Greenlight Re: Death Of Value Investing?
Summary
- Greenlight Re is a bet on a value investing strategy returning to historical performance.
- The investment portfolio, combined with its 1.7x leverage, has produced a sharp YTD drop in book value.
- If the rally in the FANG stocks continues, there is a risk GLRE could come under pressure from regulators and / or ratings agencies.
Much has been written about the death of value investing of late; The investment strategy pioneered by Warren Buffett is in crisis. Additionally, there has been much discussion of the recent under-performance seen by Greenlight Capital (one of the most well known value investors): What Exactly Happened to David Einhorn?.
On Friday, Greenlight Re reported its investment returns for June 2018 and after what some hoped was the start of a recovery in May has made a turn for the worse: the investment portfolio was down 5.8% percent in June vs. 0.1% for the S&P 500 and 0.6% for the IWM. For the year, the portfolio is now down 15.2% vs. 1.7% for the S&P 500 and 7.4% for the IWM (YTD returns through 6/30/18, exclusive of dividends).
Source: GLRE Investment Returns
It's also important to note that GLRE's investment portfolio is levered ~1.7x on its equity so the 15.2% decline in the investment portfolio actually translates to a book value decline of ~26% for the year. This is a pretty stunning figure given the market is effectively flat to up on the year - this type of negative result in a fairly benign market environment is pretty alarming, especially in a levered insurance company.
Judging by the latest performance figures, it may be time to start wondering at what point GLRE risks an extinction level event. Probably the first rule of running an insurance business is asset liability matching and ensuring it holds in different scenarios: said another way, you want to ensure you assets are positioned properly such that they turn into cash when you need it to pay claims. In my opinion, GLRE has some of the worst ALM positioning I've seen even in a scenario where Greenlight is ultimately vindicated and the infamous "bubble basket" it has been betting against corrects, it may be a Pyrrhic Victory at that. For example, in a scenario where they are proven right and Tesla, Netflix, and the rest of the bubble basket correct, it seems likely that many of the Greenlight longs do quite poorly as well; it is not clear that Greenlight would actually make money in such an environment. Take the largest disclosed Greenlight positions at 3/31/18: GM, BHF, and Aercap. GM went bankrupt in the financial crisis, many of BHF's life insurance peers were down on the order of 90% at the nadir, and AerCap was similarly down 80+% at the nadir.
From a conceptual standpoint, running a levered investment strategy invested in stocks that either went bankrupt or came close to it last crisis is a concerning way to run an insurance company - the primary objective when running an insurance company is to make sure you are always able to pay claims. It's also worth noting that Greenlight's very high concentration in a number of small and mid-cap names means liquidity might be hard to come by in a stress scenario. If there were a combination of a severe catastrophe event and a prolonged market downturn, GLRE may be unable to raise the capital necessary to fund its claims without taking a substantial permanent loss of principal.
At some point regulators and / or ratings agencies may begin to get worried about the financial strength and trajectory of Greenlight Re. I'd think it's irresponsible not to; the stock market is flat this year, and GLRE's book value is down 25+%. Durability of a business is one of the principles of value investing; unfortunately in this case, the shorts in the Greenlight portfolio seem much more durable and likely to survive over time than the longs - that does not bode well for Greenlight Re itself which is a levered investment in those stocks funded by a break-even reinsurance business at best (historically Greenlight Re has lost money on underwriting but this has been somewhat better of late). It's also not that crazy to imagine the bubble basket appreciating considerably from here - the core tenet of value investing is being situated to withstand the market volatility so you survive to see your estimate of intrinsic value vindicated - it isn't clear to me this business is positioned as such.
There is a great quote about George Soros that in the midst of getting crushed in the 1987 crash he decided to liquidate most of his positions - purportedly he told the guy on the other side of the trade: "I'm going to walk out of here, they're not going to carry me out." It seems like Greenlight Re is risking getting carried out.
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