Wednesday, May 16, 2012

GLRE: David Einhorn at Book

So David Einhorn is in the news again lately and I do notice that GLRE is trading around book value so I thought I'd post an update on this.   I posted before that GLRE is a way to get hedge fund exposure at book value.

I did say then that this is the same as the Berkshire Hathaway model, but I should say it's more based on the same idea but not the same model.  In BRK's case, they wholly own the insurance businesses that they use to hold investments.  Also, the insurance businesses also own some wholly owned businesses.

In the case of GLRE, the idea is the same; to use insurance float to make investments.  The key difference is that GLRE is a pure insurance company and they outsource the investment management to Einhorn's hedge fund (or more specifically, an entity called DME Advisors).  So it's a similar idea but different structure. 

Also, of course, GLRE then pays hedge fund-like fees to Einhorn.

Investment Performance Update
One nice thing about having GLRE listed is that they do post returns of their investment portfolio on a quarterly basis. 

Here is the latest:

From inception (of GLRE) through the end of last year, Einhorn has returned +9.3% per year.  Going through to the end of April, 2012, the return is +9.5%/year and this is net of fees and expenses.  GLRE pays a 1.5% management and 20% incentive fee to DME Advisors.

(As I keep saying, hedge fund fees are fine if they perform.  What matters is net returns after fees.  If that is good, then fees is not a problem.  I don't see a problem with pay-for-performance.  People who don't perform well and charge high fees will cease to exist pretty quickly).

The largest holdings in the portfolio as of April-end were Apple, Arkema, General Motors and Seagate Technologies.

They also own a large stake in Oaktree Capital Management (recent filing) which I posted recently about (read here).   Oaktree (OAK) is run by Howard Marks who is certainly one of the all-time greats in the investment world.  We can't know what Einhorn is thinking, but I think other than the fact that OAK is a great shop run by great people, I think the counter-cyclical aspect of OAK probably appeals to him greatly.  Einhorn, like many others, sees big problems ahead due to so much debt around the world.  When things blow up, OAK will be there to raise capital and pick up the pieces at great prices.  They will actually *benefit* in bad times.

The portfolio as of the end of the 1Q was 32% net long according to the 1Q earnings call (you can see equity long and short outstanding on the balance sheet), and that was bumped up to 39% net long in April.  GLRE also owns a big position in gold; I think they maintain a 10% position in gold.  There are also some macro bets like currency trades and credit default swaps (against Japan, for example).

Balance Sheet
At this point, the insurance business is still in a startup phase so the p/l is largely driven by investment results.  Total investments were $1.18 billion at the end of March 2012 versus shareholders' equity of $869 million.  So that's an investment leverage of 1.4x which is low for an insurance company.  Again, that's largely due to the startup nature of GLRE.   So the risk profile of GLRE from an insurance and investing standpoint is still much lower than the typical insurance company (Markel, for example, has an investment leverage of 2.5x).  Investment leverage often reflects both investment and insurance risk; investment risk because returns/losses are magnified by the leverage and insurance risk because much of the leverage in an insurance company comes from 'float' and when they are underreserved, or a bad insured event occurs, that can lead to big losses if the insurance company is too levered (too much float versus equity).

The combined ratio came in at 102.4% in the first quarter of 2012 versus 103.8% for the full year in 2011 and 102.8% for 2010.  The insurance business isn't really 'seasoned' here yet so it will take more time to see what kind of track record GLRE can develop in terms of underwriting in the longer term.

Book Value per Share
At the end of the day, an insurance company wants to grow book value per share over time.  For GLRE, fully diluted adjusted book value per share is the scorecard that we want to keep an eye on.

Here is the 'scorecard' since 2004 (when GLRE started):

             Fully diluted
2004     $10.21
2005     $11.63
2006     $14.27
2007     $16.57
2008     $13.39
2009     $18.95
2010     $21.39
2011     $21.61

March 2012  $23.29

GLRE grew BPS +11.3%/year through the end of 2011 and +12.1%/year through March 2012, which is a little more than the investment returns; this is due to the investment leverage.

Investment Leverage
Investment leverage is now a modest 1.4x, but if they can just break even on the insurance business and Einhorn earns 10% net of fees, that's a 14% growth in book right there.  If some of his bets pan out and he starts generating more typical hedge fund-like returns (OK, I hear laughter... bear with me), then GLRE can really grow book even with just 1.4x investment leverage.

Leveraging a Hedge Fund?  Are You Nuts!?
Well, seeing that so many insurance companies are long mostly bonds in what many call the biggest bubble of all time (and a perception that bonds are 'safe') with much higher leverage, leaning on the comfort of AAA and AA credit ratings, Einhorn' portfolio may even be much safer.

Also, I don't know the investment guidelines in Einhorn's hedge funds, but the investments at GLRE do have restrictions (if this is too small to read, just look it up in the 10-K):

Keep in mind that the leverage mentioned above only relates to the investment portfolio and not the leverage at the GLRE balance sheet level.  For example, if GLRE gave $100 to Einhorn to invest, then the 'equity' is $100 as far as Einhorn is concerned.

This is certainly not without risk.  Many things can go wrong here.  Einhorn may not perform going forward.  The insurance business can become a total disaster.  One of them can be enough for this not to work.  Both can happen, which would be a disaster.  

But with shares trading at $24.77 and fully diluted adjusted book value per share at $23.29 (1.06x book), it's certainly an interesting opportunity.


  1. Here's another idea if you want hedge fund exposure. TPOU which trades in London is at about a 15% discount to NAV. This is Dan Loeb's hedge fund. Instead of paying in effect 3.5% fees (2% for insurance losses + 1.5% management fees) at premium to book, with TPOU, you pay only the mgmt fees and get in at a deep discount to book. Dan himself invested $25m in this vehicle

  2. IMO, you have to account for the short book too when looking at total investments

    1. Hmmm... Interesting. If you gross up the short book, you will drastically overstate 'exposure' I think, as the short book offets the long book and a portfolio of longs stocks and short stocks will tend to offset each other (of course not perfectly).

      A long/short hedge fund will typically have a lower volatility than a naked long only equity portfolio.

      So generally, a $100 NAV value in a hedge fund will act like $100 equity fund but with lower volatility. If the fund was $120 long and $80 short for an $40 net long position, the vola will be much lower than an equity mutual fund of $100. If you gross up the longs and shorts, you will see $200 in 'investments', but that far overstates reality.

    2. The short book is offset by restricted cash, not investments.

    3. Yes, but that restricted cash is mostly proceeds from the short sale. This is the way it is accounted for. There isn't need to gross up the investment for that (no new cash is posted as collateral for a short sale; and short sales are supported by assets held in prime brokerage accounts).

      Having said that, there may be some restricted cash they may have to be accounted for as part of investments. But that wouldn't be the case for proceeds from short sales for the reason I stated above.

      This is similar to the concept of gross leverage and net leverage at investment banks; net leverage eliminates low or no-risk repos on the books as it increases securities borrowed on the liability side and cash (collateral) on the asset side but have low risk due to short term nature and underlying typically being treasuries. They net out and are pretty much non-events balance sheet-wise...