Andrew Holt says Markel has an impressive investment track record. Its chief architect, Steve Markel explains how it works
That being the case, Steve Markel and Thomas Gayner, the investment gurus behind Markel Corporation, have an impressive track record of showing up at just the right time.
From 1986 to 2006 the company’s book value has increased at a compounded rate of 23% annually. And over the past 10 years, the returns on Markel’s stock investments have averaged 14.3% annually and doubled over the past five years.
So what’s the secret? Well, the investment philosophy is simple, investing in companies with four key characteristics: profitability, managed integrity, an ability to reinvest in capital and a fair price.
“It is important to ingrain this discipline in good years because we will need to remember it and stick to it during bad years,” says Markel. The largest holdings currently are Berkshire Hathaway, CarMax, a used car seller; and Diageo, maker of Johnnie Walker Scotch and Guinness among others.
As “value” and long term investors, Markel says: “All good investors suffer years of under-performance. In those times, it is easy to lose your moorings and drift into different styles and methods of investing since whatever discipline or approach you were using didn’t work out so well over the most recent 12-month period.
“The success of our investment strategy is best analysed from reviewing total investment returns over several years. Our portfolio policy is to ensure that credit risk does not exceed prudent levels.”
Many insurers have seen their profits suffer because of a short-term investment approach. Why then do they do this? “Many insurers do not want to take on investment risk because they are already doing that on the underwriting side,” says Markel.
Markel’s method of treating its shareholders as partners has also produced significant results.
He also emphasises the importance of employee ownership, but says there is no use in giving stock options to employees. “We felt a stock option was a gift that didn’t really create an ownership mentality,” he says.
Instead the company uses low-interest loans to help employees buy Markel stock. The benefit, says Markel is that the company can then recruit people who have a desire to build wealth and understand the benefits of stock ownership. It does make the meeting with shareholders interesting, as half of them are employees.
Markel adds that this investment discipline also tends to create excellent tax efficiency over time. “The items we focus on, such as basic profitability and good investment attributes, are typically long-term attributes of a company. As such, we tend to buy and hold equity investments for significantly longer periods of time than most institutional fund managers.”
The result is that Markel defers the payment of taxes into the future rather than paying them every year as a short-term investor would. This aspect is evident on its balance sheet.
As of 31 December 2006 Markel had unrealised gain on its investment portfolio of $712m, with a deferred tax bill of $249m. The unrealised gain is invested, earning a return for Markel shareholders.
The long-term approach means that Markel does not get caught up in the boom and bust cycle – a feature of the late1990s when the tech boom went bust in a very big way.
“In the short-run, it is easy to sell at the cheapest price and grow at the expense of underwriting discipline. In the long run, this will always be a disaster
Steve Markel
“Back in 1999, we owned no tech stocks and no telecom. When the market environment gets caught up in things, generally speaking we’re not up there,” says Markel.
“Looking long-term is critical in both underwriting and investment,” adds Markel. “A great common danger in insurance is to seek premium growth at the expense of underwriting profit.
“In the short-run, it is easy to sell at the cheapest price and grow at the expense of underwriting discipline. In the long run, this will always be a disaster.”
The investment returns help to boost shareholder value. “We measure financial success by our ability to compound growth value per share at a high rate of return over a long period of time.”
For the year ended 31 December 2006 book value per share increased 32%.
Markel is conservative when it comes to loss reserves, choosing to keep them at levels that are redundant, creating a margin of safety so that loss reserves will prove adequate.
“It’s impossible to set loss reserves perfectly since they represent an estimate about the future outcome of unknown events. Given this uncertainty, we do our best to understand what drives these outcomes, monitor these drivers closely and try to be conservative,” says Markel.
Last year Markel moved into private equity and this presents the company with another long-term objective.
Private equity along with hedge funds are the hot issues in the investment arena, and not always for the right reasons.
“Our approach is to invest directly in businesses, support management teams with a long-term return on capital focus and build the skills and relationships that should allow us to participate in this area in a more meaningful way as opportunities develop over the next several years,” says Markel.
Market realities such as hurricane Katrina have meant Markel has had to rethink some of its underwriting strategies.
“We have set insured value limits on the amount of business our underwriting units can write in catastrophe prone areas,” says Markel.
And with its long term strategy in mind, Markel has been busy expanding its global branch network, opening five new branches in Bristol, Cambridge, Edinburgh, Madrid and Toronto.
Markel stresses that it will be some time before the five branches have an impact on results. Time isn’t always of the essence.
