Another season of reinsurance earnings reporting has come and gone, and I wanted to share my summary with you. For review, I post periodic updates of price to book valuations and combined ratios of a group of companies that focus on reinsurance. I have also reviewed the industry here, and I really like this summary by Far Horizon.

Just as a reminder, the list below is predominantly comprised of Bermuda-based reinsurers. I get frequent questions about why such-and-such company isn't included, and the simple answer is that I screened the others out years ago and don't track them quarterly. The universe of reinsurance companies I describe below is not meant to be comprehensive, but rather a consistent group that I have thoroughly researched on a quarterly basis for 5 years. Any company not in the list is absent for some reason such as limited disclosure, unusual domiciles, or

Hello! This is a quarterly update on reinsurance sector. We are mid-way through reinsurance earnings season for Q1 reporting, so I wanted to post an update. For review, I have previously written about investment metrics that I follow among the reinsurers. I wanted to post a mid-earnings update, to summarize results to date, and help position for the remaining results to be released next week.

Q1 results

Initial thoughts are that results

I have written previously about investing in reinsurance companies, as well as periodic updates of price to book values and combined ratio following quarterly earnings season. U.S. and Bermuda reinsurance companies will soon report financial results for FY13 Q1. I wanted to present the FY12 Q4 spreadsheet with recent stock prices, to show the price to book value based on the most recent public book values reported a few months ago. For review, the two major metrics I track are combined ratio and price to book value. In my screening, I look for the best balance between low price to book and consistently low combined ratios.

Catastrophe Events

The first quarter was apparently one without major catastrophes. I anticipate that this is already reflected in the price run up within this sector. Recall that the fourth quarter included Hurricane Sandy. Overall the industry sustained very little hit from

Most GAAP financial statements rely on accrual accounting which includes many peculiarities such as depreciation and amortization. The reason is that it helps match income and expenses within the reporting period. For example, even though a piece of equipment might be purchased with cash, if it has a useful life of seven years, cash-based accounting would record a big hit in the quarter the equipment was purchased, while accrual accounting would depreciate it over the expected useful life. This can obscure the true ability of a business to generate cash available for owners. Free cash flow is a non-GAAP metric that can help back out some of these items to help reconcile the differences between accrual and cash-based accounting. Because it is non-GAAP, FCF is not reported on the SEC filings such as the income statement. It can be computed by taking the statement of cash flows and making

U.S. and Bermuda reinsurance companies have reported financial results for FY12 Q4. I have combed through the SEC filings and press releases and updated my tracking spreadsheet. For review, the two major metrics I track are combined ratio and price to book value. In my screening, I look for the best balance between low price to book and consistently low combined ratios. Also, there are several companies that consistently trade at price to book of over 120% and I have excluded these from my universe of tracked stocks (Renaissance Re (RNR) and Arch Capital Group (ACGL) for those who are interested). I restrict my purchases to companies that trade below book value, as these have been the richest area for takeovers and also it is a form of leverage to buy bond portfolios and reinsurance operations at below book value. Also, all companies in this sector are trading within 3%

I have been a fan of the Yale Endowment portfolio for years. This portfolio has been managed by economist, David Swenson, for 25 years. The Yale Endowment is famous for its relatively large allocations to non-traditional asset classes such as absolute returns (hedge funds), private equity, and private real estate. In the following chart from the most recent Yale Endowment report, the asset allocation is listed for the past 5 years.

(click to enlarge)

The following list uses representative ETFs to mimic this allocation. I tried to list a few alternatives to stay provider-neutral:

• Absolute return: Wisdom Tree Managed Futures, (WDTI), IQ Hedge Macro Tracker ETF (MCRO), 14.5%.
• Domestic equity: Vanguard Total Stock Market ETF (VTI), or SPDR S&P500 Trust (SPY), 5.8%.
• Fixed income: iShares Barclays Aggregate Bond Fund (AGG), or Vanguard Total Bond Market ETF (BND), Vanguard Extended Duration ETF (EDV) 3.95%.
• Foreign equity: iShares

My mission: To construct a portfolio without U.S. Treasuries or U.S. Large Caps, that will have a higher yield, a higher total return over the past 3 years, and half the volatility of U.S. large caps.

I have seen a lot written about 60/40 portfolio asset allocation, usually referring to 60% equity and 40% bonds, although sometimes reversed for more conservative investors into 60% bonds / 40% equities. I wanted to describe a twist on this strategy that I am running in one sub-portfolio. It is a twist featuring 60% bonds, and 40% equities, and the allocations within each category are somewhat unconventional.

• 60% Vanguard long term U.S. investment grade corporate bond ETF (VCLT)
• 20% international equity index ETF (VEU)
• 20% U.S. REIT ETF (VNQ).

Thus, there is no U.S. treasury bond component, and no general U.S. equity component.

Reaching for Yield

This approach reaches for yield in several ways:

If you could shrink the size of your bond allocation, but maintain the same dollar and duration-weighted allocation, and free up some of that capital to put to use in other asset classes as a result, how would that sound? I wanted to present something that might be controversial in the field of portfolio allocation.

I believe that a form of bond leverage is available in the form of duration. By holding a longer average duration of bonds, the bond portion of a portfolio can then be smaller. In effect this is free leverage. Free in terms of cost, but does hold some risk. Longer duration bonds are more volatile and can expose the investor to a larger risk of loss. However, this is accounted for by having a smaller overall bond position. Additionally, the conditions that may make bonds go down would also be conducive to a favorable stock

It is almost cliché to state that asset correlations have increased following the financial crisis of 2008, and that maneuvers such as zero interest rate policy may be driving this. My question is whether the markets have been fundamentally altered in the aftermath of the financial collapse. I did not test multiple different time frames. I simply selected in advance the relatively benign year 2006 and compared to 2012. Also, I used exchanged traded funds rather than individual equities (except for the business development company, Ares Capital (ARCC), since there are not mutual funds consisting solely of those).

This is an exploratory, idea-generating analysis intended to be a starting point rather than a destination. The assets under consideration, along with their stock ticker, and brief description of the asset class:

[Author note: The following analysis was performed by me in 2007, prior to the financial collapse. I am presenting it here for historical context. The most significant change post-collapse was the near-bankruptcy of Allied Capital (ALD) although it was acquired by Ares Capital (ARCC). A forthcoming post will assess how the correlations of the assets listed below have performed post-collapse, and whether the same findings still apply.]

Introduction

The majority of investment portfolio returns is due to the mixture of asset classes within the portfolio, with only a minor portion of returns being attributable to the actual individual securities selected within each asset class. This analysis focused on the correlations of several mutual funds with each other, and did not study the investment returns of the overall portfolio mix.

With this in mind, I selected a variety of relatively low-cost, widely available funds belonging to the asset classes:

• US real

I am reading the book, The Innovator's Dilemma, (1997, revised 2011, Harper Business and Harvard Business School Press) primarily for my work in the biotechnology space, but I quickly saw that it had some investing ramifications. The author, Clay Christensen, has a website here, and a book chapter is available here. The book starts with a case study of the computer hard disk drive market, going back to the 1960's. For computer geeks, it's actually a pretty good read about the technology and how innovations occurred over the years.

In summary there are two types of innovations:

1. Sustaining technologies

2. Disruptive technologies

Sustaining technologies are described as incremental improvements demanded by the main current customers of the dominant companies within a sector. In technology this would mean things like more memory, faster memory, larger storage capacity, etc. Large, dominant companies do this quite well because they have

Markets have increasingly become correlated, in what some commentators feel is a consequence of zero interest rate policy (ZIRP). Another way this gets described is "risk-on", and "risk-off" trades. Part of our investment philosophy is to seek out isolated, less-correlated investments to accumulate as core holdings, and also to trade around the edges of these positions to take advantage of non-correlated peaks and troughs relative to the rest of the market. As I have described previously, one way that we do this is through writing naked puts to acquire positions, and to sell off appreciated positions through covered calls, a strategy which also nets some time decay premium as well.

My goal in this article is to test several investment ideas:

1. Whether iShares Barclays 20+ Year Treasury Bond ETF (TLT) and SPDR Gold Trust ETF (GLD) serve as effective diversification tools relative to SPDR S&P

I have previously written about investing in reinsurance companies, followed up by how to use free cash flow to help analyze these companies, but I intentionally left out one of the behemoths in this space: Berkshire Hathaway (BRK.B). Part of the reason is because BRK.B is a conglomerate that invests in a diverse array of industries, including pipelines, railroad, private jet leasing, candy stores, and jewelry stores, in addition to various lines of insurance. It didn't seem fair or easy to lump this conglomerate into a comparison of other companies that have operations limited to reinsurance and insurance lines. In addition, it is harder to compare the metrics when the insurance lines are buried in such large numbers produced by all the other sectors in which Berkshire conducts business. Well, my curiosity got the better of me, so I wanted to at least see how Berkshire's reinsurance lines

I recently updated my reinsurance company spreadsheet to include free cash flow (FCF), and wanted to post an update on this prior to the Q4 earnings season coming up in a few weeks. (For review, I have previously discussed reinsurance company investing in prior installments one and two).

According to wikinvest, a definition of free cash flow is that it is a non-GAAP measure that

measures the cash flow available for distribution among all the security holders of a company, including equity holders, debt holders, preferred stock holders... Many investors prefer to track free cash flow as opposed to GAAP earnings because it is much more difficult for companies to fake cash flow.

For learning the thesis behind free cash flow investing, I found a fairly simple review here, and a more technical review here. In those reviews, you will find details on how

I became interested in the offshore drilling sector 8 years ago as an asset class fairly uncorrelated to the S&P 500, and as a diversifier against my reinsurance stocks. I also believe that oil supplies are becoming harder to find and the growing global demand for oil necessitates going to offshore sources to meet that demand. Look no further than the fact that new wells are being drilled in water that is 12,000 feet or deeper as a testament to the fact that the easier and cheap sources of oil are largely exhausted. In a way, offshore oil drilling is "the last frontier", and an expensive one. Frankly, I'd rather invest in the companies with the tools necessary for this drilling, rather than the oil companies that have to pay for these costs of drilling. (The rig owner gets paid even if it ends up being a dry hole).

I have several written articles recently on a brief introduction to fundamental-based investing in the reinsurance sector, and on a put-writing strategy as a way to initiate positions. Now, I would like to go a little deeper into a technical strategy at timing the initiation of these positions, and summarize the entire strategy.

The 52-week high

Percent of 52-week high is another metric I follow. It is always more comfortable for me to buy something that has sold off rather than buying at a new recent high. You can usually find some companies trading at 85% or 90% of the 52-week high, even as other members of the sector are reaching their own 52-week high. Reinsurance is not a momentum sector like technology where stocks just keep running up and up. Show some discipline in your buying, and wait for the occasional sell-off, because they always seem to happen. As

I recently wrote an introduction to investing in reinsurance companies. I mentioned in that article that I often acquire shares by writing uncovered put contracts. In this article, I will tell you how and why I use that approach, with examples at the end. I write puts on reinsurance stocks primarily to generate income, and secondarily to acquire shares of a targeted company at a desirable price. What I like about put writing is that you are a seller of a wasting asset; in other words, the option seller benefits from the passage of time, all other things being equal.

Theory behind the strategy

I like writing puts on reinsurance companies for several reasons:

1. Reinsurance companies have an ongoing random risk of loss due to catastrophes they insure, which in theory should lead to permanently higher implied volatilities.

2. The majority of companies in this space trade below book

The Reinsurance Industry

Contrarians take note: the reinsurance industry is one of the least followed investment sectors that I have seen. Reinsurance is the business of accepting large risks to help offload risk from a primary insurer to a specialty company. Just as you have a deductible in your home, auto, and health insurance, these same insurance companies have a deductible of their own, and for outsize losses they have their own insurance: reinsurance. It turns out that regular insurance companies aren't really in the business of taking risk. They are financial and retail companies, and have little appetite for actually holding the risk for the policies they are underwriting. The process of reinsurance allows the industry to better diversify against large risks, and also reduces the capital requirements that insurance companies would face. It would be difficult for any single insurance company to insure large events such as earthquakes