20-year bonds, the argument would not change.

Final Notes

You might think you have a lot of money, but how much income can it generate? ?Are you protected against inflation? Deflation? Credit risk? ?Don’t assume because the asset balance is high that you are necessarily better off, because you might not be able to earn as much income off your assets.

Classic: Investing Is About the Whole Portfolio

Posted on 20 May 2014 by David Merkel

I wrote the following article for RealMoney in August 2005. ?I don’t like handing out individual stock ideas. ?I would rather teach people how to think about stocks and other assets, because my individual ideas will be wrong 30% of the time, and I will garner a lot of complaints from them. ?I will get few thanks from the 70% I got right. ?The ratio corresponds to that which Jesus had healing the lepers.

That said, those that invested in this portfolio for two years did well. ?Okay, read on:

==-=-==-=–=-==-=-=-=-=-=-=-=–=-=-===-=-=-=-=-=-=-

I’m not crazy about giving individual stock ideas on?RealMoney?because all investing is best viewed in a portfolio context. Individual stock ideas are important, but I believe portfolio construction and management are more important.

Too many investors are looking for the next hot company when they should really be looking for a consistent theory of how to produce reliable returns while minimizing downside risk.

In my column?Evolution of an Investment Style, I tried to describe how I achieve above-average returns while trying to squeeze out risk. This is not an easy process, but it is achievable if you think about investing in the same way an intelligent businessman thinks about his own firm.

That’s what my seven rules from that column are all about.

One of the first things you’ll notice is that there doesn’t seem to be any rhyme or reason to the order in which the stocks are listed. There is a logic here, but the order is based on the timing of initial purchases. Stocks that I have held the longest are on top, and stocks that I have bought for the first time most recently are at the bottom.

This helps me see on a day-to-day and week-to-week basis, which group of ideas are doing well. If my newest are doing well, there may be some mean-reversion happening in valuations.

If my oldest are doing well, there may be a bit of momentum happening for those that have already reverted to the mean. Because I tend to make shifts to the portfolio quarterly in groups of four or so stocks, I can see themes working out as I look at performance in the order that stocks were purchased.

The Current Portfolio

Listed below are the stocks in my portfolio. They are roughly equal-weighted.

Value With a Twist David Merkel’s current holdings
Name	Aug. 10 Close	P/E	Yield	Market Cap	P/E (This Year)	P/B	P/S
Cemex (CX:NYSE)	46.94	6.99	2.51	16.80	8.98	1.83	1.45
Dycom (DY:NYSE)	23.50	21.08	–	1.15	20.98	2.01	1.13
Cytec (CYT:NYSE)	48.25	14.87	0.83	2.22	14.26	1.81	1.18
Ameron (AMN:NYSE)	37.25	21.08	2.14	0.32	10.35	1.14	0.49
Allstate (ALL:NYSE)	58.04	11.62	2.04	38.79	9.33	1.74	1.13
Unilever PLC (UL:NYSE)	41.19	19.40	3.51	66.36	13.18	6.90	1.32
Liz Claiborne (LIZ:NYSE)	41.80	14.18	0.54	4.57	13.71	2.43	0.94
Fresh Del Monte (FDP:NYSE)	25.46	10.80	3.91	1.47	10.97	1.37	0.46
Montpelier (MRH:NYSE)	34.27	11.12	4.08	2.17	7.53	1.49	2.36
PartnerRe (PRE:NYSE)	62.92	7.43	2.26	3.47	8.84	1.00	0.84
ConocoPhillips (COP:NYSE)	65.64	9.66	2.07	91.39	8.42	2.00	0.71
SPX Corp. (SPW:NYSE)	45.36	3.75	2.22	3.41	17.43	1.21	0.76
Canadian National Railway (CNI:NYSE)	67.44	16.43	1.26	18.57	15.36	2.44	3.23
Petro Canada (PCZ:NYSE)	79.42	18.95	0.74	20.83	12.13	2.78	1.67
Stone Energy (SGY:NYSE)	53.71	9.63	–	1.44	7.86	1.51	2.34
Barclays PLC (BCS:NYSE ADR)	42.39	12.67	4.22	68.39	11.54	2.20	2.85
Valero Energy (VLO:NYSE)	90.77	10.74	0.49	23.30	10.14	2.92	0.37
Toyota (TM:NYSE ADS)	78.42	11.93	1.24	128.10	11.12	1.53	0.75
Sappi (SPP:NYSE ADS)	10.88	51.92	2.78	2.46	90.00	1.13	0.50
Apache (APA:NYSE)	71.93	11.09	0.46	23.61	9.46	2.48	3.60
Premcor (PCO:NYSE)	81.05	9.80	0.08	7.24	9.91	2.75	0.38
Ryerson Tull (RT:NYSE)	19.37	6.05	1.28	0.49	5.13	1.05	0.10
Jones Apparel (JNY:NYSE)	29.03	13.14	1.79	3.44	12.10	1.31	0.70
Neenah Paper (NP:NYSE)	31.45	20.09	0.93	0.46	20.09	2.40	0.63
Johnson Controls (JCI:NYSE)	57.46	12.39	1.70	11.03	12.83	1.91	0.39
Japan Smaller Capitalization Fund (JOF:NYSE)	11.81	5.20	–	0.19	50.00	0.98	108.19
Pfizer (PFE:NYSE)	26.39	20.04	3.43	196.20	13.39	2.92	3.70
Sara Lee (SLE:NYSE)	20.02	13.31	3.83	15.76	13.51	4.61	0.80
Repsol (REP:NYSE)	29.61	14.95	2.19	36.15	8.98	2.00	0.80
Premium Standard (PORK:Nasdaq)	14.76	6.70	0.41	0.46	9.07	1.10	0.40
Anglo American (AAUK:Nasdaq ADR)	26.72	11.68	2.62	39.62	10.32	1.59	1.53
ABN AMRO (ABN:NYSE)	24.73	11.54	7.52	41.28	10.25	1.78	1.61
Gold Kist (GKIS:Nasdaq)	18.93	8.60	–	0.97	7.86	2.46	0.90
Dana (DCN:NYSE)	15.01	11.73	3.12	2.26	12.92	0.98	0.24
SABESP (SBS:NYSE)	17.14	8.00	4.52	1.95	10.05	0.54	0.98
		11.68	2.04	4.57	10.97	1.81	0.90
Source: David Merkel, Yahoo!

This Portfolio Is Weird

Even though I manage this portfolio the same way that a “long-only” mutual fund manager would, because my portfolio is diversified by country and capitalization, it doesn’t fit any of the neat classifications common to mutual funds. I’m not running a mutual fund for which I’m anxious to gather assets, so this doesn’t bother me. Given that, I will now describe the way the portfolio breaks down by country, capitalization, sector and industry.

Sector Mix
The makeup of this portfolio defies easy categorization

Source: David Merkel

A notable characteristic of the portfolio is that 34% of it is non-U.S. Even adding back the two Bermuda reinsurers (which only trade in the U.S.), the percentage foreign is 29%. This is high enough that it would be hard to call this a domestic fund, but low enough that it can’t be an international or global fund. Why do it this way? Because I believe it offers the best returns to a U.S. investor. I try to buy stocks that operate in stable parts of the world, with reasonable legal systems. I consider information, war and expropriation risks. When something outside the U.S. seems too cheap, I buy it, but I don’t force myself to stay inside or outside of the U.S.

My approach to market capitalization is not as idiosyncratic. I am “all capitalization,” which is done by a number of mutual funds. I am probably more large-cap now than I have been in years. Small-caps generally don’t offer the valuation discount that I like to see when buying something off of the beaten path. Mid-caps I normally like best, because they typically have the stability of large-caps, but still have enough potential to grow, like some small-caps do. At present, many large-caps seem quite cheap, so I have more of them than normal.

The most important thing to look for in market capitalization is rule No. 4 from the column I mentioned above: “Purchase companies appropriately sized to serve their market niches.” Some businesses need scale in order to be profitable. Other businesses favor the entrance of smaller competitors following a niche strategy. “Is the business the right size in order to prosper?” is a question that intelligent investors ask.

Sector/Industry Mix

Looking at both the sector and industry mix, Jim Cramer would probably gong me in his radio show’s “Am I Diversified?” segment. Well, no, I’m not diversified, at least not by sector and industry. I can hear the comments: Where’s the tech and telecom??Pfizer?is not enough for health care. Only one utility, and that one’s in an emerging market? You’re too overweight in materials and energy. Agriculture has been a loser for years. You’re joking, right?

I’ve always run an undiversified portfolio, because intelligent sector rotation can add value. Industries tend to trend in the short run and revert to the mean over the intermediate term. I try to analyze where the pricing power of industries is as I evaluate companies for investment. There are two things that get me primed for purchase:

Things are abysmal and no one wants to invest there. (Think of auto parts.)
Or, stock prices have not caught up to the industry pricing cycle. (Think of energy.)

That’s how I view it. I want to be in industries that are underrated, whether that’s due to a bruising bear market in an industry, or because of an abundance of skepticism in the face of improving fundamentals.

Valuation Parameters

The summary statistics of my portfolio are shown in the table below.

The Numbers at a Glance
Category	Median Value
P/E last year	11.7x
P/E this year	11.0x
P/E next year	10.4x
P/Book	1.8x
P/Sales	0.9x
Yield	2.00%
Range	72%
ROE	18%
Source: David Merkel

You can tell that my portfolio broadly fits into the “traditional value” style. I like my modified form of Graham and Dodd, with tweaks from Marty Whitman and a number of other notable value investors. That said, it’s my unique synthesis, and it has paid off for me in performance. Buying them cheap is critical to both good performance and risk control.

You might adopt my style or you might not; it takes some effort to do well with it. But the important thing is thinking through your portfolio management process to make sure that it’s fundamentally sound, businesslike, intelligently contrarian and something that fits into the way you live your life. Life is broader than investing, and management techniques must be small enough in time use for them to be a part of a broader, well-balanced life. You have my best wishes as you work out your own investment management style.

Full disclosure: still long VLO, IBA, JOF

Unlikely Bid for Tower Group

Posted on 13 May 2014 by David Merkel

Tuesday, a subsidiary of Eurohold Group, Euroins Insurance Group, announced a $3.75 bid for Tower Group. ?I think it is bogus. ?Here’s why:

At the price they are paying, they are offering more than their net worth to buy Tower Group $215MM vs $190MM.
They would pay a 2x+ premium over book to buy Tower when they trade at ~70% of book.
They have no overlapping lines, geographically. ?It would be cheaper for Eurohold to buy a Bermuda shell and poach some talent, if what they want to do is diversify.
TWGP isn’t even worth the $2.50 that ACP Re is offering.
The language in the “offer” is weaker than that of many “letters of intent” I have read, much less a binding offer.

Now, let me take one step back, and say that the numbers I calculated above derive from documents written in Bulgarian that I have translated mechanically. ?I may have made mistakes.

Also, a fool and his money are soon parted. ?If Eurohold is foolish, a bid could be made where economics doesn’t matter. ?After all of my dealings with foreign insurers, I have seen many ill-thought-out deals.

Kudos to the guy who sold near $3 on Tuesday. ?He got the best outcome out of this sordid mess. ?Opposite for the one that bought.

As for me, I have no position. ?I rarely short, and there is no significant margin of safety in owning TWGP. ?The odds of the operating subsidiaries as a group?having not enough surplus?to exceed?the?relevant company action level risk based capital??for the group as a whole is not high, but is not zero. ?That is the one condition that can break the $2.50 deal with ACP Re.

Now let’s see how the first quarter earnings come in. ?That will say a lot.

As an aside, the bonds of Tower Group offer about as much upside, and less downside than the equity does, if the ACP Re deal is the only real deal.

Industry Ranks May 2014

Posted on 11 May 201412 May 2014 by David Merkel

My main industry model is illustrated in the graphic. Green industries are cold. Red industries are hot. If you like to play momentum, look at the red zone, and ask the question, ?Where are trends under-discounted?? Price momentum tends to persist, but look for areas where it might be even better in the near term.

If you are a value player, look at the green zone, and ask where trends are over-discounted. Yes, things are bad, but are they all that bad? Perhaps the is room for mean reversion.

My candidates from both categories are in the column labeled ?Dig through.?

You might notice that I have no industries from the red zone. That is because the market is so high. I only want to play in cold industries. They won?t get so badly hit in a decline, and they might have some positive surprises.

If you use any of this, choose what you use off of your own trading style. If you trade frequently, stay in the red zone. Trading infrequently, play in the green zone ? don?t look for momentum, look for mean reversion. I generally play in the green zone because I hold stocks for 3 years on average.

Whatever you do, be consistent in your methods regarding momentum/mean-reversion, and only change methods if your current method is working well.

Huh? Why change if things are working well? I?m not saying to change if things are working well. I?m saying don?t change if things are working badly. Price momentum and mean-reversion are cyclical, and we tend to make changes at the worst possible moments, just before the pattern changes. Maximum pain drives changes for most people, which is why average investors don?t make much money.

Maximum pleasure when things are going right leaves investors fat, dumb, and happy ? no one thinks of changing then. This is why a disciplined approach that forces changes on a portfolio is useful, as I do 3-4 times a year. It forces me to be bloodless and sell stocks with less potential for those with more potential over the next 1-5 years.

I like some technology stocks here, some industrials, some retail?stocks, particularly those that are strongly capitalized.

I?m looking for undervalued industries. I?m not saying that there is always a bull market out there, and I will find it for you. But there are places that are relatively better, and I have done relatively well in finding them.

At present, I am trying to be defensive. I don?t have a lot of faith in the market as a whole, so I am biased toward the green zone, looking for mean-reversion, rather than momentum persisting. The red zone is pretty cyclical at present. I will be very happy hanging out in dull stocks for a while.

That said, some dull companies are fetching some pricey valuations these days, particularly those with above average dividends. This is an overbought area of the market, and it is just a matter of time before the flight to relative safety reverses.

The Red Zone has a Lot of Financials; be wary of those. I have been paring back my reinsurers, but I have been adding to P&C insurers. What I find fascinating about the red momentum zone now, is that it is loaded with cyclical companies.

In the green zone, I picked almost all of the industries. If the companies are sufficiently well-capitalized, and the valuation is low, it can still be an rewarding place to do due diligence.

Will cyclical companies continue to do well? Will the economy continue to limp along, or might it be better or worse?

But what would the model suggest?

Ah, there I have something for you, and so long as Value Line does not object, I will provide that for you. I looked for companies in the industries listed, but in the top 5 of 9 balance sheet safety categories, and with returns estimated over 12%/year over the next 3-5 years. The latter category does the value/growth tradeoff automatically. I don?t care if returns come from mean reversion or growth.

But anyway, as a bonus here are the names that are candidates for purchase given this screen. Remember, this is a launching pad for due diligence, not hot names to buy.

I’ve tightened my criteria a little because the number of stocks passing last quarter’s screen was much higher, which was likely an artifact of earnings expectations rolling forward another year.

Anyway, enjoy the list of purchase candidates — I know that I will:

Full Disclosure: long SYMC

Sorted Weekly Tweets

Posted on 10 May 2014 by David Merkel

Market Dynamics

Yellen Comments Boost Demand for Treasury Bonds?http://t.co/2lzFhL97br?Carry trade rescued, grows larger 4a later day of reckoning $$ $TLT?May 10, 2014
One of the Best Retirement Deals 9 of 10 People Ignore?http://t.co/oYw4xRjEdc?Contribute 2a Roth 401(k) & save big on future taxes $$ $TROW?May 10, 2014
NYSE to Curtail Order Types Amid Debate Over Their Fairness?http://t.co/JOlTvX7sie?Will b interesting 2c what they curtail $$ Affects my biz?May 10, 2014
What Baby Boomers? Retirement Means For the US Economy?http://t.co/GuECsqqWHA?Cheer up, the US is in better shape than rest of the world $$?May 10, 2014
I’m worried about a crisis bigger than 2008: Faber?http://t.co/JwpcvxA53o?”For the next six months, maybe cash is the most attractive.” $$?May 10, 2014
When Stocks and Bonds Disagree?http://t.co/BGbY9Y0C2L?@reformedbroker points out anomaly. Bond mkt bigger than stock mkt, should b right $$?May 07, 2014
research puzzle pix by tom brakke?http://t.co/xtPUCU7PDj?Bloat, which I would measure by number of days to trade away the portfolio $$ $SPY?May 07, 2014
Ten Surefire Trading Rules To Make You Rich?http://t.co/fHqVJkaVuj?@reformedbroker tongue-in-cheek way of telling you what not to do $$ $SPY?May 06, 2014
Early Tap of 401(k) Replaces Homes as American Piggy Bank?http://t.co/x16yXooOSx?If you don’t have an “out” door 4 $$, less will go “in”?May 06, 2014
The bond market is giving the stock market angst?http://t.co/rfuGqyaPTK?2 many long bond shorts, economic weakness, low govt-measured inf $$?May 06, 2014
Free Life-Insurance Offer Scrutinized?http://t.co/EZz4zbJsXS?Nothing is free; this will come out of the life insurer dumb enough 2sell it $$?May 06, 2014
Bond Returns Post Global Records as Warnings Go Unheeded?http://t.co/t0aXCtsu8T?Long bond buyers need to fund long liabilities & momentum $$?May 06, 2014
Borrowing Cash to Buy Complex Assets Is In Vogue Again?http://t.co/8urmZjge1i?Borrowed $$ is mostly being used 2buy AAA CLOs; 10x lev ~ 8%yd?May 06, 2014
Can?t Find Enough 30-Year Treasuries to Buy? Here?s Why?http://t.co/tmFjBQ4emS?Fed buying, also pensions, life insurers & speculators $$?May 05, 2014

Banks

Covered Bond Talks Intensify as Bank Liquidity Rules in Play?http://t.co/aM7LuzeXIK?Denmark needs bank capital concessions 4covered bonds $$?May 10, 2014
Bitcoin Breakthroughs Studied by Banks the Currency Is Out to Replace?http://t.co/Frls6s04am?May not be a currency, but a payment system $$?May 10, 2014
JPMorgan Joins Wells Fargo in Rolling Out Jumbo Offerings?http://t.co/9mJFfYArs2?High end of residential housing market is hot $$ $JPM $WFC?May 10, 2014
Fed 2 Bank Giants: Don’t Get Bigger Via Mergers?http://t.co/fjw4dDAAIZ?Have >10% of total financial system liabs can’t merge $$ $BAC $C $JPM?May 10, 2014
The Real Reason Big Banks Stay Big?http://t.co/GRvSHhDAUx?The larger the bank, the larger the management pay packets $$ $C $BAC $WFC $JPM?May 06, 2014

Rest of the World

Russian Aggression Prompts Finnish-Swedish Military Pact?http://t.co/K9amWYRP0F?It’s not an expansion of NATO yet, but reaction 2 Russia $$?May 10, 2014
China Property Slump Adds Danger to Local Finances?http://t.co/WXdGmStbU5?Local govts rely on selling property 4 revenue; now what to do? $$?May 10, 2014
Ukraine’s Arms Industry Is Both Prize and Problem for Putin?http://t.co/1RNJMzBvQ6?Has many arms joint ventures w/ Ukraine $$ #irony $MACRO?May 10, 2014
Panama Can School US on Immigration?http://t.co/2UYhldzlPJ?”Panama is the kind of country the US once was: quick to embrace workers.” $$?May 10, 2014
Draghi?s Euro Angst Rising as Rally to $1.40 Pummels?http://t.co/nLzHP74nYE?What will he do? Sell Euros & buy Dollars? Has 2 many $$ now.?May 10, 2014
Accident Leads to Scrutiny of Oil Sand Production?http://t.co/DHVJukJNVR?Little damage, but made regulators think of other bad scenarios $$?May 06, 2014
British Coins Pass Test in 800-Year-Old Ritual?http://t.co/GKfA1KhXKO?Trial of the Pyx, 1 of Britain?s oldest&strangest legal procedures $$?May 06, 2014

Global Economy

US Ready to Join 6-Nation Tax Alliance?http://t.co/PVRpUJ1ShZ?Members Will Share Information 2Fight Multinational Corporate Tax Avoidance $$?May 10, 2014
Ron Wyden: We Must Stop Driving Businesses Out of the Country?http://t.co/ypwwGbrWlM?Cutting corporate taxes to 24% would be a start $$ $SPY?May 10, 2014
Corporate Tax Planners Vexed by New International Tax Guidelines?http://t.co/LcCyHgfDc7?If elites agree, can limit tax leakages 2 havens $$?May 10, 2014
Decoding Dollar Turns Into Wall Street?s Parlor Game?http://t.co/PeI1wrlq4v?Bad speculation on strengthening $$ fails, trade gets reversed?May 10, 2014
World Economy Stabilizes in Great Moderation 2.0?http://t.co/yCIRqXpF9h?Really seems 2 early 2b trotting out an idea like this $$ $SPY $TLT?May 10, 2014
How Russia Inc. Moves Billions Offshore & a Handful of Tax Havens May Hold Key to Sanctions?http://t.co/ylIL6w66EF?Expropriation risk $$?May 05, 2014
Tax Break ?Blarney?: U.S. Companies Beat the System With Irish Addresses?http://t.co/Ia2cM1brCS?Maybe a “Value Added Tax” could fix this $$?May 05, 2014

Companies & Industries

Fat-Destroying Machine Doubted by Stock Traders?http://t.co/2Klv4c4ozG?$ELOS uses ultrasound 2 heat up & destroy fat cells. Does it work? $$?May 10, 2014
Son Makes $58B on Alibaba With Buffett-Type Return?http://t.co/uywgbnCaxg?Masayoshi Son had insight into Alibaba when invested $20M $$?May 10, 2014
US Shale Boom Keeps Global Oil Prices From Soaring?http://t.co/ipDZdMke1o?Oil Majors have 2 invest more 2 get less http://t.co/9u5lRnolmh $$?May 10, 2014
Lenovo Targets Mobile as Tech Empire Grows on Castoff Businesses?http://t.co/sXSytLozjV?Squeezing good $$ out of mature tech businesses?May 10, 2014
Pitney Bowes changing stripes: Cramer?http://t.co/QzDuxGLZjT?Talks about their partnership w/ $EBAY to seamlessly estimate shipping $$ $PBI?May 10, 2014
5 quality stocks that are missing out on the bull run?http://t.co/8GTmjMt46J?Quality often misses out when credit spreads r tight $$ 2005-7??May 10, 2014
Alibaba Partners Keep Control After Shunning Hong Kong for US?http://t.co/4XvRaqoUM5?A partnership will govern, limiting takeover efforts $$?May 10, 2014
Wal-Mart Notches Web Win Against Rival Amazon?http://t.co/3f9chtgyME?Still $AMZN is 6x larger than $WMT in online sales, long way to go $$?May 06, 2014
IBM’s Watson supercomputer can help settle your debates?http://t.co/cFmXZXmEV6?Ask Watson a question, will give top 3 args for & against $$?May 06, 2014
Symantec Develops New Attack on Cyberhacking?http://t.co/xbeAQgcnab?Declaring Antivirus Dead, Firm Turns2Minimizing Damage From Breaches $$?May 06, 2014
Buffett Phase Two Means Seeking Deals More Enduring Than Stocks?http://t.co/FyERjB7YO5?Trying to build the best long-term conglomerate $$?May 05, 2014

US Politics & Policies

Benghazi Isn’t Iran-Contra?http://t.co/otSpoLR38P?But the comparison reflects poorly on the Obama administration $$?May 10, 2014
SEC Finds Illegal or Bogus Fees Majority of Buyout Firms?http://t.co/TwU954gwzm?Who pays what expenses? How r fees & returns calculated? $$?May 10, 2014
What Timothy Geithner Really Thinks?http://t.co/CxMmqJF18b?Just don’t blame him, didn’t want the job & wanted 2 leave it sooner, Really? $$?May 10, 2014
Railroad: Federal order won’t affect oil shipments?http://t.co/9nFXjxRTcP?BNSF carries most of the oil coming from Bakken FD: + $BRK.B $$?May 10, 2014
Why Nonbank SIFI Designations Put the Cart Before the Horse?http://t.co/oRQCv7r5jf?FSOC & Fed don’t get systemic risk & designating SIFIs $$?May 10, 2014
Massachusetts Scraps Its Health Insurance Exchange?http://t.co/nVB3C17iVg?Fascinating how many states had to scrap their healthcare sites $$?May 06, 2014
Why Weather Could Determine Who Wins a Race To Measure Inflation?http://t.co/2PTidHexu6?Billion Prices Project inflation measure 1%>CPI $$?May 06, 2014
The End of the Permissionless Web?http://t.co/MWyAraGxUT?Regulators want 2 become the gatekeepers for Internet innovation. It ain’t broke $$?May 06, 2014
Toilet Bowl Kills Fan in Violence at World Cup Host Brazil?http://t.co/Qx0HSiv0dB?Soccer hooliganism hits a new low, death by toilet $$ $EWZ?May 05, 2014

Other

Woman With Printer Shows the Digital Ease of Bogus Cash?http://t.co/kN4Ua9zZl0?Fascinating 2c how easy it is to convert $5s into $100s $$?May 10, 2014
Career Advice for Managers: Learn to Execute Strategy?http://t.co/jI85DW4Itj?Strategy should come b4 reaction to the problems of the day $$?May 10, 2014
Growing Number of Hispanics in US Leave Catholic Church?http://t.co/0jXt2caYjl?Most of those leaving go evangelical protestant $$ #readbible?May 10, 2014
Economics students call for shakeup of the way their subject is taught?http://t.co/vv8OL1xq9m?Right diagnosis, wrong cure, need Austrian $$?May 07, 2014
Rethink The Word ‘Cancer,’ Panel Says?http://t.co/jiuSNLF4JM?Cancer comes in many different forms; with some, early treatment is needed $$?May 06, 2014
Virtual reality preps 4 impact in healthcare, manufacturing, finance?http://t.co/taBVd2dFy1?Retirement planning, worker safety, training $$?May 06, 2014
MLB: The Year That No One Got Caught Stealing?http://t.co/Pn3itlbi36?Catchers now spend more time practicing hitting than throwing $$ $SPY?May 06, 2014
Elite Colleges Don’t Buy Happiness for Graduates?http://t.co/H2S5hTml6g?Happiness stems more from personal attitudes than college type $$?May 06, 2014

US Economy

Cancer Doctors Join Insurers in US Drug-Cost Revolt?http://t.co/OrqflkeN32?Drug costs reflect price 4 successes but paying 4 failures $$?May 10, 2014
Later Easter Drives Retail Sales in April?http://t.co/VAuXPhVGR7?Never thought Easter was that big of an economic factor $$?May 10, 2014
Record Meat Costs Mean Pricey Barbecues?http://t.co/tNr7vcb11K?Herds r smaller, as ranchers shake off past water & feed problems $$ $TSN?May 10, 2014

Wrong

Wrong: Happy Hedge Fund Managers Earn Money for Nothing?http://t.co/pOSYH3SSXO?Wrong benchmark S&P 500 4 hedgie comparison s/b t-bills $$?May 10, 2014
Wrong: Blackstone?s Schwarzman Says Individuals Need More Alternatives?http://t.co/Mnp0cjlXZ5?He’s just trolling 4 dumb $$ folks. Ignore him?May 10, 2014

Comments, Replies & Retweets

If the treatment is cheap enough, & has no harmful side-effects, investors will benefit from fat returns ;)?http://t.co/ROAQUU6Rpu?$$ $ELOS?May 07, 2014
“He might be comparing IRRs on PE to total returns on stocks. Trouble with that one is that capital?” ? D. Merkel?http://t.co/MhXU9vLCvG?$$?May 07, 2014

Yet Another Letter from a Reader

Posted on 6 May 2014 by David Merkel

I get a lot of interesting letters — here is another one:

First, let me say how much I appreciate your blog. I started my career in sellside research covering life insurers (after interning in insurance M&A). Your posts on insurance investing were invaluable in developing my understanding of the industry. My superiors did not have time to teach me the basics – I would have had a hard time getting started without your blog.?

?I’m now in equity research at a large mutual fund company, also covering insurers (and asset managers). However, I do not have an actuarial background. So I am very interested in why you think financial & mortgage insurers don’t have an actuarially sound business models.?

?And as a former life insurance analyst, I am curious what aspect of life insurance reserving you view as liberal – I’m guessing secondary guarantees on VAs??

?Finally, to digress, do you have any views on medical malpractice insurance? I’ve been looking at PRA, and find it pretty compelling at first glance: massive excess capital, consistently conservative and profitable underwriting, and a relatively reasonable valuation. 90% of policies are claims made. There are headwinds: Obamacare, the reserve releases from mid-2000s accident years rolling off, and a diversifying business model (although PRA has historically proven competent at M&A). My only concerns are management continuing to underwrite at too low a level (currently writing at 0.32x NPW / Equity; regulators would be fine with up to 1.0x), and potentially squandering that capital.?

In the interest of full disclosure, I own no insurance stocks personally for compliance reasons.

Thanks for writing. ?Let’s start with mortgage and financial insurance. ?It’s not that there isn’t a good way to calculate the risk (in most cases), it is that they do not choose to use those models. ?The regulators do not subscribe to contingent claims theory. ?They do not look at default as an option, even if it is not efficiently exercised. ?They should use those models, and assume efficient execution of default risk.

Even if they use approximations, the recent crisis should have forced reserves higher for mortgage credit, and other credit exposures.

Credit and mortgage insurers are bull market stocks. ?When I was a bond manager, I sold away my few financial insurer bonds from MBIA and Ambac, and avoided the mortgage insurers. ?The possibility of default was far higher than he market believed.

With respect to Life Insurers, it is secondary guarantees of all sorts, especially with variable products. ?Options that have a long duration are hard to price. ?Options?that have a long duration, and involve significant contingencies where insureds may make choice hurting the insurer are impossible to price.

On Medmal, I have always liked PRA, but it has never been cheap enough for me to buy it. ?Always thought they were the best of the pure plays. ?They have survived many other companies by their clever management. ?I would not begrudge them their conservatism, Medmal is volatile, and it pays to be conservative in volatile businesses.

Another Letter From a Reader

Posted on 25 April 2014 by David Merkel

From reader after last night’s post.

I hope you are well. I think your blog is fantastic, thanks so much for sharing the time and wisdom for so little 🙂

I was wondering whether you could elaborate a bit more on the bad business models existent in the insurance field. If there would be a simple rule of thumb or similar it would be useful, but I’m guessing it has to be something (difficult ?to analyze) like chasing growth when premiums are insufficient, hiding leverage through subsidiaries, etc.

This was your comment:

Now, let me list for you the companies I would avoid on this list: IFT, GLRE, AGO, AEL, CNO, AIG, XL, MBI, LNC, FBL, AHL, ING, AXAHY, AFG, GNW. ?That does not mean that I endorse the others. ?In general, those that I say to avoid have poor underwriting skills or a bad business model.

(AIG is the biggest position in my portfolio.)

And secondly, I was wondering whether the fact that some are based in Bermuda gives them (or the LT investor) a competitive advantage when it comes to compounding (t)BV over time, because they are paying a lower tax-rate, aren’t they?

[normally, investors have to suffer a double whammy for taxes: the companies they invest in are taxed when they have profits –the US has one of the highest tax rates internationally–; and then they are taxed when realizing the capital gains / receiving dividends. Which led me to think that if one would be investing in Bermuda-based cos. through a ROTH IRA account, he would be avoiding both fronts, right?

Thanks so much for your time David.

I know it was a long email, and I apologize for that, couldn’t make it shorter…

Okay, let me take it piece-by-piece. ?I have biases, which I think are well-informed, but they are biases, ways of foreshortening the deluge of data, so that I can avoid making big errors.

1) I don’t believe that financial and mortgage insurers have an actuarially valid business model, and the last crisis proved me right. ?Thus I am not interested in AGO and MBI.

2) I don’t believe that long-term care is insurable, and so I am not interested in CNO and GNW.

3) With AIG, I don’t think that all of the reserve strengthenings are done for them. ?They have always been aggressive in reserving. ?I am not sure that has changed.

4) I think the business that IFT is in is unethical, and difficult if legal.

5) I think the takeover of AHL will fail, and the stock price will fall.

6) I think that many common life insurance reserving practices are liberal, and so I don’t like AEL, LNC, FBL, ING, and AXAHY.

7) With XL, GLRE and AFG, I don’t respect the management. ?Maybe with a few more years, that might change.

This explains my views on these companies. ?Other questions, let me know.

Miscellaneous Notes

Posted on 23 April 2014 by David Merkel

When I was writing at RealMoney.com, I would often do little posts in the Columnists Conversation, and title them “Notes and Comments,” or something like that. ?I don’t normally do that here, but I would like to tie up some loose ends.

1) I received the following e-mail six weeks ago, and I feel it is worthy to be shared with readers:

Hi David,

I follow?the Aleph blog from time to time. I run value and special situations oriented hedge fund whose goal is to purchase businesses that sell for at least 50 cents on the dollar. It seems that we are like minded in investment terms. I have an extensive investment checklist which that I believe can add value to investors. It took me a few years and I derived it by reading stacks of annual reports from Buffett, Klarman, etc?

If it adds value to your readers, more than happy to share the 90+item investment checklist.

http://www.brarifunds.com/wp-content/uploads/BIF-Checklist.pdf

Regards,

Pope

Pope Brar, Managing Partner/Founder

Brar Investment Funds

I’ve read through the checklist and it is a good one. ?It has all of the elements of my processes (though I am not as rigorous) and much more. ?His checklist is worth a read. ?Have a look at it.

2) From last night’s post, a reader asked:

Lots of insurers here.? Given your expertise in that area, I’d be curious to know if you think this screen is turning up names that are on the riskier end of the spectrum.

I wrote a seven part series on this, and here are the summary ideas, and the links:

I’ve been decreasing my insurance shareholdings lately because:

Pricing is weak for most P&C coverages, and
I don’t trust the reserving for secondary guarantees in life and annuity policies.

Here’s the insurance companies from last might’s article in decreasing order of earnings yield:

Company	Ticker	Industry	Country	B/P	E/P	ROE
Imperial Holdings, Inc.	IFT	0709 – Insurance (Life)	United States	?1.38	?37.03	?26.83
Greenlight Capital Re, Ltd.	GLRE	0715 – Insurance (P&C)	Cayman Islands	?0.90	?19.45	?21.61
Assured Guaranty Ltd.	AGO	0715 – Insurance (P&C)	Bermuda	?1.18	?18.59	?15.75
American Equity Investment Lif	AEL	0709 – Insurance (Life)	United States	?0.86	?16.77	?19.50
Everest Re Group Ltd	RE	0715 – Insurance (P&C)	Bermuda	?0.88	?15.35	?17.44
Validus Holdings, Ltd.	VR	0715 – Insurance (P&C)	Bermuda	?1.00	?13.30	?13.30
Axis Capital Holdings Limited	AXS	0715 – Insurance (P&C)	Bermuda	?1.01	?13.20	?13.07
Endurance Specialty Holdings L	ENH	0715 – Insurance (P&C)	Bermuda	?1.31	?12.55	?9.58
CNO Financial Group Inc	CNO	0709 – Insurance (Life)	United States	?1.29	?12.39	?9.60
American International Group I	AIG	0715 – Insurance (P&C)	United States	?1.34	?12.00	?8.96
Montpelier Re Holdings Ltd.	MRH	0715 – Insurance (P&C)	Bermuda	?0.99	?11.83	?11.95
Allied World Assurance Co Hold	AWH	0715 – Insurance (P&C)	Switzerland	?1.00	?11.73	?11.73
XL Group plc	XL	0715 – Insurance (P&C)	Ireland	?1.12	?11.72	?10.46
Argo Group International Holdi	AGII	0715 – Insurance (P&C)	Bermuda	?1.27	?11.55	?9.09
Platinum Underwriters Holdings	PTP	0715 – Insurance (P&C)	Bermuda	?1.02	?11.25	?11.03
Allianz SE (ADR)	AZSEY	0715 – Insurance (P&C)	Germany	?0.92	?11.08	?12.04
ACE Limited	ACE	0715 – Insurance (P&C)	Switzerland	?0.84	?10.92	?13.00
ProAssurance Corporation	PRA	0715 – Insurance (P&C)	United States	?0.87	?10.86	?12.48
MBIA Inc.	MBI	0715 – Insurance (P&C)	United States	?1.45	?10.86	?7.49
National Western Life Insuranc	NWLI	0709 – Insurance (Life)	United States	?1.63	?10.85	?6.66
Partnerre Ltd	PRE	0715 – Insurance (P&C)	Bermuda	?1.23	?10.75	?8.74
Old Republic International Cor	ORI	0715 – Insurance (P&C)	United States	?0.88	?10.53	?11.97
Employers Holdings, Inc.	EIG	0706 – Insurance (A&H)	United States	?0.93	?10.46	?11.25
United Fire Group, Inc.	UFCS	0715 – Insurance (P&C)	United States	?1.05	?10.30	?9.81
Maiden Holdings, Ltd.	MHLD	0715 – Insurance (P&C)	Bermuda	?0.93	?10.11	?10.87
EMC Insurance Group Inc.	EMCI	0715 – Insurance (P&C)	United States	?1.02	?9.88	?9.69
Investors Title Company	ITIC	0715 – Insurance (P&C)	United States	?0.86	?9.85	?11.45
Protective Life Corp.	PL	0709 – Insurance (Life)	United States	?0.92	?9.76	?10.61
Lincoln National Corporation	LNC	0709 – Insurance (Life)	United States	?1.07	?9.76	?9.12
FBL Financial Group	FFG	0709 – Insurance (Life)	United States	?0.96	?9.73	?10.14
Assurant, Inc.	AIZ	0709 – Insurance (Life)	United States	?1.00	?9.67	?9.67
Kemper Corp	KMPR	0715 – Insurance (P&C)	United States	?0.95	?9.64	?10.15
Aspen Insurance Holdings Limit	AHL	0715 – Insurance (P&C)	Bermuda	?1.12	?9.61	?8.58
Horace Mann Educators Corporat	HMN	0715 – Insurance (P&C)	United States	?0.91	?9.60	?10.55
Unum Group	UNM	0709 – Insurance (Life)	United States	?0.98	?9.55	?9.74
WellPoint Inc	WLP	0706 – Insurance (A&H)	United States	?0.89	?9.52	?10.70
ING Groep NV (ADR)	ING	0709 – Insurance (Life)	Netherlands	?1.14	?9.46	?8.30
Axa SA (ADR)	AXAHY	0709 – Insurance (Life)	France	?1.19	?9.46	?7.95
Hanover Insurance Group, Inc.,	THG	0715 – Insurance (P&C)	United States	?0.99	?9.44	?9.54
Baldwin & Lyons Inc	BWINB	0715 – Insurance (P&C)	United States	?0.98	?9.42	?9.61
American Financial Group Inc	AFG	0715 – Insurance (P&C)	United States	?0.87	?9.15	?10.52
Alleghany Corporation	Y	0715 – Insurance (P&C)	United States	?1.01	?9.15	?9.06
American National Insurance Co	ANAT	0715 – Insurance (P&C)	United States	?1.40	?8.99	?6.42
HCC Insurance Holdings, Inc.	HCC	0715 – Insurance (P&C)	United States	?0.82	?8.92	?10.88
Allstate Corporation, The	ALL	0715 – Insurance (P&C)	United States	?0.82	?8.75	?10.67
Symetra Financial Corporation	SYA	0709 – Insurance (Life)	United States	?1.23	?8.64	?7.02
Selective Insurance Group	SIGI	0715 – Insurance (P&C)	United States	?0.90	?8.51	?9.46
White Mountains Insurance Grou	WTM	0715 – Insurance (P&C)	Bermuda	?1.07	?8.49	?7.93
Fortegra Financial Corp	FRF	0712 – Insurance (Misc)	United States	?1.28	?8.18	?6.39
Cna Financial Corp	CNA	0715 – Insurance (P&C)	United States	?1.10	?8.15	?7.41
Stewart Information Services C	STC	0715 – Insurance (P&C)	United States	?0.83	?7.96	?9.59
Navigators Group, Inc, The	NAVG	0715 – Insurance (P&C)	United States	?1.09	?7.68	?7.05
Reinsurance Group of America I	RGA	0706 – Insurance (A&H)	United States	?1.08	?7.49	?6.94
Safety Insurance Group, Inc.	SAFT	0715 – Insurance (P&C)	United States	?0.84	?7.39	?8.80
State Auto Financial Corp	STFC	0715 – Insurance (P&C)	United States	?0.83	?6.92	?8.34
Genworth Financial Inc	GNW	0709 – Insurance (Life)	United States	?1.72	?6.87	?3.99
First American Financial Corp	FAF	0715 – Insurance (P&C)	United States	?0.87	?6.75	?7.76

Now, let me list for you the companies I would avoid on this list: IFT, GLRE, AGO, AEL, CNO, AIG, XL, MBI, LNC, FBL, AHL, ING, AXAHY, AFG, GNW. ?That does not mean that I endorse the others. ?In general, those that I say to avoid have poor underwriting skills or a bad business model.

3) Another letter from a reader, on a very different topic, the FOMC:

thanks again – I always look forward to this update.

My thoughts are, they are increasing their flexibility in one direction (towards??accommodation?).? While they did move the point about??after the purchase program ends? to a spot perhaps better suited to a discussion of that point, I also took it to mean that there may be less commitment to end QE.? (Although, so long as the deficit keeps declining, they really have no choice but to dial back purchases to keep the supply and the non-Fed demand in line.? This is the overlooked reason, I believe that long rates appear to be moving independently of Fed action.? Their demand is not the only variable).

?Final thought -?to what extent do you think that the Fed?s great misunderstanding is their inherent bias towards lowest rates possible under any economic conditions: i.e. for any given level of inflation, that Fed policy is best that reflects the lowest level of non-inflationary?interest rates [because this presumably encourages credit expansion and therefore economic growth]?

?To my way of thinking, the difficulty with this is that it assumes that credit always has to expand FASTER than the economy overall.? I don?t mean that credit expansion is not important, it is a big component of growth, just that credit can?t grow faster than income forever and at some point, we have to find a model that enables income to grow fast enough to increase living standards without overleverage.

?To me, this is the central policy challenge of the 21st century, because a) globally, credit has surged relative to national income and has reached a limit, b) populations are aging and must therefore favor lower levels of credit – and consumption – overall and c) the bills associated with 1 and 2 are now coming due.

?The Fed, however, seems stuck on the idea that their job should be to inflate rapid credit expansion regardless of the creditworthiness of the borrowers.? This strikes me as dumb, or perhaps more like wishful thinking that if credit expands, growth will drive incomes higher and somehow these will catch up (with some acceptable lag).

?Notice that no one at the Fed talks about things like the household savings rate any more?? I would be ok with QE if the Fed could explain that they were facilitating an orderly deleveraging: in which case Household Debt/Equity (which indicates potential for end-consumer final demand) would be a better metric than unemployment.

?As it is, I believe that what they are really targeting (large) bank balance sheets, and that QE is really a massive backdoor subsidy to money center banks to guarantee enough operating income to allow them to write off bad loans while increasing capital reserves to comply with Basel III.? (Full disclosure, I have a significant portion of my assets in a large US bank that was trading well?below the strike price of the warrants issued against its shares to Berkshire Hathaway at the time I purchased the shares, which bank shall remain nameless).

?Politically, I suppose, saying,??well, we need to ensure banks are profitable so as to ensure the solvency of the payments system? looks disturbingly like a bailout for the 1% and is out of touch with a more populist America.

?Anyway, sorry for the diatribe, but curious to get your thoughts.? I think I am less reflexively sceptical about the efficacy of the Fed?s policy (but I fully agree with your view that they are not supporting employment with it).

?Thanks again for all the work you do.

The central idea I would like to comment on is that incremental easing has had less and less effect on the economy, at least in the short-run. ?Aside from energy companies, willingness to invest in the business has been light, while willingness to buy back stock has been high. ?That doesn’t produce growth in the economy.

The Fed doesn’t realize that it can’t stimulate the economy at the zero bound. ?QE is ineffective, and may become fuel for high inflation if the banks start to lend aggressively. ?Inflation is not the goal, and I think many policymakers are confused — the goal is real growth.

We can protect the payments systems by protecting the regulated subsidiaries of banks, and letting the holding companies bear the losses, which is what we failed to do in 2008-2009.

All that said, we have a punk economy, but what will happen if we get a large increase in bank lending, leading to inflation. ?What will the Fed do then?

Tower Group Errata

Posted on 7 April 2014 by David Merkel

I try to run an ethical blog here, so when I make mistakes, I admit them. ?In this case, I don’t think the errors make a lot of difference to the investment decision, but I will confess to being wrong on ?details in my last post. ?I made the statement:

Though there are no financing contingencies to this deal, ACP Re can walk away with no penalty if it merely wants to do so.

That’s wrong. ?ACP Re can walk away of its own accord if there is a material adverse change, and under some conditions, they would receive a breakup fee. ?As such, it is not a “free look.” ?But it is one-sided in this sense: if the reserves are too low, ACP Re can declare a material adverse change. ?If they are fair or high, ACP will happily do the merger and enjoy the profits.

On the delay of the 10-K, which is more than a month late, I repeat that most of the figures in the balance sheet are easy to calculate. ?I was trained as an actuary, albeit a life actuary, though I was an insurance buy-side analyst for 4.5 years. ?The difficult question with any P&C insurer is whether the reserves are correct, and even actuaries inside a company are never fully sure of the reserves. ?That’s why reserves at P&C insurers are usually set conservatively, even though GAAP says to use best estimate. ?It is not a bad thing to bend GAAP accounting to be conservative, and be slow in recognizing income.

My experience with insurers that are tardy with their financials is that it is wise to steer clear. ?Aggressive insurance management teams tend to go through a string of corrections before the financials are set right.

Between 1998-2000, I used to do arbitrage on small deals. ?On net, I did fair with it, but the deals where I lost, you could feel a kind of “sag” where you would not ordinarily expect it. ?Good arb deals show strength after an initial period of selling by those that do not want to hang around for the arb.

Now, I don’t think my reasoning is depressing the stock price, but it is interesting that the stock price keeps heading lower, and slowly. ?I have a saying that slow moves tend to persist, while fast moves tend to mean-revert.

I don’t have any inside information, but this situation feels bad. ?Ordinarily with takeovers, the bid for stock is far more firm.

Full disclosure: No positions in any of the companies mentioned

Best of the Aleph Blog, Part 24

Posted on 4 April 20144 April 2014 by David Merkel

These articles appeared between November 2012 and January 2013:

On Time Horizons

Investment advice without a time horizon is not investment advice.

This Election Will Solve Nothing

So far that is true of the 2012 elections.

NOTA Bene

We need to add “None of the Above” as an electoral choice in all elections.

Eliminating the Rating Agencies, Part 2

Eliminating the Rating Agencies, Part 3

Where I propose a great idea, and then realize that I am wrong.

The Rules, Part XXXV

Stability only comes to markets in a self-reinforcing mode, from buy and hold (and sell and sit on cash) investors who act at the turning points.

The Rules, Part XXXVI

It almost never makes sense to play for the last 5% of something; it costs too much. Getting 90-95% is relatively easy; grasping for the last 5-10% usually results in losing some of the 90-95%.