It’s not often that you can buy into a legendary value investor hedge fund at a discount. Third Point Re (TPRE, Financial) might be the exception.
Ever since Warren Buffett’s Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) found long-term success, hedge fund managers have scrambled to set up their own insurance companies. In this structure, the insurance entity focuses on underwriting policies, while the premiums are managed by the hedge fund manager.
It’s a win-win scenario for a few reasons:
- Outsized returns – According to Ernst & Young, “these reinsurance vehicles are virtually certain to outperform funds managed by the same asset manager using the identical investment strategy.” The reinsurance entity can invest its capital in the hedge funds strategy, however, it also receives profits from its underwriting activities, which in turn generates profits, and these cash flows are also invested into the asset manager’s investment strategy. “Accordingly,” Ernst & Young continues, “provided that the investment returns are positive over the long term, the reinsurer is virtually certain to outperform a fund with an identical investment strategy.”
- Tax benefits – If you invest in a hedge fund, you’ll need to file a K-1 every year, paying taxes on your allocation of any capital gains, dividends, or interest income. By owning the stock of a hedge fund manager’s reinsurance company, you pay simple capital gains taxes when you sell your shares.
- Permanent capital – Hedge funds typically see wild inflows and outflows based on quarterly, even monthly performance. As an insurance entity, premiums continue to flow in regardless of the market or investor sentiment. This allows the manager to remain long-term focused. Plus, any movement in the reinsurance companies stock won’t effect the underlying availability of capital.
Setting up a reinsurance entity takes a significant amount of time (think years) as well as millions in start-up costs. Once one is public, you can typically rely on it for long-term investing purposes. While Dan Loeb’s Third Point Re has only been public for a few years, his investing record dates back to 1995. Since that time, results have been extraordinary.
As you can see from the chart above, his performance has had its years of underperformance. Still, his long-term value focus has resulted in statistically significant outperformance over the past two decades.
What would you pay to buy into one of his funds? How about below book value? The past 12 to 18 months have been tough for value investors, especially with the market still above historical valuation ranges. Hedge fund titans like Pershing Square’s Bill Ackman (Trades, Portfolio), Greenlight Capital’s David Einhorn (Trades, Portfolio) and Glenview Capital Management’s Larry Robbins (Trades, Portfolio), all posted losses last year of almost 20%. Third Point Management meanwhile lost only 1.4%.
To start the year, however, Third Point’s portfolio continued to decline, with investors pressuring TPRE’s valuation down to just 0.9x book value. To buy into one of the industry’s best stock pickers at less than the book value of his assets seems like a reasonable long-term strategy to wealth creation.
