Most value investors are quite familiar with Markel Corp. (MKL) which is essentially a younger, smaller version of Berkshire Hathaway. The company is very well run both on the insurance side and on the investment side of the business.
I like to follow them for two reasons. One is whether now is a good time to be investing in Markel or other companies in their industry. The other is to listen to what Tom Gayner is currently investing in and what he is avoiding.
They had their Q4 2010 earnings call earlier this week and I made the following notes.
Combined ratio was 97% for 2010 compared to 95% in 2009. (Anything under 100% means they are effectively being paid to manage their float)
Book Value Growth
Net income to shareholders of $267 million, vs $202 million in 2009. Book value per share increased 16% to a $326 per share at December 31, 2010, an all-time high. (continuation of long term low to mid teen percentage growth in book value, current share price is $410)
Gayner Comments on Investment Results
Wonderful year on our investment operation. The total portfolio return was 8.1% or 7.9% after conversion of our results to U.S. dollar.
Fixed income deposits, we earned 5.4% in total return, which matches the coupon from the portfolio. Exactly what should happen overtime. They work hard to avoid credit losses and do not aggressively trade the portfolio trying to be a superior guesser of the future direction of interest rates of. Simply match liabilities from the insurance side against the portfolio of high quality fixed income.
But also applies common sense, which continues to suggest that rates are headed higher so continue to maintain bond maturities at a lower level in our insurance book. Thereby accepting lower current income for protection against rising rates and lower bond prices.
Fantastic year on equity side, up 20% vs 15% on S&P. Up 6.2% over the last 5 years vs 2.1%, up 7.6% for last 10 years vs 1.1%.
Equities are 54% of shareholder equity.
Markel Ventures Group
Gayner had mentioned how insurance and investing were the first two engines of growth for Market. The third is the Markel Ventures group which represents a slow steady move into controlling interests of non-insurance business (like Buffett does).
Expect $250mil of revenue from this group in 2011 and expect at least double digits of this to turn into cash flow.
(I certainly like the idea of a solid core group of businesses providing cash flow that is outside of insurance. What bothers me a bit is how you assess Markel's ability to manage such a group of companies. Not everyone is Buffett who is clearly in most cases a very astute judge of managers. And when your background is insurance, you are going to have to rely fully on the managers of the businesses you acquire.)
Gayner on Munipal Bonds
In response to whether Markel would be moving away from muni bonds because of credit quality concerns.
- Half the fixed portfolio is in munis which is about $3bil which is equal to shareholder equity
- That muni portfolio is made up of the top of the food chain
- They have a 10% rule which means never have more than 10% in one state
- Even if they have 10% in one state they won't ever have 10% in one specific bond (ie. They might own bonds on LAX and the City of Los Angeles and the City of San Fran etc)
- His personal belief is that even in a nightmare situation you aren't looking at zeros for those bonds but rather a restructuring that lowers the interest rate but still involves a full return of principal
- Comfortable with all of the risk management steps they have (clearly though they do have a lot of exposure with muni holdings equaling shareholder equity)
Gayner On What Investment Areas He Currently Finds Attractive
- Same place as he has for a few years and that is global blue chip brand name companies
- Had a really good 2010 despite not being invested in smaller caps but was instead in high quality
- Thinks commodities might sprint ahead this year but he isn't chasing as Markel are marathoners not sprinters
- Will continue to put new money into the best franchises in the world if prices stay the same
.Back in the summer Gayner was quite vocal in his presented remarks about a likely bond bubble:
Here are his comments:
"If you are tuned into the financial markets these days, it seems like deflation is the headline story of our time. As is almost always the case, the genesis for the headlines is true, true especially if you're looking in the rearview mirror of recent hard data, as opposed to the unclear, unknowable and imprecise future.
All across the globe, we face persistent unemployment issues, the ongoing deleveraging of the economy, increased savings rates and new labor pools from the developing world, which are creating more in the way of global supply than demand.
All of these factors create pressure on prices and worries about deflation. These facts and worries can be seen clearly in the low levels of inflation expectations and interest rates. I don't hear bondholders talking about things like the fact that Disney just raised the admission price and the tuition and medical bills among others continue to rise.
A one-year treasury now offers a yield to investors of approximately 0.3%. You can get almost 10 times that if you commit money for 10 years, since the 10-year yield is almost 3%. Neither one of those rates is acceptable to us.
The popular idea of investing in bonds today strikes me as about the same as the chance of Dow 36000 a decade ago. The arguments were well-reasoned and seemed plausible at the time. A bull market can make you believe some incredible things. Today the multi-decade bull market has been in bonds, not equities and I think that similar incredible ideas are out and about in the financial markets. I don't think that committing our capital for returns of roughly 3% is a good idea that will stand the test of time.
In 1904, the New York City subway system opened with a fare of $0.05. The fare stayed the same 44 years until 1948. Over the next 62 years, prices increased regularly and now stand at $2.15. Investing in long-term fixed income instruments at today's interest rates makes sense if you think the coming decades will see the subway fare remain at $2.15 or thereabouts.
Personally, I'll take the over bet and invest your capital reflecting this view. We're not interested in locking up our capital for such low nominal returns. We maintain the fixed income holdings we must to match and protect our policy holders. Beyond that, we keep cash and fixed income in order to have the option of investing differently as market conditions change and different opportunities present themselves."
The logic is hard to argue with. Of course as always, the timing of the change in sentiment is impossible to predict."
The general message from the call on the insurance side is that they are growing tired of the soft pricing market, but that they will stick to their disciplined approach.
On the investment side Gayner (like Jeremy Grantham) believes that the best quality companies in the world are still on sale. He also is avoiding any longer duration bonds as much as possible.
Here is a link to the most recent SEC filing for the Markel equity portfolio: