An investment that promises high returns and almost no correlation with the market? Wexboy seems to have found it in Alternative Asset Opportunities PCC Ltd. This is a closed-end fund listed on the London stock exchange that has investments in traded life interests (hence the TLI ticker). I suggest you start out with reading Wexboy’s write-up on the fund, aptly titled “An Investment To Die For” since he has all important points solidly covered and I’am not going to reinvent the wheel.
The question that I do want to answer is how much should should TLI be worth today? The fund is currently trading at 44.5 pence per share while NAV at 31 October, pro-forma adjusted for the equity issue earlier this month, was 56.0 pence per share. This is already a nice 20% discount, but I think the NAV is significantly understated because the company uses a ridiculous 12% discount rate to value their assets. While the capital asset pricing model (CAPM) does have it flaws the general idea behind it is solid: an investor should not be compensated for idiosyncratic risk because you can eliminate it using diversification. What matters is systematic risk.
So how much systematic risk does an investment in TLI have? You can probable argue that there are some relations between the life expectancy of 89 year old’s and the general economy, but it’s going to be far fetched. The only major source of systematic risk is the credit risk from the insurance companies that have underwritten the insurance policies. As a policy holder I imagine that you have a pretty solid position in the capital structure of these companies, but not to make things overly complicated: what happens if we use the yield on investment grade US corporate bonds as a discount rate? At the moment this yield is 3.3% according to Bloomberg, and using Wexboy’s spreadsheet, you can easily figure out expected cash flows. This gives me a present value of 89 million dollar (55.8 million pound) or 77.5 pence per share. This is still a reasonable conservative estimate in my opinion. Wexboy is nice enough to add almost a year to the average life expectancy of the old folks in his spreadsheet, and I think the proper discount rate is probably even closer to the risk-free rate (near zero these days…) than the yield of investment grade bonds.
Return of capital
I don’t expect that the market is going to agree with me on that discount rate anytime soon, but the good news is that the fund is basically in liquidation mode (shareholders actually have to vote every year to extend it’s life!) and intends to return all capital to shareholders. The fund already has the authority to buyback shares, and with all debt eliminated this month it shouldn’t take very long before they get enough cash to start buying back shares. Given the big discount between ‘true NAV’ and the current market valuation this could enhance returns even more.
I think that TLI offers a truly remarkable opportunity. The performance of the policies should have almost zero correlation with the market, and yet at the same time potential returns are very attractive. The biggest risk is that the insured group lives longer than expected, but with an average age of 89 and a 4.7 years weighted average LE you can’t be off by a huge amount. Not a lot of people manage to hit the magical 100 number, and there isn’t a lot of time for things to change radically. The life expectancy of a new born is much more uncertain.
Rating: just before the first anniversary of this blog I’m going to give out my first five star rating. I believe an investment in TLI is very low risk while the expected return is more than respectable. Not only is the risk/reward ratio great, there is a reliable catalyst: no-one can escape death…
Long Alternative Asset Opportunities, and looking to increase my position.