Over the first-quarter of 2016 the results of the two main hedge fund backed reinsurance firms diverged, both on underwriting and investment returns, as Einhorn backed Greenlight Re reported a profit, while Loeb backed Third Point Re fell to a loss.
After one of the most volatile periods in the history of these hedge fund reinsurance companies in the last few months of 2015, when both firms suffered negative investment returns for the full-year, 2016 began in a similarly volatile manner, but one firm has suffered worse than the other as investment results particularly diverged through Q1.
Greenlight Re, backed by hedge fund manager David Einhorn’s Greenlight Capital, Inc., and Third Point Re, backed by hedge fund manager Daniel Loeb and his Third Point LLC firm, have both had a fairly torrid time thanks to the financial markets lately, but over the quarter Einhorn’s strategy came out on top.
Greenlight Re reported net income of $28.7 million for Q1 of 2016, compared to a net loss of $24.0 million a year earlier. The main reason for the difference was net investment income of $28.4 million, a gain of 2.5%, compared to a loss of $24.8 million on investments in Q1 2015.
For Third Point Re the investment side of the business was less profitable and drove the hedge fund reinsurance company to a loss.
Third Point Re reported a net loss of $51.1 million in the first-quarter, compared to net income of $50.5 million in Q1 2015. Investment performance made most of the difference, with the portfolio suffering a net investment loss of $40.1 million, compared to net investment income of $64.9 million a year earlier.
Third Point Re’s quarterly investment performance was -2% for Q1 2016, compared to 3% a year earlier, so a 5% differential. Greenlight Re reported an investment gain of 2.5% for Q1 2016, compared to a -1.8% investment loss a year earlier, so a 4.3% differential, but for Greenlight Re this was in a positive direction.
So investment performance has diverged considerably in the first-quarter of 2016, driving the profitable result in the case of Greenlight Re and the loss in the case of Third Point Re.
On the underwriting side divergence was also clear, as Third Point Re reported a combined ratio of 104.9%, which CEO John Berger said was “in line with our expectations given current market conditions and the lines of business on which we focus.”
Greenlight Re meanwhile reported an underwriting profit for the quarter, with a combined ratio of 97.3%, although it should be noted the firm has changed the way this is calculated slightly to exclude non-underwriting related corporate expenses. However the ratio still beat the 99.8% from Q1 2015, so is impressive.
For a hedge fund reinsurer, or investment oriented, total return or hybrid strategy (whatever you prefer to call them), getting a profit on both sides of the business is the ultimate goal.
If the underwriting can be kept profitable, so at least paying its way, then the float can build up and generate more investment income. The problem comes when the float is invested in volatile strategies, which both Einhorn and Loeb tend to do, compared to some other investment oriented players who take less asset risk.
And this is the big question about this strategy. How much asset risk is too much?
When you’re assuming risk on the underwriting side, as that after all is the business of insurance and reinsurance, how much asset risk should you take on the investment side?
Perhaps the answer is in a target return, across both sides of the business. If a reinsurer could target a 95% combined ratio and between a 5% to 10% annual investment return, the level of risk required on the asset side would not be that much more considerable than some traditional reinsurance players take, but the overall return would be at the market level (perhaps even upper right now).
Commenting on a profitable quarter, Greenlight Re CEO Bart Hedges said; “We are pleased to report positive performance from both our underwriting and investment operations during the quarter. We continue to be encouraged by our current underwriting portfolio as we grow our existing client relationships and selectively add new business in a competitive environment.”
And on the asset side, Einhorn added; “Our investment portfolio performed adequately during the quarter as our portfolio remained defensively positioned in an uncertain investment environment. We are pleased with the current growth and diversification of our underwriting portfolio.”
Berger of Third Point Re commented; “Despite challenging conditions in both the financial and reinsurance markets, we continue to believe in our total return model.”
These have not been easy months for the hedge fund reinsurance firms, and the second quarter has again begun with an element of diverging performance. Third Point Re reported a positive investment return of 1.8% for April 2016, leaving it at -0.2% year-to-date, while Greenlight Re reported -0.7% for April and 1.8% for the year so far.
It’s the volatility inherent in the bets that hedge fund managers like Einhorn and Loeb take that result in the varied performance. Over the longer-term, it’s easy to see how if the financial markets are kind these strategies can be very profitable.
But while the volatility persists we’re likely to continue to see divergent performance, as the strategies respond to market conditions in different ways.