Replicating The Big Idea
Only four asset manager backed reinsurers have gone public, and we advised three of the four. Two of them (Scottish Re, sponsored by Maverick, and Max Re, sponsored by Moore) are no longer in business.
The two remaining publicly traded asset manager backed reinsurers, Greenlight Capital Re and Third Point Re, have not only significantly outperformed their sponsors’ funds, but have also outperformed Berkshire Hathaway by a large margin. Consider the graph of $1 invested from August of 2004 through December 31st, 2013 in Greenlight Capital Re, Berkshire Hathaway, and Greenlight Capital’s Offshore and U.S. funds (GLRE and BRK were marked to market on NASDAQ and the NYSE respectively):
After nearly 10 years, the magnitude of Greenlight Re’s outperformance is a gain of $2.5 versus $1.5 for Greenlight Capital’s offshore fund and $1 for Greenlight Capital’s U.S. fund and Berkshire Hathaway. In addition, GLRE provided roughly $3 million of daily liquidity on NASDAQ, whereas the Greenlight fund investors were subject to lockups, periodic redemption and notice periods, and could be gated.
Since insurers and reinsurers are exempt from PFIC taxation, there were no K-1s nor annual taxes on GLRE’s earnings for U.S. investors and taxable investors in jurisdictions such as Australia, Canada, the UK and the U.S. are only taxed at capital gains rates if and when they sell their shares.
In an ideal world, asset managers would launch or acquire an insurer, reinsurer, or bank solely due to his or her passion for improving performance for his or her investors without incurring a proportionate increase in risk. Sadly, most managers are primarily interested in the Big Idea to secure permanent capital, gather assets, and/or lower their taxes.
On this last point, tax authorities take the view that activities undertaken solely to reduce taxes are abusive and that the tax position should be challenged, whereas additional tax benefits for investments that are made for economic reasons irrespective of taxation are generally accepted by tax authorities.
If you look at the graph above, you can see that the reinsurer has significantly outperformed Greenlight Capital’s offshore fund and an offshore or tax-exempt investor with no tax concerns would have been happy to have invested in the reinsurer instead of the offshore fund. In this case, Structural Alpha has been worth 4.7% for nearly 10 years.
If you look at the difference between Greenlight Capital’s offshore funds and its U.S. funds, the difference is 1.8%, which we call Tax Alpha. For a U.S. investor, GLRE’s Structural Alpha has been nearly 3 times its Tax Alpha and tax is a tertiary (maybe even a fourth level) benefit relative to higher ROEs and a premium to book value (for some investors, daily liquidity would be the third level).
Third Point Re is a little more than 2 years old, so a graph would not be as meaningful as it was in the case of Greenlight Capital Re. However, if you look at the table below, which compares Third Point Re with Berkshire Hathaway and Third Point’s London Stock Exchange listed closed end fund and its open ended funds from inception until December 31st 2013, the benefits are similar to those of Greenlight Re:
For asset managers, it is important to note that Greenlight Capital Re and Third Point Re have nearly $4 billion in assets, all of which is permanent capital. Furthermore, we estimate that $3 billion of these assets would not be available to the asset managers if they only offered funds and managed accounts.
Aside from nearly $2 billion in float, each of them have pensions and endowments, mutual funds, and individuals as shareholders, few if any, of which would or could invest in their hedge funds. In addition, $390 million of Third Point Re’s startup capital came from PE funds, none of which would have invested in the Third Point funds.
For additional information on replicating the Big Idea, the following two pieces are available on request:
1. IRS Notice 2003-34 – The IRS questions the PFIC exemption for hedge fund reinsurers in 2003.
2. A December 2013 piece by E&Y on the subject of hedge fund backed reinsurers