BERNSTEIN RESEARCH
Actuaries on Wall Street: the party is truly over...
CAGNY Presentation
November 28, 2001
Analyst: Todd Bault
212-756-1857
BaultTR@bernstein.com
Cop yright 2001, San ford C. Bernstein & Co., LLC, a su bsid iary of Alliance Cap ital Management L.P. ~ 767 Fifth Avenu e ~ N ew York, N Y 10153 ~ 212/ 486-5800. All rights reserved .
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BERNSTEIN RESEARCH
Agenda
• What I do (overview of institutional research)
• What I think (about how to look at stocks)
• What I recommend (actuarial career advice)
Warning: don’t tell me anything!
• Seriously, all communication regarding a company needs to be through
Investor Relations (if you work for a mutual, gab away)
• If I hear inside information, I am “tainted”
– I cannot speak to anyone (including bosses) until information is disclosed
– They often send analysts away to remote places during tainted periods
(not so bad—Bermuda ranks pretty highly)
• We can talk all day about the industry and general issues, or anything
that I or a company have publicly disclosed
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Quick bio—Todd Bault
• Industry background
– Fellow of the Casualty Actuarial Society (FCAS 1994), Member of the
American Academy of Actuaries
– St. Paul Companies 1988-1998
• Officer—Corporate Development: strategic planning, acquisition analysis
• Corporate Financial Actuary: rate of return analysis, acquisition valuation
• London Reinsurance: pricing, reserving, planning, strategy
– Odyssey Reinsurance: 1998-1999
• Senior Vice President & Chief Actuary
• Brought in by new CEO to help turn around company (then TIG Re)
• Developed new products, structured deals, helped set policy and strategy
• Other stuff
– Named “Up-and-Comer” for Non-Life Insurance in 2001 Institutional
Investor rankings of US equity analysts (#8 overall out of 21)
– Education
• SUNY at Buffalo: BA Mathematics, BFA Music Composition
• Michigan State University: MS Applied Mathematics
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Sanford C. Bernstein
• Was one of the last private partnerships (like Goldman)
– And is no more (like Goldman)—bought by Alliance Capital for $3.5 billion
– Combination is very powerful and complementary
• Asset management
– For pension funds, mutual funds, private clients
• $92 billion under management; $438 billion for Alliance in total
– Value focus (low P/E stocks), complements Alliance growth emphasis
– Private clients a specialty
• Institutional research
– What I do
– Outsourced research for institutional clients
– Bernstein hallmark is detailed, unbiased research
• No investment banking (conflict of interest)
• Analysts from covered industry, not “The Street”
• Very highly ranked coverage (in the top 10 overall, many top 1-3)
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My life as a stock analyst, by the tick
World changes here:
Downgrade Progressive, investors buy
insurance stocks
92% outperformance
from initial hard sell
S&P P&C Index (SPCCC)
Join Sanford C. Bernstein—previous
employer who hired me out here 16 month
earlier not pleased
1,200
1,100
1,000
Neglect to
downgrade stocks
before New Year’s-tsk tsk
Insurance industry
promptly goes to
hell without me
900
Miss downgrading
Allstate in time, but still
get 80% outperformance
800
700
7 months later, decide not
to push launch and see
opera with wife, missing
bottom
600
500
Launch here instead--could
be worse; personal lines
recommendations treated
with scorn and derision
Absolute performance
Nov-01
Sep-01
Jul-01
May-01
Mar-01
Jan-01
Nov-00
Sep-00
Jul-00
May-00
Mar-00
Jan-00
Nov-99
Sep-99
Jul-99
May-99
Mar-99
Jan-99
400
Relative to S&P 500
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Institutional investors
Support
services
Buyside
analysts
Portfolio
manager
Buyside
traders
• Institutional investors manage money for others
– Mutual funds, pension funds, hedge funds, private clients
– Called the “buyside”, as they buy the stock for their customers (retail
investors)
• Centers around the portfolio manager (PM), who makes the
investment decisions
– Buyside analysts provide research and insight to the manager by sector,
investment style, or individual stock
– Traders execute the manager’s trading decisions
– Vast network of support services: IT, admin, legal & compliance, etc.
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Institutional research
•
Support
services
Buyside
analysts
Sellside
analysts
& sales
force
Portfolio
manager
Sellside research
•
Buyside
traders
•
•
Sellside
traders
•
Support
services
Institutional research is
nothing more than
outsourcing the buyside
research
Generally viewed as
more in-depth research
than is possible on the
buyside
Called the “sellside”
because—well, good
question!
All functions are
replicated, with many
relationships between
PMs, analysts, and
traders
Sellside sales force
extremely important in
providing visibility and
relationships for analysts
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Economics of a broker/dealer
• We make money by generating trades from institutional investors
– 6 cents a share and falling—compare to 8-30 cents for online retail trades
– We can be paid lots of ways
• Directly for specific trades based on recommendations
• Indirectly for overall advice provided (e.g. I pitch insurance, you buy IBM)
– What broker/dealers provide for that 6 cents:
•
•
•
•
Research and advice—the principal product of a sellside analyst
Execution—some institutional trades are labor intensive and specialized
Banking—taking companies public and giving clients access to IPOs
Capital—commit capital behind clients to provide liquidity
– Bernstein does not do the last two (ask Meyer about this…)
• Banking is a conflict of interest to research
– Example: most 1998-2000 tech research was secondary to the deals, and is
considered highly suspect by many clients
• Capital commitment enhances banking and other relationships
• Yet we are still paid the full 6 cents—we need to justify that with very highquality research
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Sellside analysts
• We perform three key functions (the Mahedy list):
– Recommend stocks
• Most obvious: we estimate earnings, set target prices, and make buy/hold/sell
recommendations
• It’s great to be a great stock-picker, but not necessary (great stock pickers
often become PMs)
– Provide detailed research on industries and companies
• Build company earnings models, conduct industry strategic studies, talk to
company management, customers, regulators, etc.
• Many ways to do this successfully:
–
–
–
–
Quantitative/technical approaches that talk about stock behavior
Qualitative/fundamental approaches that talk about company/industry behavior
“Schmoozing” to dig up the good company dirt (hedge funds are masters of this)
Best approach combines all of these to some degree
• How people did this without the Internet is beyond me!
– Act as “thought partners” for clients
• Perhaps the most valuable service we provide
• In the end, PMs pick stocks, not analysts, so just picking our brains to gain
comfort with their own intuition is extremely important
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What’s important to investors?
• Making money--period
–
–
–
–
Investors buy stocks, not companies (sorry, Mr. Buffett)
They buy stocks if they think the price will go up
They sell stocks if they think the price will go down
Stocks that don’t move are bad
• Understanding companies is a means to making money
– If there were another way, they’d use it, and many do (e.g.
technical analysis)
– So investors will never care as much about an industry or company
as an analyst
– As a sellside analyst, you are an expert they consult to help them
make money in stocks from you industry
• Not easy--investors are a VERY smart bunch!
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What matters to investors regarding non-life insurance?
• Pricing, pricing, pricing
– The #1 concern, without peer: one could talk about nothing but this and be fine
– This despite the fact that pricing can’t easily be measured by investors
– Investors want to buy ahead of pricing increases, and consequently far ahead of
earnings
– Supply-focused, as demand is viewed as fairly constant
• Quality of balance sheet and financials
– Loss reserves a big concern, very hard for outsiders to analyze
• But relationship of reserves and earnings not well understood by some
– Capital adequacy matters for ratings, ability to bear risk
• But the flip side is the dreaded “excess capital” problem
– Also concerned with asset quality, cash flow, debt
• These are overemphasized by investors--they are more important in other industries
• Qualitative factors (AKA what actuaries ignore)
– Insurance is so difficult to analyze that these take on added value
– Quality of management, market share, business profile are examples
Afterthought: I never would have guessed that insurance stocks had such high
trading potential, but they become mis-priced constantly
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How do investors and analysts value insurance companies?
• Discounted cash flow
– Our preferred method: takes into account all economic factors
– A properly managed DCF model serves as a valuation anchor
– But many investors don’t like the complexity or the parameter sensitivity
• Price/book
– Best surrogate for DCF, and used with many other financial stocks
– Stocks usually trade in a range of P/B, with some premium for future earnings
– Not as useful for comparing companies (capital structure matters)
• Price/earnings
– #1 valuation tool for stocks generally, so it matters
– Most investors understand that P/E less useful for insurance given volatility
– P/E could be more useful if normalized, but then why not use DCF?
• P/E is in fact a very quick and dirty DCF model
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So you want to be a millionaire…ah, stock analyst?
• Can actuaries do this job?
– I’ll let you know for sure in a couple of years
– Yes, of course—this is a great application of actuarial skills, even
outside of covering the insurance industry
• Should actuaries look at non-insurance options?
– Absolutely—our modeling skills and general risk training are
applicable in any industry, suitably adapted
– Actuaries should also pursue broader roles in insurance companies
• Should actuaries supplement their training (CFA, MBA)?
– Only if you want the credentials—they are not necessary
– But either would probably be well-received by “The Street”
• So, can I be a millionaire as an analyst?
– I’ll let you know for sure in a couple of years
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Do actuaries have the right stuff?
• Ask your CEOs—the CAS CEO study is valuable reading
• What actuaries are good at:
– Math, basically—quantitative and analytical skills
– But this is very valuable—many people are weak in this area
• What actuaries need to work on—everyone of these is very applicable
to equity analysts and other financial jobs:
–
–
–
–
–
Develop general business skills and a broader perspective
Learn to operate under uncertainty and take business risks
Generate creative ideas or solutions
Grow and mature beyond their technical training
Improve modeling techniques
• develop models that do not require large bodies of historical data
• incorporate current information and trends into models
– Provide quicker, more responsive solutions
– Improve teamwork skills with non-actuaries
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My views on some specific criticisms
• Some actuaries are too narrow/technical and need to develop general
business skills and a broader business perspective
– Very common complaint: I generally agree, but don’t lose the technical
background—it’s our edge
• Actuaries do not have an interest in running a business and therefore
are of little value in the organization
– All activities must help run the business, and given that actuarial work
does this, key is effectively conveying the value of that work
• Actuaries are expensive
– So are stock analysts and any other high-value talent
– Insurance industry is losing out on high-quality people with this attitude
• Not getting help from actuaries on most important business issues
– Actuaries should help define the important business issues—this criticism
implies that we are not effective at this
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My views on some specific criticisms
• There may be too much comfort for actuaries to stay within their own
"narrow" discipline
– This is applicable to nearly everybody in some way (including CEOs),
despite media saturation that we’re all entrepreneurs now
• Actuaries are pursuing greater precision in areas of decreasing
relevance
– It is the actuary’s job to show relevance—you’re the expert
– It is also human nature to refine the known rather than push boundaries
• Actuarial tools not adequate to handle the demands of the fast-paced,
competitive world in which we now live
– This is wrong, but actuaries must show why:
• Tools only as good as users
• Non-statistical personnel generally underestimate uncertainty
• Response that “large ranges don’t tell us anything” doesn’t change the fact that
the range is large
• Must show how understanding the uncertainty fully is useful (manage
downside, hedging, act when others are scared, etc.)
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BERNSTEIN RESEARCH
Addendum: What the insurance industry thinks of stock analysts
Day by Day (The Analyst’s Song)
Day by day,
Week by week,
Quarter by quarter,
Three things we seek:
To keep the top line growin’,
To keep the cash flow flowin’,
Prevent the loss reserves from glowin’
So the analysts will cheer.
Month by month,
Year by year,
They think our business is linear,
Well, we can’t out shrewd ‘em
And we can’t subdue ‘em,
So we’ll smother ‘em with b***s*** and delude ‘em every
Day by day, by day by day, by day by day, by day by day, by day by day, by day!
Words by Mark Hinkley
Sung to the tune “Day by Day” by Stephen Schwartz
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