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Brian Abbott
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In investing, I have a heavy focus on reinsurance companies, and I enjoy learning how to value their investment portfolio and underwriting ability, taking inspiration from the reinsurance companies that Warren Buffett used to help build Berkshire Hathaway's investing empire. The other focused... More
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Montana Semi-Precious Metals
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  • Hedge Funds To Return 4-5% Per Year Through 2018?

    Wow. That's all I can say after reading this article in Business Week quoting the recent forecast from Goldman Sachs (NYSE:GS) Private Wealth unit.

    Goldman Sachs Group Inc. (GS)'s private- wealth-management unit expects hedge funds to return an average of 4 percent to 5 percent over the next five years as the industry struggles amid low interest rates.

    "Everybody hopes to get the five hedge funds, all of whom are going to have 15 percent returns," Sharmin Mossavar- Rahmani, chief investment officer of Goldman Sachs Private Wealth Management's Investment Strategy Group, said at a press briefing today. "People need to be more realistic."

    This is amazing. Hedge funds typically charge 2% a year for management fees, plus 20% of gains. Plus, your money gets locked up with restrictive provisions dictating specific timing and procedures required in order to get it back. So a 4 to 5% annual return for the next 5 years is extremely significant, as forecasts go.

    I am going to spend some time digesting this. Maybe there are some other factors behind this forecast, such as other investments that Goldman Sachs gets more fees from, for example. I agree we're in a low return environment for a while longer, most likely. But hedge funds have a bunch of MBA's from Harvard. They're supposed to be really smart to deserve all those fees. 4 to 5% ? That makes bonds yielding a pretty safe 2 or 3% look like a pretty good deal, even with their interest rate risk.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Tags: GS, hedge funds
    Jan 11 6:58 PM | Link | Comment!
  • Is Tin A Semi-Precious Metal?

    OK, semi-precious may be a stretch. We'll come back to that choice of title at the end. I am trying to pay homage to the mini-boom we experienced in "rare earth" metals a couple of years ago. After all, the first step of a bubble is having a catchy meme. If in a few years we see a boomlet in tin mining stocks.... well, perhaps you heard it here first.

    An introduction to tin

    Tin is usually considered a base or industrial metal. Tin (Atomic Number 50, symbol Sn) is used in the manufacture of solder for electronics and a variety of metal alloys. It is a significant component of pewter and bronze, for example. It has also found more use in manufacture of plastics and fire retardants.

    The US Geological Survey has a nice overview of tin statistics. A brief summary of the variety of uses of tin, from the USGS:

    Today, most tin is used as a protective coating or as an alloy with other metals. Tin is used as a coating for steel cans, in solders for joining pipes or electrical conductors, and in bearing and other alloys for widely diversified applications. Tin is essential to an industrial society and in many applications for which there are no completely satisfactory substitutes.

    The largest producer of tin, by far, is Indonesia. In the past, the instability of this region has led to price spikes in tin. Essentially no tin is mined or smelted in North or Central America. Tin's price per pound is about 3 to 5 times that of base metals such as zinc, lead, and copper, yet it is much cheaper than precious metals such as silver, gold, and platinum. Hence, I think tin could in the future be considered a "semi-precious" metal.

    Tracking tin prices

    A number of price charts for tin are available at infomine. I happen to like the 5-year tin price chart - long enough to show some trends, but not so long as to be overwhelmed by the impact of chronic inflation like the longer-term charts suffer from. As you can see, recent prices have been US$8-14 per pound, which is about 2-3 times the low reached following the 2008 financial crisis. This is similar to the behavior of many other, more common commodities.

    (click to enlarge)5 year Tin price chart

    This compares with copper recently at $3 per pound, zinc at under $2 per pound. On the other hand, the least expensive precious metal is silver, at approximately $30 an ounce. This is why I introduce the concept of tin as a "semi-precious" metal. I hypothesize that if and when global inflation ramps up, and silver becomes priced out of reach for low-end investors, that tin could become considered an "investable" metal. Of course, this is pure speculation on my part. But just as a thought exercise, I wanted to go through the process of finding out exactly how to invest in tin.... just in case!

    Investing in tin equities

    There are no US-based companies with significant exposure to tin. The equities that trade on global markets are predominantly listed in Canada and Australia. Since those markets aren't discussed on Seeking Alpha and are generally risky investments that trade on the US OTC market, I didn't go any further into them at this time. The closest US equity miner listing I could find was the Market Vectors Rare Earth/Strategic Metals ETF (NYSEARCA:REMX). While its top holdings do not include any primary tin miners, the movements of this fund do seem to track with tin prices. Plus, one would get the added benefit of diversification, which is a plus when investing in the volatile sector of mining.

    Another way of getting even more direct exposure to the metal is the exchange traded note, iPath Tin ETN (NYSEARCA:JJT). A more diversified base metal ETN is the ELEMENTS Rogers International Commodity Metal ETN (NYSEARCA:RJZ). Other base metal ETFs and ETNs are listed here, but none have as much tin exposure, if any, compared to the Rogers fund. As a reminder about risk, ETNs carry the credit risk of the issuer, which did become material during the 2008 credit crisis.

    Tin futures and physical metal

    For even more esoteric and possibly riskier ways to invest more directly in tin, futures traders could trade tin on the London Metal Exchange, via futures (where prices were recently US$24,000 per ton). Obviously, futures are risky and potentially illiquid in a market such as tin. You can buy and take delivery of smaller quantities (with a markup, of course) from metal suppliers such as Rotometals (a supplier I have dealt with over the past years a number of times). Finally, I have seen tin ingots for sale on Ebay!

    Conclusions

    So this initial foray into tin as an investment metal has yielded a few conclusions thus far:

    • There are few ways to get exposure to tin mining in the US markets
    • The most direct exposure is the exchange traded note, JJT
    • Physical markets are available, but not widely

    The contrarian in me wonders if the lack of interest in tin means I might be on to something.... a potential future trend. The spike a couple of years ago in the rare earth sector was on my mind as I did this initial research. Successful investing sometimes requires looking in unexpected places for the trends of the future. The nature of the thinly-traded tin market, along with continued global growth, potential global inflation, and the concentration of tin mining in volatile unstable, parts of the world, could create the makings for a base metal bubble.

    Thank you for reading, and good luck in your investing endeavors!

    Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in JJT over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Jan 06 6:01 PM | Link | Comment!
  • Assessing Profitability Of Reinsurance Companies

    As a follow-up to my previous article about investing in reinsurance companies, I wanted to delve into how to assess the profitability of these companies. The combined ratio is the most accepted measure of an insurance or reinsurance company's underwriting profitability. For review, the combined ratio, or CR, is a combination of the loss ratio and the administrative overhead. Lower is better for the CR.

    Another component of profitability is the investment income, but since most portfolios are mostly bonds, that income has been diminished lately in the zero interest rate policy.

    Combined ratio is available from several sources. While I normally obtain CR figures from each individual company's quarterly earnings statement, they are also available in summary form from several sources. You may be able to access research reports through your stockbroker. Also, there is an industry group, Association of Bermuda Insurers and Reinsurers. This association publishes semi-annual updates as shown below, which include a number of metrics such as premiums written and combined ratio. You can also go to their website and obtain data from prior years.

    (click to enlarge)ABIR Sept 2012 report

    Looking even longer term

    While 6 months is better than a single quarter, you may also wish to look at a number of these to get an idea of the longer term underwriting trends. Wikinvest charts this for annual data as shown in this example for Axis Capital Holdings (NYSE:AXS)(although they seem to stop updating the numbers after 2008!). I haven't found other sources, so I just track it myself.

    Comparing Companies

    While comparing combined ratios, it is also important to note how the company compared to peers. For example, in a year with major catastrophes such as 2011 which had earthquakes in New Zealand and also the Japanese tsunami, companies that avoided these tragedies and stayed more profitable might deserve a look. However, the flip side of this may be that the company was simply pursuing different (more conservative) lines of risk, which will ultimately make the company less competitive in years without major catastrophes - especially as pricing rebounds in markets such as those affected by the NZ earthquakes, or the Hurricane Sandy affected areas. In other words, companies that pursue less risk (an example would be Maiden Holdings (NASDAQ:MHLD)) will look better in years of catastrophes compared to companies that took more short-tail catastrophe risk, such as Montpelier Re (NYSE:MRH). It is not necessarily skill in underwriting, so much as chronic risk aversion and lower average profitability.

    Company Metrics

    My reinsurance company list is shown below, current as of January 5, 2013, and updated with 3rd quarter 2012 book value and combined ratios, and current percentage of 52-week high:

     

     

      201220122012 
    companycurrent priceQ3 BVQ3 P/BQ3 CR% of 52wk hi
    Arch Capital (NASDAQ:ACGL)$44.63$36.79121%90%99%
    Aspen Insurance Holdings (NYSE:AHL)$33.26$41.5380%87%99%
    Axis Capital Holdings (AXS)$36.15$43.5783%85%93%
    Endurance Specialty (NYSE:ENH)$41.72$54.9576%100%97%
    Greenlight Capital (NASDAQ:GLRE)$23.10$23.5798%114%88%
    Montpelier Re Holdings$23.76$26.6189%73%99%
    Partner Re (NYSE:PRE)$82.89$99.5483%81%98%
    Platinum Underwriter (NYSE:PTP)$48.01$54.6088%61%100%
    Everest Re (NYSE:RE)$112.78$131.2286%87%98%
    RenaissanceRe (NYSE:RNR)$80.82$68.20119%53%98%
    Validus Holdings (NYSE:VR)$34.96$33.91103%70%93%
    XL Group plc (NYSE:XL)$26.01$32.8279%92%100%

    A few key observations:

    • Price to book value ranges from 76% to 121%
    • Combined ratios for this single quarter range from 53 to 114%, a wide range of profitability!
    • Most companies are close to 52-week highs, and only one has sold off more than 10% off the 52-week high
    • There is not an obvious link between more richly P/B valued companies and favorable CR. Arch Capital with the richest P/B has a middling CR for this quarter, for example.

    Possible next steps would be to chart out combined ratios over a longer period of time. However, as discussed below, I am not aware of proof that this would necessarily result in a superior investment decision.

    Risk

    It is impossible to completely separate out risk when investing in the reinsurance sector. This industry earns its very profits from risk itself. Yes, there is skill involved in underwriting, but after 7 years of following this industry I can tell you it is nearly impossible to truly assess this. This is because all combined ratios are rear-looking. They tell you nothing about the current book of risk, although they may hint at it, as noted above comparing MHLD to MRH. Another point is that there can be reserve releases or charges which essentially retrospectively change the combine ratio in a subsequent quarter based on longer tail claims data. I would caution the investor to not get overconfident in their understanding of any single company, because there can always be an earthquake or hurricane the next quarter in an geographic area in which your favorite insurer was overexposed - something that none of the previous combined ratios could have possibly told you.

    Contrary to what some Seeking Alpha commentators have posted about assessing underwriting skill, I feel that the best antidote to company-specific risk is to diversify in several companies. I choose to invest in the top 4 or 5 based on my own metrics, as hinted above. This is where I have faith in the competitiveness of underwriting labor and the pricing of risk. I think there is not much alpha available from underwriting skill in this space. Capital is very fluid and once a profitable area is found, it will rapidly attract more risk capital and bring more competitors -which brings down price, which inherently makes the combined ratio less favorable in that segment or geography. Much more important, I feel, is the broader industry-wide pricing factors of hard versus soft market, for example.

    Also, going too far back in analyzing companies can be counter-productive or give a false sense of confidence, for several reasons:

    • Underwriting personnel can change
    • Company coverage policies can change over time, in response to changes in management or perceived market conditions
    • Pricing conditions change year to year
    • Perils change year to year, whether earthquakes, hurricanes, or crop failures for example
    • Even if a company overcame ALL of the above, this should quickly be factored into stock prices and price to book value, as investors acknowledge a truly superior company. This would bring forward-looking returns back into line with industry averages.

    Upcoming Updates

    Earnings season for reinsurers largely will start the first week of February. I will be watching closely and posting updates. Thanks for reading, and I hope I achieved the right balance of informing without getting too esoteric.

    Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AXS, PTP, ENH, AHL, RE, PRE over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Tags: ACGL, GLRE, MHLD, MRH, VR, AXS, long-ideas
    Jan 06 5:29 PM | Link | Comment!
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