The Best Kind of DIY: Getting Others To Do The Work For You
One of the most interesting aspects of investing is just how many ways there are to play the game. Investing has increased in both scope and sophistication in the past several decades, from placing your faith in the performance of a single company to a collection of companies (a mutual fund), the whole market (an ETF) or the judgment of others (hedge funds and holding companies).
In the hedge fund universe, there is a significant amount of energy devoted to obtaining an edge, be it through computer algorithms, an all star management team, or the willingness to "outsource the thinking" and to invest in another hedge fund. This is called "Fund of Funds" investing, and is often inaccessible to many retail investors. This system is also potentially very costly.
In this article, I will discuss a few companies that I believe, when measured in aggregate, constitute a well diversified collection of assets that closely resemble the concept of a "Fund of Funds" - except in this situation, it's more like a "Portfolio of Holding Companies" with no excess fees.
I will attempt to highlight some similarities among these names, and I will briefly discuss why I believe that these companies are exceptional over a long term period due to their operating strength, internal diversification, exceptional management and cost benefits to individual investors.
The Leucadia Corporation (LUK)
Leucadia is a corporation that has grown mightily since it was taken over by Ian Cumming and Joseph Steinberg. Leucadia owns a diversified portfolio of assets, with its largest business currently being Jefferies, a global investment banking. Leucadia also owns and holds investments in a range of other businesses, including beef processing, timber, real estate and power generation. The company has also teamed up with another company I will mention later in this article.
Currently priced at a P/E ratio of 7.8 with a market capitalization of $9.98 Billion and trading slightly under book (P/B of .99), I believe that investors are paying a fair price for a good business. In contrast to the next two companies that I will discuss, Leucadia both splits its stock regularly and pays a dividend currently yielding .91% annually.
The Alleghany Corporation (Y)
The Alleghany Corporation has a long history and currently operates in a very similar manner to the more famous Berkshire Hathaway (BRK.B), (BRK.A). In addition to being engaged in the insurance business, Alleghany makes investments in other companies in the heavy industry, petroleum and the real estate sector. The company is also incredibly conservative, with a stated mission statement of "shunning investment fads" in favor of prudent, stable and uncomplicated investments.
Currently priced around $400 a share, the company has a P/E Ratio of 19 with a book value of $387 against a current price of $402 per share. Though the company's earnings are exposed to a certain degree of volatility which is inherent to the insurance business, the company is able to generate consistent underwriting profits in addition to float investment, with a combined ratio regularly under 100, and in some years, superior to Berkshire Hathaway. The company is of medium size, with a current market capitalization of $6.75 Billion. The company pays no cash dividend, and recently ceased paying a stock dividend which amounted to a 2% annual return (a 51:50 split).
The Seaboard Corporation (SEB)
With a market capitalization of $3.3 Billion and currently priced at $2,769 per share, the Seaboard Corporation is immediately eye catching because of its enormous growth over its long operating history as well as its high share price and eclectic operating segments.
With a P/E ratio of 13, high insider ownership (currently standing at 75%) and a very diverse operating segment including interests in Shipping, Power Generation, Pork, Alcohol production and distribution, Sugar, Milling, Turkey production and Flour Milling.
In contrast to the previous companies I have mentioned, it lacks an insurance apparatus or exposure to the financial services industry. The company also has a global footprint, with operations concentrated in North and South America and Africa.
This legendary company needs no introduction.
Currently trading at around $171,000 per A share against a book value of $122,899 and a P/E of 15 - Berkshire has produced a consistent record of earnings and growth in book value since the company was taken over by Warren Buffett.
With a market capitalization of $283 Billion, a long operating history, a highly profitable insurance business at its core in addition to a diverse portfolio of wholly owned businesses as well as a significant portfolio of marketable securities, Berkshire Hathaway provides investors with a highly diversified exposure to a broad swath of American industry.
I believe that should investors decide to construct a "Fund of Funds" style portfolio, Berkshire would represent the logical anchoring position. Despite the fact that the company is an excellent addition to a portfolio, I believe that there are two factors that investors must be aware of going forward:
1. The "Law of Large Numbers" makes it difficult for an entity of such enormous size to continue growing at the pace it has in the past, making it increasingly difficult to generate significant compounded returns over the long haul. In spite of this drawback, I believe that Berkshire will provide an excellent foundation for investors, and may even pay a dividend should the "upper limits" of growth be achieved.
2. Possible exposure to enormous one-time losses caused by writing "Super-Cat" insurance. As with any company operating with insurance at its core, an earnings record will be lumpy and exposed to the vicissitudes of world affairs. An enormous natural disaster, or one followed by another, has the potential to cause a significant one time loss for Berkshire. Though I believe the possibility of this event occurring is remote, it is something that will eventually happen, should one maintain a position long enough.
A Discussion of Similarities
When examining these companies together - some shared characteristics immediately become apparent:
1. Many of these companies are involved in the Insurance business. With the exception of Seaboard, all of the companies that I have mentioned either are or were involved in the insurance business at one time. A properly underwritten insurance apparatus provides profits not only through underwriting, but through something called the "float", which is able to be invested, typically into fixed income securities. However, in this case, it is often well-chosen equities or other businesses. This "float," when properly and conservatively deployed, functions as an interest free loan - not bad.
2. These companies do not pay significant dividends. Though Leucadia and Seaboard do pay dividends, they are not large relative to the operating earnings of these companies and for good reason. There are more profitable avenues to invest these retained earnings which can be compounded internally, maximizing returns and reducing tax liabilities for long term shareholders.
3. A high share price and aversion to splits. With the exception of Leucadia, which does split its stock, these companies all have very high share prices. A high share price reduces the chance of speculative trading "noise" and attracts the "right kind of capital", those who mean to invest in these companies over the long haul.
Advantages over "Fund of Fund" Hedge Funds: Lower Costs, Exceptional Long Term Performance
For investors that have an eye towards controlling costs, purchasing shares in well regarded holding companies with a long operating history, a diversified base of subsidiaries and record of steady growth in book value furnishes one of the best options available.
Aside from the occasional commission, individuals purchasing shares in these companies on the open market do not have to deal with the irksome nature of Hedge Fund fee structures which are typically structured along the "2 and 20" model; 2% of assets each year, 20% of profits each year.
Risk mitigation through diversification is also something to be aware of. Many of these companies that I have mentioned have a well-deserved reputation of being "fortress-like" in their capital structure and enjoy a significant margin of safety by virtue of their diversified operating segments and large cash positions.
Despite this protection they are not totally immune from significant drawdowns, as seen with Leucadia during the financial crisis. However, this single company risk is somewhat mitigated by having a portfolio of companies.
What Would I Get If I Bought These Four Companies?: Few Names, Huge Diversification
If you only invested in these four companies, you would be getting exposure to a significant amount of business including, but not limited to:
All manners of insurance, agriculture, construction, manufacturing, alcoholic and non-alcoholic beverages, investment banking, consumer products, railroads, petroleum products, mortgage origination, plastics, medical products, real estate, power generation, marine transport and more.
Through investing in these four companies, investors will find themselves exposed to an enormous cross section of the domestic and global economy. The only sector that might be overlooked or underrepresented is technology, but I'm sure there are quite a few Hedge Funds that cater to that sector.
There are many other companies that have done an incredible job in a diverse group of businesses including White Mountains Insurance (WTM), the Markel Corporation (MKL). I believe that investors will be well served to further investigate these names as my discussed examples are but a few suggested companies.
Other names with a more limited operating history that investors might be interested in examining are Prem Watsa's Fairfax Financial Holdings (OTCQB:FRFHF), Biglari Holdings (BH) and Icahn Enterprises (IEP).
I was inspired to write this article after reading about the lackluster performance of many Fund of Funds options available to investors and their "fees on top of fees" cost structure. I believe that the proliferation of many of these entities (there are, of course, deserved exceptions) is a disservice to individual investors.
It is the apex of irrationality in my mind to outsource your thinking to other people who then outsource their thinking to other people when publicly traded alternatives like this exist.
It requires very little effort for investors to cut out the middleman and benefit substantially over the long haul by selecting and holding companies of this nature that I have mentioned.
One need only take glance at a 30 year chart of these companies to appreciate the results of this strategy. While Berkshire will likely grow at a slower pace in the future, the small size of Alleghany, Leucadia and Seaboard all provide significant space for growth.
I believe that these companies that I have mentioned would constitute an excellent "Widows and Orphans" or "Desert Island" style portfolio, provided that the individuals benefiting from these assets do not require an income stream and instead have the goal of achieving a maximum total return over a long time horizon.