Re-insurance risk

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packer16
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Re-insurance risk

Post by packer16 »

I like the idea of re-insurance risk as diversifier. Therefore, I think it may make sense to holds a group of good re-insurers as diversification and return enhancing investment. I have heard some talk about SRRIX but IMO this is an expensive option that has had poor historical performance versus skilled re-insurers like Berkshire, Fairfax and Markel.

I have heard the objection that this approach adds market beta to re-insurance but I have hard time believing that the amount of market beta is material because most the insurance portfolios are bonds, typically 90%+ & therefore when you buy a re-insurer you are getting re-insurance risk plus bonds. So when people make a statement like you are getting market risk when you buy a re-insurer must be assuming that the market is missing the fact of what they are buying when they buy a re-insurer & is not smart enough to "look trough" the stocks to the underlying assets.

Another point about re-insurance is selectivity. They key to marking money is good underwriting & the diversification approach followed by SRRIX can be in fact the wrong strategy to follow in re-insurance as you want to choose you areas wisely & focus on them & invest counter-cyclically. Also the publicly traded re-insurers have a huge cost advantage to SRRIX as they can provide management at basis point levels vs. SRRIX's 2%+ expense ratio.

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nedsaid
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Re: Re-insurance risk

Post by nedsaid »

My take on eliminating beta risk with non-liquid or semi-liquid investments is that it is an illusion. Asset values fluctuate in price regardless of whether those assets trade or not. It is like living in a house and ignoring the change of market values, values change whether you choose to look at them or not. It is liking putting beta or market risk behind the curtain and choosing not to look at it. I would agree that a cheaper way to get into reinsurance would be to own directly publicly traded re-insurance companies.
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Re: Re-insurance risk

Post by aristotelian »

I would consider holding 5-10 or so stocks in this industry. I can't imagine you would be taking on much more risk than an active fund focused in this sector.
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Re: Re-insurance risk

Post by boglerdude »

Well, commodities stocks behave like stocks, not CCFs. And gold miners dont track gold too well.

SRRIX requires an advisor. Hoping Vanguard starts a fund
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Re: Re-insurance risk

Post by packer16 »

The difference between the miners & the commodity is the miners have costs (so there is operational leverage) & financial leverage. So buying miners is buying leveraged exposure to a commodity with all the lenders ahead of you taking most of the return most of the time, similar to shipping companies. With insurance companies you have variations in leverage constrained by regulators, who prevent too much leverage, like banks. So the insurance companies get most of the return versus others in the case of miners.

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golfCaddy
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Re: Re-insurance risk

Post by golfCaddy »

AIG FP effectively bankrupted AIG. With a large insurance company, do you really understand all the risks that it is exposed to?
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Re: Re-insurance risk

Post by stlutz »

With mining stocks or reinsurance stocks, the prices will fluctuate based on market expectations of future earnings, not so much on what was earned over the past 12 months.

How well the reinsurance industry performs would still drive your returns over the long haul.
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Re: Re-insurance risk

Post by packer16 »

IMO the insurance risk managers like Buffet, Markel & Watsa know more about re-insurance risk than some relatively inexperienced folks running SRRIX. One clue is the masters focus in area they have an edge versus trying to diworsify into areas to reduce volatility. IMO the market is becoming more efficient so the differences in value between groups of assets publicly held (re-insurance stocks) vs. privately held (funds like SRRIX) should converge over time.

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Re: Re-insurance risk

Post by brentflog »

packer16 wrote: Sun Mar 18, 2018 6:46 am IMO the insurance risk managers like Buffet, Markel & Watsa know more about re-insurance risk than some relatively inexperienced folks running SRRIX. One clue is the masters focus in area they have an edge versus trying to diworsify into areas to reduce volatility. IMO the market is becoming more efficient so the differences in value between groups of assets publicly held (re-insurance stocks) vs. privately held (funds like SRRIX) should converge over time.

Packer
Just curious what insight or special expertise you have to state that the SRRIX folks are "relatively inexperienced". Are you an expert in the field or did you just stay at a holiday inn? Also, why do you say it has performed poorly? It seems to me that it basically has performed like it should, if there are large natural disasters like a bunch of hurricanes then the fund should be expected to lose money. Did VFINX perform poorly during 2008 because of some fund management decision or did it do what it was supposed to do.

There seems to be a bunch of money that has flowed into this space over the last few years which would tell me that the premium will likely be lower than it was in the past. Also it is behaviorally a difficult fund to hold. Slow steady small gains followed by large fast losses.

The alts that Larry speaks about are not magic bullet investments and if not well understood, should not be used. If well understood and behavior and expectations can be managed then they could be valuable. That is a tall task for most though, which is precisely why they will likely continue to work.
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Re: Re-insurance risk

Post by james22 »

From an interview with Jim Tisch and Joe Rosenberg of Loews Corporation in the Fall 2012 Graham & Doddsville newsletter:

Over the last few years a few hedge fund managers have started P&C insurance businesses. Given how well you know the space, what are your thoughts on this?

Tisch: I think they are crazy! I haven’t looked at this carefully at all but the thing I know is that they are generally going into the reinsurance business. It’s really easy to lose a lot of money in the reinsurance business.

There are a lot of people in that business who sound like they are really smart and who know a lot about it. One thing I think these upstarts need to remember is that it’s not written that your losses can be only 100% of your premiums. They can go much higher than that.

And I assume that these hedge funds are getting into this business because they see it as a source of permanent capital, but the reinsurance business is not an easy business, as it’s basically blind risk that you are taking. You don’t really know what the risk is and it’s easy to lose a lot of money.
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Re: Re-insurance risk

Post by packer16 »

brentflog wrote: Sun Mar 18, 2018 9:58 am
packer16 wrote: Sun Mar 18, 2018 6:46 am IMO the insurance risk managers like Buffet, Markel & Watsa know more about re-insurance risk than some relatively inexperienced folks running SRRIX. One clue is the masters focus in area they have an edge versus trying to diworsify into areas to reduce volatility. IMO the market is becoming more efficient so the differences in value between groups of assets publicly held (re-insurance stocks) vs. privately held (funds like SRRIX) should converge over time.

Packer
Just curious what insight or special expertise you have to state that the SRRIX folks are "relatively inexperienced". Are you an expert in the field or did you just stay at a holiday inn? Also, why do you say it has performed poorly? It seems to me that it basically has performed like it should, if there are large natural disasters like a bunch of hurricanes then the fund should be expected to lose money. Did VFINX perform poorly during 2008 because of some fund management decision or did it do what it was supposed to do.

There seems to be a bunch of money that has flowed into this space over the last few years which would tell me that the premium will likely be lower than it was in the past. Also it is behaviorally a difficult fund to hold. Slow steady small gains followed by large fast losses.

The alts that Larry speaks about are not magic bullet investments and if not well understood, should not be used. If well understood and behavior and expectations can be managed then they could be valuable. That is a tall task for most though, which is precisely why they will likely continue to work.
My expertise, although limited, is observing & investing in insurance for over 18 years. I also have some friends who are in the business & are fellow insurance investors. I have seen what works & what does not. IMO what does not work is trying to get re-insurance exposure all the time. What skilled insurers do is find niches where they have an edge & invest when others will not. To certain extent, re-insurance is more of a zero sum game than equity investing where you have growth of cash flows over time that provides a nice tailwind. In that case diversification across the tailwind makes sense. If you are dealing with a zero sum game diversification can hurt you as the average is zero.

Let's look at the combined ratios for the last year for BRK, MRK & FFH. The combined ratios were form 105% to 107%, about a 6 to 7% loss versus a 10% underwriting & float loss for SRRIX. SRRIX's returns also include returns on float where as the 6 to 7% losses do not. As an example, Fairfax had an average investments return of 8.2% since inception so on average this makes the insurance co losses gains v. losses for SRRIX. In addition, you are paying over a 2% expense ratio for SRRIX just to lose out to more skilled players who have much lower expense ratios & taking on illiquidity risk to boot. I like the idea of re-insurance risk, I just think SRRIX is poor choice in how include in your portfolio. Just some additional info.

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Re: Re-insurance risk

Post by nedsaid »

After reading through this thread, an important question emerges. How does the Stone Ridge Re-Insurance Fund control its risk? Can it control its risk enough to keep a catastrophic event from busting the Fund? Does the fund itself buy re-insurance? I can see a parallel between re-insurance and shorting stocks. In theory, your losses could be for all intents and purposes unlimited. This is where really good underwriting comes in.

From what little I have read about this, it seems that Warren Buffett picks his spots carefully. If he sees something in a deal he doesn't like, he just walks away. Probably, all the big reinsurers do this. Just because you have a sign on the door doesn't mean you have to take all the business opportunities that show up.

Pretty much there is a big difference between knowing what you are doing and just thinking that you know what you are doing. Packer is right to raise the question about the knowledge and experience of the Stone Ridge managers, I don't know the answer. Perhaps Larry will personal message someone with his input.

A couple other issues got raised. One was the institutional money going into re-insurance and the question of whether this would drive down the performance of such investments. It would also seem to me that scale is a big issue here too, you want the size to be able to absorb the occasional big loss.

My guess is that re-insurance contracts are very carefully written. The underwriters would put limits on the financial risk they were willing to take and of course it all depends upon how accurately they price that. Seems to me to be a very sophisticated business and it does seem scary that hedge funds are venturing into this. I wonder if retail investors ought to go here.

Edit: I suppose I will just have to pull up the Stone Ridge prospectus and read up on exactly what they are doing. For example, I thought that the Stone Ridge alternative lending fund was making loans directly to the consumer, just like a bank. It wasn't actually quite like that, it was buying the loans at the various direct to consumer lending platforms. So I wonder if Stone Ridge is really directly in the business or perhaps buying insurance contracts? I suppose that just as consumer loans and mortgages can be purchased, so could insurance contracts? Is this what the hedge funds are doing?
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Re: Re-insurance risk

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For your information, Larry did respond to some of the questions. Here is his response:

"You also I believe are incorrect in your understanding of SRRIX. Since they basically only buy quota shares, meaning entire slices of the books of the reinsurers, no cherry picking, they are getting the same underwriting as the people they are buying from, the leading reinsurers. This is very different than with hedge funds who typically are looking to add alpha--my underwriters are better than yours. That is not the case with SRRIX or any SR fund, they are only seeking to gain exposure to BETA, not alpha (except through patient trading). You therefore might want to correct that post."

I asked some follow-up questions:

"But how do you know that SRRIX is getting all of the re-insurance slices and not the only the ones the insurers want re-insurance on? Would they not want sell the higher risk business that they may not have underwritten and retain the stuff they understand more? Would this not lead to am adverse selection issue? My understanding from studying Buffet, Markel & Fairfax is that insurance is a business where you want to pick your spots and buying a cross section over time may not be desirable, like junk bonds. I have seen in some journals (FAJ) and the industry average combined ratio being 100% would put some doubt in my mind that investing over the whole cycle is good idea. Is there date to show the purchased re-insurance slices are at least equal to the industry loss/combined ratios?

The other issue, which over time will as others enter the market be resolved, is high fees. Given the small shop they have, the fees they charge are pretty high. I am assuming they provided some type of historical actual return and low correlations they generated to convince you the expected returns and correlations were realistic."

here is the response:

"as to how we know, re SRRIX, that's the benefit of working with not just any advisor but one that has the depth of resources and knowledge that we have. We did literally years of research on SR before investing with many meetings. And I worked with insurance company and ran credit for the largest mortgage company in country, and we have many contacts with great depth of experience we utilize to help with the due diligence, stuff you would never get to see.

SR works as long term strategic provider of capital to reinsurers and that enables them to get those type deals. And you want not to pick spots but highly diversified across risks and regions, otherwise you think you are smarter than the market and the evidence is that you aren't, in insurance as well.

As to fees, yes they are high and wish they were lower .... Unless pure commodity you look at value. Like two index funds on same index. There are in fact somewhat cheaper alternatives to LENDX (River North) and SRRIX (Pioneer) but we currently utilize SR funds even though more expensive because we believe they are superior talent and able to negotiate better deals so will have higher returns. To give you example of the stupidity of focusing on costs ONLY SR has negotiated significantly lower servicing fees from the lenders, which of course goes right to the bottom line. So even if have somewhat higher ER the net return to investors is higher.

Costs matter but value added is what really matters. "

I agree on his assessment of cost versus value on fees but am still skeptical of the approach/implementation of getting market re-insurance risk as being a good idea. I do not see why not investing in the equity of re-insurers would not be a better approach. It has provided higher returns over time with exposure to re-insurance risk. I will take return over non-correlation anyday as I use ST bonds and bucketing to provide my cash needs (especially in today's low fixed income return environment) vs. non-correlation that takes away return. Time will tell.

The structure of the fund, a beta fund vs. an alpha fund, explains the lack of underwriting experience in portfolio manager and analysts. These folks are Wall Street and fund insurance structured products folks versus underwriters. If that is the case, you would expect more index-fund type fees versus actively managed fees which we appear to have in SRRIX.

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Re: Re-insurance risk

Post by nedsaid »

The reinsurance concept for retail investors is an interesting one. My take is that those who recommend alternative investments are allocating about 20% of a portfolio to these investments. Larry is recommending such things as the AQR Style Premia Fund (factors), Alternative Lending, Reinsurance, and Portfolio Insurance. Probably, if you invested with Buckingham, about 5% of your portfolio would be in reinsurance.

The risk would be if Factors, Alternative Lending, Reinsurance, and Portfolio Insurance could go south at the same time. Factors, Alternative Lending, and Portfolio Insurance would be highly affected by markets and the economy. Factors, in theory, should not be correlated to the markets. Reinsurance would correlate to natural disasters and not the markets and economy.

My problem with alternatives is that these are beyond my expertise and experience. The factor type funds use leverage and shorting, two things I have zero experience in. Alternative Lending and Reinsurance involve underwriting, something else in which I have zero experience. Hard to evaluate these things on my own, pretty much have to rely on experts. You then have to have faith that your experts are better than other experts.

20% of a portfolio in alternatives will most likely work out for investors. The concepts are great but I will be interested in how this works out for retail investors who often suffer from the "late to the party" problem and who find that the best deals go to the big institutions. Hopefully Stone Ridge would be in the position to get some of the better deals. What has worked for such folks as David Swenson at Yale might not work so well for retail investors.

Again, where I a Larry Swedroe client, I would "get with the program" with faith in Larry, his firm, and the underlying research. It seems that his four recommended alternative investments are diversified enough that they are likely to help a portfolio and unlikely to hurt it. But that is only my semi-educated guess.
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Re: Re-insurance risk

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Got comments from Larry Swedroe based upon what I had posted. Posting to correct whatever comments I made that Larry thought were wrong.
got this one wrong. Alt lending may NOT be affected at all by markets as it only correlates with unemployment, and markets can crash without unemployment rising. I can cite several examples. But of course they can both crash. However, a crash in PRIME alt lending (like SR) is a loss we think of maybe 8%, vs say 60% in stocks. Yet similar expected return to TSM but 1/4 of vol and much less than that downside

Larry

And this:
BTW, even in an 08 with 10% unemployment that means 90% employed and the high quality credits have much lower unemployment rates than average, which is why the losses are limited if you stay high quality historically. Note even in 2008 bank credit card lenders made money
And more:
no problem
UE is unemployment

So you can have bear markets like in summer 1998 and in 2011 and yet UE did not rise so the returns then in that type period will be negatively correlated. But of course you get a 2008, negative demand shock. and UE goes up and market goes down and LENDX will have say a 3 SD event, but that is maybe an 8% loss versus say 50-60 for stocks. And very low duration so little inflation risk

Note re the comments on reinsurance, the comments show almost complete lack of knowledge of what SRRix does. Except for small amount of CAT bonds held for liquidity purposes the fund ONLY buys quota shares from about 10 of the leading reinsurers. So slices of entire books of business, No cherry picking. If they like the premium you should to. What happens beyond that is only a negotiation for how much of the premium the ceding company gives up. It won't be 100% because they have all the origination costs. But a Stone Ridge as multi billion provider of capital as strategic partner is able to negotiate more favorable terms than smaller players, just like they are able to negotiate lower servicing fees on LENDX loans (offsetting some of the higher ER if you will).

Note the quota shares are in effect buying reinsurance beta, with no attempt at trying to generate alpha like hedge funds in this space do, as they try to figure out which risks are mispriced.

What the critics fail to understand is that you cannot simply by an index of insurance or loan risks, so you have to run a company, a reinsurer or a bank, and from that perspective SR fees are IMO reasonable, leaving investors with equity like returns with much less than equity like risks

Larry
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Re: Re-insurance risk

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Thanks nedsaid. In response, to Larry's last comment, this critic does understand that to get re-insurance and credit exposure you have to buy it as a part of a larger business. But the real question is it worth the cost to get pure exposure to these risks. The alternative for re-insurance is to get re-insurance exposure via price re-insurance cost combined with primarily a bond portfolio with in some cases some equity exposure. The question is the additional returns from the primarily bond operations & selective exposure based upon insurance pricing worth more than the 200bp drag associated with SRRIX? IMO the bond re-insurance option is. Another factor is lack of marketability for both re-insurance & alt-lendning. For the re-insurance stocks you can sell and rebalance when you want with SRRIX the options are more limited. The same factors need to be considered for alternative credit & credit card companies. I did some historical analysis comparing said products against other market implementations & found higher returns & lower costs with a stock implementation. I have asked for details behind these trade-offs made by Larry or other & have only got responses like I do not understand & we have experts that can get access to these great deals others cannot. IMO this is not enough information for me to compare the 2 sets of analyses to show that investing in SRRIX or LENDX is worth the cost.

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Re: Re-insurance risk

Post by Random Walker »

Packer16,
Not sure I understood your point, but if you’re talking about buying the stocks of reinsurers, that would defeat the diversification purpose of buying the reinsurance business directly. See a post today from Larry in the above reinsurance thread. The stocks of reinsurers have too much market beta in them. Buying directly into the business is what provides the big diversification benefit. The interval structure certainly does limit rebalancing and tax loss harvesting opportunities, but it also provides some illiquidity premium too I would think.

Dave
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Re: Re-insurance risk

Post by packer16 »

Dave,

Do you know if there has been any issues with repurchases not being filled since SRRIX started? I know they limit redemptions to 5% of total shares per quarter but if they have patient capital then this should not be a material issue. Thanks.

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Re: Re-insurance risk

Post by nedsaid »

packer16 wrote: Mon Jun 04, 2018 6:40 am Thanks nedsaid. In response, to Larry's last comment, this critic does understand that to get re-insurance and credit exposure you have to buy it as a part of a larger business. But the real question is it worth the cost to get pure exposure to these risks. The alternative for re-insurance is to get re-insurance exposure via price re-insurance cost combined with primarily a bond portfolio with in some cases some equity exposure. The question is the additional returns from the primarily bond operations & selective exposure based upon insurance pricing worth more than the 200bp drag associated with SRRIX? IMO the bond re-insurance option is. Another factor is lack of marketability for both re-insurance & alt-lendning. For the re-insurance stocks you can sell and rebalance when you want with SRRIX the options are more limited. The same factors need to be considered for alternative credit & credit card companies. I did some historical analysis comparing said products against other market implementations & found higher returns & lower costs with a stock implementation. I have asked for details behind these trade-offs made by Larry or other & have only got responses like I do not understand & we have experts that can get access to these great deals others cannot. IMO this is not enough information for me to compare the 2 sets of analyses to show that investing in SRRIX or LENDX is worth the cost.

Packer
Packer, my best guess is that the answer to your questions would be found in a careful study of the prospectus and the annual reports of these two funds. There gets to be a point that if there is a secret sauce or a business model, they don't want to reveal too many details as they don't want somebody copying them. There might be details you can't get to no matter how hard you try. In other words, you are probably trying to get at proprietary information.

Yes, you could somewhat replicate SRRIX and LENDX with baskets of similar public companies. Larry and Random Walker would say that you are exposing yourself to beta risk. I have always believed that the market value of assets change whether they are liquid or not. I might be all wet on that one but that is what I believe. So lack of beta might be an illusion but these are long term investments anyway and you are trying to pick up an illiquidity premium. Larry would say that the illiquidity premium is there for the taking for patient investors. So you could perhaps mostly replicate these two Stone Ridge funds with more volatility and without an illiquidity premium. Your historical return comparisons might not be 100% apples to apples comparison. Hard to say.

Larry has messaged me a few times on these topics and gradually this stuff is sinking in. These are areas that are outside my investing expertise and I have to put the old noggin into higher gear trying to conceptualize these funds. The basic concepts of lending and reinsurance don't seem too hard to understand, what has confused me is how SRRIX and LENDX actually operate. Getting there but I probably still don't understand 100%.
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Re: Re-insurance risk

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Random Walker wrote: Mon Jun 04, 2018 10:33 am Packer16,
Not sure I understood your point, but if you’re talking about buying the stocks of reinsurers, that would defeat the diversification purpose of buying the reinsurance business directly. See a post today from Larry in the above reinsurance thread. The stocks of reinsurers have too much market beta in them. Buying directly into the business is what provides the big diversification benefit. The interval structure certainly does limit rebalancing and tax loss harvesting opportunities, but it also provides some illiquidity premium too I would think.

Dave
Even if they have beta, shouldn't you be able to compensate by taking some of the reinsurance out of the stock side? For example, instead of 40% bonds/40% stocks/20% SRRIX, 40% bonds/20% stocks/40% reinsurers, if you assume reinsurers act like 50% stocks and 50% alternatives.
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Re: Re-insurance risk

Post by Random Walker »

I think Larry once mentioned something like his firm had looked into buying the stocks of reinsurers and shorting the equity market so that an investment would have no or little net equity market exposure but retain significant exposure to the characteristics specific to reinsurance. This sounds similar to golfcaddy’s idea. I think I remember Larry saying they decided this was inefficient way to do it.

Dave
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Re: Re-insurance risk

Post by stlutz »

I think Larry once mentioned something like his firm had looked into buying the stocks of reinsurers and shorting the equity market so that an investment would have no or little net equity market exposure but retain significant exposure to the characteristics specific to reinsurance. This sounds similar to golfcaddy’s idea. I think I remember Larry saying they decided this was inefficient way to do it.
I don't think that it works anyhow. Suppose SRRIX is up 7%, the reinsurance stocks are up 7% and the S&P 500 is up 15%...
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Re: Re-insurance risk

Post by ClosetIndexer »

Random Walker wrote: Mon Jun 04, 2018 9:37 pm I think Larry once mentioned something like his firm had looked into buying the stocks of reinsurers and shorting the equity market so that an investment would have no or little net equity market exposure but retain significant exposure to the characteristics specific to reinsurance. This sounds similar to golfcaddy’s idea. I think I remember Larry saying they decided this was inefficient way to do it.

Dave
Perhaps an approach like this is less efficient than owning SRRIX, but I wonder if it could be a decent alternative for those of us outside the US. Certainly in back tests switching a few % of the equities side of my portfolio into Fairfax increases sharpe ratio significantly. (Although presumably with a fattened left tail.)
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