Wednesday, February 20, 2013

Greenlight 2012 Results

So, Greenlight Capital Re (GLRE) announced a not so good quarter/year.  Investment performance came in at +7.1% which is not very good given a +16% stock market last year.  In 2011, the return was 2.1%, same as the S&P index, and 2010 was +11% versus the S&P's +15%.  So that's three years in a row that Einhorn failed to beat the S&P 500 index.   That's not good.

The BPS (fully diluted adjusted BPS) growth hasn't been too hot either over the past three years.  BPS grew 13%, 1% and 2% in 2010, 2011 and 2012 versus +15%, 2% and 16% for the S&P 500 index.   BPS also lagged the S&P 500 for the last three years.

But!
But hold on.  We always advocate the long term.  It may be a mistake to jump to conclusions on recent history.  We know that a lot of investment errors occur due to the overweighting of the most recent data points. 

GLRE has done better over time.  Here is the table of net investment performance (of GLRE's investments) and BPS growth compared to the S&P 500 index:


GLRE Investment Performance and BPS Growth

The GLRE investment return for 2004 is only for two quarters, so I just looked at returns/changes since the end of 2004 (the S&P 500 index return for 2004 is for the full year so is not comparable). 

On this longer term basis, GLRE looks much better.  GLRE's investments returned an average 9% (versus 4% for the S&P 500) over eight years and 5.7%/year (versus 1.7%/year for the S&P 500) over the past five years.  That's an average outperformance of 3.8%/year over eight years and 2.4%/year over five years.

BPS change, which is basically a function of investment return and combined ratio, also outperformed the S&P 500 index by a nice margin (see above table).

Insurance Business
Other than investments, the other piece of GLRE's return is the insurance business.  For that, let's take a look at the combined ratio.  For 2012, it looks pretty bad.  The combined ratio came in at 112.9%, far higher than it's ever gotten, and far worse than the competition.

I just updated the combined ratio table that was in GLRE's presentation last year and this is what it looks like:

GLRE Combined Ratios Versus Comps
TRH was merged into Alleghany (Y) and hasn't reported yet.  But if you look at the others, it doesn't look too good.  The average, too, since 2008 doesn't look good for GLRE's business.

Questioned about this during the 4Q12 conference call, they said it's due to one or two things (commercial autos) and they are working on it.  But you know, does it matter if, for example, all of your stocks you bought went down or if one stock pick really tanked?  I don't know.  Just because the bad combined ratio is because of one (or two) bad idea, that isn't too comforting if it has such an impact on the total ratio.  It just illustrates how concentrated/focused the business is and how important it's going to be to be right.

Hedges did say, though, that some of this is due to timing; GLRE didn't start writing insurance until recently whereas the competitors have been writing for a long time with policies written during the hard market years.  Some of the low combined ratios recently have come from reserve releases from that period which GLRE doesn't have.  There is definitely some truth to that as we know insurers have been releasing reserves for the past few years.

In any case, it looks like over the longer term, Einhorn is fulfilling his end of the bargain (outperforming the S&P 500 index) while the insurance side has seemed to lag (whether it's because of the reserve release issue, one time mistakes or just bad insurance underwriting).

Anyway, I updated a table that GLRE showed in their presentation last year.  It shows how ROE changes according to various scenarios of investment returns and combined ratios.

I used the current balance sheet of net earned premiums of 60% of capital and investment assets of 150% of capital.

Below is how ROE would change according to the two inputs:

Return-on-Equity with Various Investment Returns and Combined Ratios

If the insurance business can just break even and the investments return 10-15%/year, BPS can grow 15-23%/year.   

The big question, of course, is if they can achieve that.   

I did raise some concerns about Einhorn due to his getting into what seems like macro investing.  I may be wrong but my impression has been that he has gotten into this after the financial crisis.  I have said before that so many value investors and equity managers spent so much time on the macro in the past few years that I felt that there is sort of a macro-forecasting/investing bubble going on.   

The yen trade has certainly paid off in the past couple of months but it has been on the books for a while now so who knows if the returns is worth it given how long it's been there.

Whatever happens to these trades, I wonder if these things distract Einhorn from what I think he is supposed to be really good at (stock picking).

Anyway, I do understand that managers want to put on low cost, tail hedges to benefit from large movements that may negatively impact the equity portfolio.  But I have my reservations about that.  Also, managers may want to get into new areas to deploy larger amounts of capital.  It's one thing when you are a $500 million - $1 billion equity manager, but when your assets get up to $5-10 billion, macro starts to get very attractive because of the large, liquid markets that you can deploy capital in.

I won't mention the New York Mets thing (some believe that when hedge fund managers start dabbling in trying to own a sports team, that may signify the end of their good run as their focus seems to be elsewhere.  But David Tepper seemed to do well last year so...).

Increasing AUM, of course, is another factor.  I don't have detailed data on Einhorn, but I'm sure the best years were the early years when he had way less capital.  Can he get back to 10-20%/year performance at this AUM level?  This is a question for all hedge fund managers at some point.  We will have to wait and see.

Anyway, here is a look at GLRE's stock price versus the BPS over time:

Greenlight Re Fully Diluted Adjusted Book Value per Share vs. Stock Price

It seems to have averaged 1.2x book over time and is now trading at $24.57/share, 1.1x book value.
GLRE hasn't done as well as I would have thought in the past couple of years, but they have done well over time.  I don't own a lot of GLRE, but I still do like it.  The potential is there for this to be a really good performer over time and it is reasonably priced. 

Of course, things can go the other way too.   James Tisch, on one of the Loews conference calls recently said (not about GLRE specifically) that these reinsurance companies started by hedge funds may not realize that the insurance business can lose more than the premiums earned (combined ratios can get over 200%).  He seems to feel that some of these entities may not understand the risk that they are taking.  

(Note after the fact:  It may not have been a conference call, but a TV interview that he said this.  And I think he meant that CR can get above 200% or some such thing.  I may revise this if I find exactly what he said, but it's not that relevant to this post, actually; just that insurance can be risky!).

It's a very interesting and scary point.  This is an interesting situation, but it is risky (this is no Berkshire Hathaway).  It is a no-brainer in a sense; get levered return on Einhorn (levered due to insurance float) at close to book value, but not without risk.



 

26 comments:

  1. Gold is a macro investment (that has done very well until recently) and Einhorn has had gold positions in the top 5 positions for quite some time.

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    1. Hi,

      Yes, he's had a gold position on for a while as a sort of tail hedge. I think he wants to keep a 10% or so position in that.

      And I haven't really been a big fan of gold recently (I've posted about gold in late 2011 etc...); I'd rather equity guys focus on equities and leave that macro stuff to Soros.

      But then again, I do understand that managers sometimes have to evolve and learn other tricks and expand their repertoire... It's just that I am a bit of a skeptic when it comes to that stuff.

      Of course, there are plenty of examples where managers have evolved and added many new tricks over the years. David Tepper is a great example; he went from junk bond trading to making a killing long bank stocks etc...

      It's a tough question.

      Anyway, thanks for reading and posting a comment.

      Delete
  2. http://seekingalpha.com/article/1206981-greenlight-capital-re-s-ceo-discusses-q4-2012-results-earnings-call-transcript?part=single

    With respect to our property catastrophe aggregates, maximum exposure to a single event is $102 million and our maximum exposure to all events is $118.7 million.

    While the ratio could spike to 200% short term, I would not be concerned long term about a ratio spike.

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    1. Hi,

      Thanks for that. Yes, I am not worried about anything at the moment. But don't forget that GLRE is still in ramp-up mode. We don't know where the float leverage is going to get to over time, so a snapshot of the balance sheet today is not necessarily reflective of the risks that will be taken going forward.

      Right now, their float leverage is still very low (net premiums 60% of equity, investments 1.5x equity etc...).

      I don't worry too much as I think Einhorn is very smart about risk management. But I would not completely ignore James Tisch's comments either.

      I like GLRE even though it hasn't done well recently. But it's certainly not as 'safe' as say, BRK or MKL.

      But then again, they are totally different beasts so you really can't compare...

      Delete
  3. I think David Einhorn is a great investor.
    but...

    the problem for me here is a) the fees charged for him to manage the money, and b) they appear to have no discipline underwriting at Greenlight. What signs do you see that the float will ever be a "paid float"? It is nice to play what if on a superior combined ratio, but I see no competitive advantage for GLRE.

    At current interest rates, why not just buy into the hedge fund on margin if you want to lever Einhorn's investments. You can prob lever up cheaper than Greenlight's loose pen. Better yet, you could just go out and match his 13f if you want and avoid his fees. Lever up to your liking.

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    1. Hi,

      Thanks for commenting. As for the fees charged, note that the performance figures of GLRE investments are net of fees. I think if you outperform the S&P 500 index net of fees, then you have earned your fees.

      As for GLRE's loose pen, that's a risk for sure. You can't ever be sure with these things, but I am assuming that with Einhorn's stake (more than just his stock ownership, but his plan on using this as a way to raise permanent capital) he won't let GLRE be run to maximize market share, premium growth and things like that but would approach this more from a risk management standpoint.

      Whether or not he can do this is, of course, a big question.

      Why not just lever up on your own? Sure, why not. There are many things investors can do, and GLRE is one of them. Some ideas will be better than this, and others not.

      But I do tend to focus on U.S. listed stocks and this is one of them and it is an interesting situation.

      I'm sure many investors can set up something more interesting with access to hedge funds, prime broker, financing etc... and I don't mean to say this is the best way to get that sort of exposure.

      Thanks for reading!

      Delete
    2. Thanks for the response. I enjoy the blog, and enjoyed the article. Best of luck in 2013.

      Delete
  4. Interesting analysis. Here's a question. Let's say you're a high net worth individual who doesn't share your concerns about Einhorn's recent investment performance and really wants to invest your money with Einhorn. Given the tax advantages of investing through GLRE rather than directly in GC, aren't you willing to tolerate for a certain level of losses in the reinsurance business in order to access these tax benefits? In fact, if/when more hedge funds begin to take advantage of the Bermuda reinsurance company structure, won't these reinsurance companies start to "over-compete" with each other given the limited amount of reinsurance business that can be done and push their revenues down to a level that wouldn't be sustainable were it not for the tax benefits being enjoyed by their investors?

    I should note that this obviously isn't the case here, given GLRE's underperformance relative to other reinsurance companies. And of course this hypothetical is dependent on the assumption that these hedge funds are able to outperform the market on a consistent enough basis that it makes sense to go to all this trouble (or at least that there are investors who want to put their money in hedge funds badly enough). Lastly, I have no idea what portion these hedge fund reinsurance co's make up of the total reinsurance business, but in order for the above scenario to come true, it'd have to be substantial (otherwise they wouldn't have to "over-compete" with each other). Still, an interesting question I think.

    BTW, Bloomberg just had a really good article on the Bermuda reinsurance business: http://www.bloomberg.com/news/2013-02-19/paulson-leads-funds-to-bermuda-tax-dodge-aiding-billionaires.html that I found very edifying.

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    1. Hi,

      Good point about the tax benefit. Yes, one would assume the investor would be OK with some underwriting losses as long as the overall return is good, but I think Einhorn wants both sides to be profitable.

      As for hedge funds getting into reinsurance, yes, some funds have started reinsurance companies recently. The first one I know of was Max Re way back started by Moore Capital. It was a fund of funds type thing (part of float in fund of funds) and that turned into Alterra and they just merged (or are merging) with MKL. Max Re, though, did well in insurance but the investment side was not so good so they wound down their investments in fund of funds (run by Moore) over the years.

      Recently, SAC, Loeb and Paulson have launched reinsurance companies but they are private so I don't know much about them.

      The main question, though, is just a question of excess capital in the sector. How much capital is there? At one point there was too much capital, not necessarily from hedge fund launched companies, but just from capital all over the place looking for a return, not to mention catastrophe bonds, sidecars and other 'vehicles' where investment funds can work their way into the insurance industry. I think even Buffett said super-cat bonds and other structures do keep prices down...

      I think the view is that the supply/demand is balancing out more these days and prices are firming up; the low interest rates is making it not so attractive etc...

      Thanks for the discussion.

      Delete
  5. What are the net fees paid to invest in Einhorn via GLRE vs.via his hedge fund? For the capital invested in the hedge fund via GLRE, does Einhorn receive his usual hedge fund fee? Or does GLRE get a lower fee? Conversely, is there an additional fee paid by GLRE (over and above the fee charged to Einhorn's other investors)? Thanks in advance. The posts are consistently thorough and educative.

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    1. Hi,

      GLRE pays 1.5% management fee to DME (which is the Einhorn-owned manager) and a 20% incentive fee. The incentive fee has no hurdle rate but there is a high water mark (sort of; if the fund is underwater, DME can only earn 10% of the profits until losses are gained back and then 150% of the loss is earned).

      I don't know that they pay any other fees/expenses than that.

      Thanks for posting and the nice comment.

      Delete
  6. Howdy,

    I think you misrepresent Einhorn's returns and his ability to generate alpha relative to the S&P if you DON'T detail or list his standard dev to those returns relative to the S&P.

    I think if you look at his "outperfomance" relative to the S&P you will quickly see Einhorn like very many others creates VERY little 'real' alpha over time.

    Which btw might very well explain his recent enthrallment with gold 'as a tail risk hedge' and his latest bit of corporate 'activism' in trying to tell Apple how they can 'create shareholder value' via issuance of a preferred! Yes, beating the market is VERY VERY VERY VERY HARD, even Mr. Einhorn.

    Would only his LPs be the wiser, they may yet be as rich as Mr. Einhorn one day.

    MB

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    1. Hi,

      That's a valid point. Einhorn's performance has been very subpar in the recent past. Not too long ago, if a hedge fund didn't earn 20% or 30%/year, then it wouldn't even be considered. A sub-10% return over time is totally unacceptable for this type of fund, usually. I guess it's OK for more diversified, event-driven funds that invest more in arbitrage-type strategies with low correlation to the stock market (convertible arbitrage, merger arbitrage etc...), but for an active long/short, I do think under 10% is not really good at all.

      As for Sharpe ratios and things like that, those are really good for fund advisors and consultants to talk about. And yes, it's nice for some funds to use to demonstrate their favorable risk/return profile.

      But I am not such a big fan of that concept at all for more general hedge funds, long/short funds etc...

      As Buffett says, I would prefer a lumpy 15% to a smooth 10%. And I don't know what the fund consultants would say about each.

      But still, I understand your viewpoint and for the most part you are right. Most hedge funds don't do too well (Barton Biggs showed in one of his great books how whether it be private equity funds, venture capital funds or hedge funds, it's usually only the top funds that consistently do well. All the others do horribly.)

      And I am just assuming at this point that Einhorn is one of the guys that will do well over time even if he hasn't blown us away recently.

      But then again, he may not do well over time.

      If we knew for sure, this stuff would be easy!

      We all have to make up our own minds. GLRE really hinges on what you think of Einhorn and you can stick 10 of the smartest people in the world in a room to discuss it and you will have varying opinions that goes from one extreme to the other, I'm sure.

      Thanks for commenting.

      Delete
    2. Howdy,

      And thanks for actually answering me. I have to politely disagree however. I will not even get into Sharpe ratio specifically. I will simply point to the basic Std Dev of Greenlight vs S&P over 10yr, 8yr ,5yr period- we know the 3 yr is horrible.

      Buffett's 15% lumpy vs 10% steady is apropos to "Buffett" and most 'long only' managers, the math is straightforward why. But to long/short guys like Einhorn, no way. Why? You are "paying" him for "his alpha" and that alpha reside both in his long AND his shorts- the difference of those two is by definition his idiosyncratic 'alpha'. His and no one else's, therefore you are measuring his Einhorn 'unit' of return relative to his Einhorn 'unit' of risk.

      With a long only, you only get his performance over or under the S&P (its always long) not so with any long/short manager. He is being paid for his management of said unit of risk per unit of return and so Std Dev MUST be factored in. If not then why pay him, just be levered long S&P and make the same or better unit of return when you are lucky enough to catch 'up' years in the S&P!!! You will save yourself Greenlight's and anyone else's fees.

      Einhorn is making the case that his acumen in managing his portfolio's unit of risk per unit of return is SUPERIOR to what you would get in the S&P, period. That is his entire business model, so to NOT measure said riskiness of his return units is rather erroneous if not grossly negligent.

      Thanks much,

      MB

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    3. OK, good point. If he is long/short, he should have lower vol, so I suppose it's a reasonable expectation for his fund to have lower volatility than the market overall. So I concede that point; he runs a long/short for a reason (although he fully expects both sides to make money; he doesn't short just to hedge and be OK with losses on the short side).

      I did take a quick look at the standard deviation for 5 and 8 year periods and GLRE investment's performance has a lower volatility. I only looked at the annual figures, though.

      Also, in the worst year for the stock market (and for Einhorn), GLRE investments went down -17% while the stock market went down -37%.

      So that's pretty good.

      So I guess we go back to the beginning; what are you looking at? Einhorn has better returns in the longer term with lower volatility.

      Thanks for the discussion. Disagreements are always welcome!

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    4. Volatility is not risk for a true investor. Unless you are a day/week trader you should heavily discount the information the sharpe ratio provides. It's an vast academic oversimplification of risk.

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  7. If you want to invest in a hedge fund (which I assume is the interest in GLRE), I think Loeb's fund traded on the London exchange is a better option. TPOU trades at $13.15 or so, the fund's last NAV was $14.73. And Loeb has a better record over the last few years.

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    1. It also paid a 60c dividend in 2012, so the real return from inception in 2007 would be $15.23. 50% over 5 years is not great, but certainly better than the market.

      Delete
    2. Hi,

      Thanks. Yes, I am aware of that. That is also certainly an interesting investment, and Loeb is a great manager. I do like Einhorn too despite his recent subpar performance.

      The thing with GLRE, though, is that it's sort of not just a hedge fund investment. First of all, you do get leverage here through float. Of course, if they don't underwrite well, this may not work out too well. But if they do OK underwriting, there can be some good leverage here.

      In a presentation last year for investment return / combined ratio versus ROE, Einhorn had a slide with 175% investment leverage, so that may be a level they would be comfortable with.

      At 1.8x leverage, there can be an interesting explosive opportunity here. Of course, there can be an implosive nightmare too.

      Also, since this is a Cayman entity, the return can be retained and compounded tax free over time; a hedge fund investment may be pretty tax inefficient. Over time, this can be a major factor. Of course, there is no guarantee that this tax status will be maintained.

      Thanks for commenting.

      Delete
    3. It is in tax-free Guernsey, and if you hold it in an IRA, the tax shouldn't be a problem. But I see you're point. As I see it though, the real opportunity for a company like GLRE is to buy its own shares below book. I think a good portion of BRK's success came from buying back its own shares via the insurance subs (this wouldn't show up as share shrinkage because the shares weren't retired, but it is effectively increased leverage). But if GLRE always trades above book, that might not be an option.

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    4. Hi,

      I am not aware of BRK buying back their own shares and that being part of their success...

      But anyway, I tend to focus on looking at U.S. listed corporations, so that's the other point. There are plenty of hedge funds out there that people can invest in, but that's not really my focus of attention. I do look at closed end funds now and then (I posted about SPE last year), and I did look at Loeb's fund but I didn't really have much to say about it so I never made a post about it.

      Thanks for the discussion.

      Delete
    5. I think this is related to what you are talking about with the discussion of 175% leverage.

      http://www.opalesque.tv/hedge-fund-videos/Joe_Taussig/1

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    6. Hi, thanks, that's a great summary of it.

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  8. If you think about it, buying your own shares at 60% and selling at 120% is a guaranteed money machine. Schroeder's book talks about the "homeostatic" effect of the float and buying BRK's own shares via the subs. Thanks for tolerating my hijack of the thread.

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  9. Bjdubbs, care to elaborate on what you're saying about BRK buying its shares using subs? Have never come across that one before.

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