While many people consider themselves to be great investors, only a few investors could be considered Titans of Wall Street, who've earned billions in gains and can influence stocks with a simple tweet. Unfortunately unless you have $50 million lying around, you're not getting a hedge fund star to manage a piece of your portfolio. As such, investors have tried to find other ways to mimic the best and the brightest, noticeably by looking to 13-F filings.
13-Fs are filed 45 days after the end of the quarter, so there is a massive time lag that makes mimicking a weak strategy. For all you know, a manager could have sold a stock they showed in the 13-F, and you would be stuck with a loser for the next quarter. Similarly, the price could have changed tremendously from when they purchased a given security, further deteriorating your performance. As such, I cannot endorse using solely 13-Fs to follow billionaires' strategies, especially because there is another option. Several titans have publicly traded companies, through which they invest. I want to take a minute to briefly look at the four most notable examples: Greenlight Capital Re (GLRE), Third Point Reinsurance (TPRE), Icahn Enterprises LP (IEP), and Berkshire Hathaway (BRK.B) (BRK.A).
I want to first focus on the reinsurers. Hedge fund managers have been trying to find a way to build a permanent capital base unlike the transitory ones at their funds. After a couple of bad quarters, investors could redeem, dropping AUM or even closing the firm. These managers with longer term time horizons want the capacity to ride intermediate bumps to long term profits. In a sense, this is one reason why Warren Buffett has been so profitable. He invests permanent capital as shareholders can't force Berkshire to buy back the stock, they can only sell it to another investor on the secondary market.
Lately, hedge funds have been opening up reinsurers to build this permanent capital. These reinsurers start with about $500 million in equity, engage in reinsurance, and use the capital and premiums to be fully invested within the hedge fund. Here capital only declines when the reinsurer has to make a payment. Investing this insurance float is what Buffett has done for years through GEICO within the Berkshire family. While TPRE (investments managed by Daniel Loeb) and GLRE (investments managed by David Einhorn) are the primary public hedge fund reinsurers, there are several privately held one, including one by John Paulson and another by Steve Cohen. It would not be surprising to see more come public in the next 12-24 months.
This new supply of reinsurers, funded by hedge funds, has killed reinsurer rates, by pushing supply beyond primary insurer demand. Evan Greenberg of Ace Limited (ACE) has said Wall Street firms have pushed premiums down 5-15%, and Ace is prepared to step back from the reinsurance market because at current rates, few contracts will be profitable. This is my primary concern with these two reinsurers, a lack of profitability from their reinsurance arms.
At TRPE last year, the firm generated $136 million in investment gains but only $99 million in profits. In other words, its reinsurance operations lost $37 million, cutting your effective return by 27%. GLRE has been even worse. In 2012, investments gained $79 million, but net income was only $15; in 2011, it was $23 million and $7 million, and in 2010, investments earned $104 million while net income was $90 million. Thus over the three years, its reinsurance arms lost $94 million, knocking your rate of return down by 46%! With reinsurance rates softening further, I expect these firms' reinsurance arms to continue to lose money, dragging down returns. By buying either of these two stocks, you will serially underperform their brilliant investing managers, Einhorn and Loeb. As such, you will be disappointed if you buy them hoping to do as well as an investor in their fund.
That leaves us with IEP and BRK.B. It is important to note that these firms are conglomerates that own entire businesses in addition to an investment portfolio. For Icahn Enterprises, investments account for 39.6% of assets excluding cash. As of July, IEP's book value per share was $71, so at current levels, it trades at a 6.5% premium to book with a dividend yield of 6.6%. For Berkshire, investments account for 40.4% of assets excluding cash. As of June, book value per was $82, so at current levels, it trades at a 39% premium to book. Buffett likes to adjust book value to reflect increased value in assets on its balance sheet that have to be held at cost. This metric suggests Berkshire's "fair" book value is around $100, so the stock still trades at a 14% premium while paying no dividend.
When buying either of these billionaire's investment vehicle, you thus have to recognize that over half of the company are businesses not investments and both trade somewhat higher than book value. Equally important, both companies are reliant on their founders and would likely experience a sharp decline in price should Icahn or Buffett pass away. While both appear healthy now, Buffett is 82 while Icahn is 77, which means that their age is a risk an investor simply has to consider, as grim as it feels.
I think that Icahn and Buffett are the two smartest investors on the planet, though personally I prefer Icahn's activist approach to Buffett's long term passive one, though both men's track records are beyond reproach. I also do prefer Icahn's business mix as he is overweight autos and energy through Federal-Mogul (FDML), CVR Energy (CVI), and ARI (ARII) while Berkshire has an insurance and reinsurance tilt (which as I stated above has a pricing problem in my opinion). I don't think BRK.B should trade at a premium to IEP and consider it relatively expensive with its 14% premium to adjusted book. Thus, I would rather own IEP at current levels.
Trying to invest alongside the best and brightest is a respectable strategy but one fraught with difficulty. Due to time lags, I would avoid funds that mimic 13-F changes. TRPE and GLRE are compelling ways to invest with Loeb and Einhorn, but their reinsurance arms weaken overall returns, a problem that should be exacerbated by weak reinsurance pricing, making those stocks ones I would avoid. The two best stocks to own to follow the billionaires are Buffett's BRK.B and Icahn's IEP, though investors must be wary of the founders' health risk. In the medium and long run, I think you will do well in either, but given its smaller premium to book and preferable asset mix, I would initiate IEP here. If Berkshire declines below $107, I would consider buying it. If you want to mimic the returns of Wall Street titans, BRK.B and IEP are the only viable options.