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September Idea of the Month: What about Deflation?

A buy for the pessimists, and checkins on Altius, REITs and more

By Travis Johnson, Stock Gumshoe, September 16, 2016

Time for some “Idea of the Month” thoughts for you, dear Irregulars.

When you think the investing climate is a little more nerve-wracking than usual, why not go with a master investor who’s also nervous and is preparing for an awful economy?

I’ve spoken quite a few times about my fondness for insurance company stocks. If these kinds of companies are well run and can underwrite risks profitably, they get to use other peoples’ money to make more money for you. It’s a great business, usually driven by interest rates (insurers put most of the money they might use to pay future claims into relatively safe investments, largely bonds) and by pricing for premiums (what they charge when they’re selling insurance coverage).

Interest rates are likely to not go down much more, which is relatively good for insurers — it means they don’t get the tailwind of capital gains from their bond portfolios that they’ve enjoyed over the past few decades as rates have fallen, which is a shame, but they would get to continually reinvest both their float and their own money at higher rates, which is good (and likely more important when it comes to long-term returns).

All of this exists in a continuum — if rates stay low, that’s generally bad for insurers, but if rates go up and insurers compensate by cutting prices for policies (insurance folks would call this a “softening” market), that’s also bad. Insurance companies have a tendency to get too competitive and price their risk too low, and when interest rates were a bit higher you often saw insurers consistently lose money on their underwriting just because they knew they could still make money with their bond portfolios.

That’s why investors put so much emphasis on choosing excellent insurance companies, and why those excellent companies that are consistently great at underwriting tend to be more expensive… and yes, the companies that are consistently great at investing sometimes get expensive, too, though investment returns are not generally all that consistent for anybody over relatively short periods of time (as we’ve seen from some insurers that have done quite poorly with bad patches on the investing side, like the hedge fund-managed insurers Third Point Re (TPRE) and Greenlight Re (GLRE) — both of which I’ve owned and written about in the past, I don’t own either currently).

I’ve noted ...

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