Alternative Asset Opportunities (TLI.L)

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.

Present value

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.

Conclusion

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…

Disclosure

Long Alternative Asset Opportunities, and looking to increase my position.

17 thoughts on “Alternative Asset Opportunities (TLI.L)

  1. Czos

    There is some legal/regulatory risk with this business. Just look at what happened to Imperial Holdings, Inc.(NYSE:IFT). Ya they were running the structure differently, but the point is that at the time, what they were doing was perfectly legal and the business got slammed shut by the authorities.

    Reply
    1. Wexboy

      IFT was one obvious example I had in mind when I said: ‘inevitably the promoters & brokers ruin it for everybody’..! But their 10K is well worth reading – every single sentence – it actually helped persuade me of the merits of TLI. The key phrase in the entire K is ‘…policies had a nexus to our premium finance business’. This is their problem: i) it explains the discount rates they utilize, and ii) it explains why, for example, they accepted a 35-40% for a $10 mio policy maturity earlier this year! – something I’ve never seen elsewhere!?

      They’re now on the hook for $24 mio+ in annual premium payments, and the average age of their insured is only 78 yrs of age… It’s interesting to see Phil Goldstein invested here, but I think it’s revealing he & partners have joined the board – I think this will only prove a good investment if he’s on the inside and can, say: Either steer it into a gradual wind-down, or ramp up its platform into a much larger vehicle (perhaps with a well-financed/larger partner). IFT may ultimately turn out to be a good investment, but it looks fairly dicey now, lacks any kind of clarity, and certainly offers a v different risk/exposure to TLI.

      Reply
      1. Wexboy

        I meant to write: ii) it explains why, for example, they agreed a settlement for a 35-40% discount for a $10 mio policy maturity earlier this year! – something I’ve never seen elsewhere!?

        Reply
    2. Alpha Vulture Post author

      When I’m reading the latest IFT 10-K I’m not getting the idea that what they were doing was perfectly legal, but have to read a bit more to get a better understanding of what they exactly did and what happened there.

      My thinking about legal/regulatory risk w.r.t. TLI is simple: they have been running for years, and have no trouble collecting money so far, so would seem to me that contractually they got their stuff right. Regulatory risk also seems small to me. The US Supreme Court confirmed the right to trade life insurance policies more than 100 years ago or so, and since TLI did just that without fancy bells and whistles I don’t see a specific risk.

      Reply
  2. Wexboy

    Thanks, Hielko, excellent write-up & perspective! We are definitely muy sympatico on this. And thanks, any discount doubters might want to come & argue with you now instead 😉

    To add some context: What you lay out above has already happened…in reverse!

    In 2007-09, the BoD was slow to recognize an appropriately higher discount rate (in light of the financial crisis, wider spreads & extreme risk aversion) in its valuations . The market corrected for this far more quickly by re-pricing TLI at a huge discount to what it considered an optimistic/over-stated NAV. If the board’s now slow to move away from this 12% rate (in place for some years now), I believe the market will soon be happy (in similar fashion) to correct it by awarding TLI shares an appropriate premium.

    In that scenario, shareholders might also ultimately want to agitate (somewhat bizarrely) for share buybacks even at a premium to NAV – as long as they’re still at a discount to TLI’s perceived intrinsic value. But I’m jumping ahead – we mostly just need patience, diminishing life expectancy will pretty much take care of everything here 🙂

    ps You need a five star graphic!

    Reply
    1. Alpha Vulture Post author

      I would be perfectly happy if they would buy back shares at a premium, as long as the transactions are on the open market. If a shareholder thinks the premium is getting too big, and they are paying to much for their own shares, you should sell your owns shares asap for the ‘too high’ price :).

      Reply
  3. Filipe

    Wexboy & Hielko, very nice write-up on TLI, certainly got my attention. I’m just finishing up some work on another investment idea and will dive into this one next week.

    Meanwhile I talked with a friend of mine that doing a Phd in Finance @ LBS and is focusing his study on the market for traded life interests or policies. He raised some questions about:
    1. Many funds were badly structured and ran out of money to pay the premiums (shouldn’t be the case here), and lost the right to the benefit from the policies
    2. There has been lots of litigation in the area because of STOLIs (stranger originated policies). What happens here is that sometimes “maturity” is reached and the insurance companies put you in court and won’t pay you because you bought a STOLI.
    3. Medical underwriters have the incentive to say that people in your pool are expected to die early, which increases the value of securitizations. He specifically told me to be careful with pools that have been put together a long time ago, and that the best way to check if the LE are well estimated is to see how many people have died versus what was expected at the beginning of securitization.

    4. Finally because there were very bad experiences in the UK with these “products” there is a high likelihood of mispricings (such as appears to be the case with TLI), and that selling to retail investors has been banned.

    I’ll be honest, I don’t understand much about this, but will get deeper into the subject next week.

    cheers

    Reply
    1. Alpha Vulture Post author

      Certainly the right questions to ask.

      1. Not anymore a problem for TLI given that amount from policy maturities is for years in excess of premium payments, and this can only get better. But still, even here you can see that financing can be problematic: there is a reason they had to raise equity this month.

      2. They have successfully collected on a decent number of policies already, all without problems. Doesn’t mean that you can be sure that there are no STOLI policies hidden in the portfolio, but it has to be a really small percentage if it’s so far so good.

      3. They actually were too optimistic with the life expectancy in the past. They have been reviewing, and adjusting LE’s upwards. You also see in the latest report that they provide various measures on LE’s with a +10 or +20% adjustement for LE’s estimated before 1/01/2011. The +20% adjustment changed LE from 4.7 to 5.0. I think the +0.8 years used in Wexboys spreadsheet is conservative enough to capture this, and possible other optimistic assumptions in the LE’s.

      4. Exactly! 🙂

      Reply
  4. John Galt

    I’d caution you on this investment…I’ve had experience with life settlements in the past. Typical discount rates I’ve seen these days are 15%+. 12% actually seems low. Cash flows are highly sensitive to LE assumptions: if an insured lives a year longer than expected, its not just a PV factor of not receiving benefits for a year longer; you also have to pay another year’s worth of premiums. Because of this high degree of sensitivity and the fact LE assumptions are not black-and-white, I’d advise extreme caution here and make sure you trust management.

    Reply
    1. Alpha Vulture Post author

      I think the opportunity is here because you are probably sharing that bad experience with life settlements with a lot of other investors. But unlike other life settlement investments most of the risks are not that big anymore, see also my reply above on Filipe.

      About the discount rates: the latest annual report actually discloses that recent market transactions point towards a 16% IRR, but also that this is the result of distressed sellers. Earlier this year the company sold a part of their portfolio for 95% of book value, so if they would liquidate today you would probably still not be overpaying today. But think liquidating would be insanely stupid since I don’t agree with the market discount rates for the TLI portfolio.

      The valuation of TLI is actually not that sensitive to changes in LE’s. The face value of the policies is 165M with a current book value of 65M. Using the spreadsheet linked above – that’s already using a +0.8 years higher LE – I estimate a total of 43M in premium payments and 13M in overhead costs running the fund for 13 years (I think it’s likely the fund is liquidated earlier when for example 90% of policies have reached maturity). This means that at the end of the funds life you have 109M in cash, or 94.4p/share (twice the current share price).

      Even if you add two full years to the LE there would still be significant upside. This would add just 2* 8.4M in premium payments, and you still end with 80p/share. Shit has to go seriously wrong before you manage to lose money in this investment.

      Reply
  5. Zimbo

    Premiums run at about 80k$ annually per policy (8,4m/106). Hence only the rich can afford to buy them. These guys obviously sold their policies, but they have benefited from wealth during some period of their lives. They probably have health insurance and college education.

    I did not find data comparing income to LE, but this CDC doc says that education level does impact LE at 25 significantly. http://www.cdc.gov/nchs/data/hus/hus11.pdf#021
    “On average in 2006, 25-year-old men without a high school diploma had a life expectancy 9.3 years less than those with a Bachelor’s degree or higher; women without a high school diploma had a life expectancy 8.6 years less than those with a Bachelor’s degree or higher”

    Could this be the reason for these people living longer than average?

    Reply
    1. Alpha Vulture Post author

      Yes, you certainly have a negative self-selection bias in life insurance policies related to the wealth of the insured. But you have to realize that the effect of the bias diminishes when the average age goes up because a larger percentage of those who initially had a low LE will be dead already. A large part of the population that made it to the age of 89 is presumably living a healthy lifestyle, so LEs will be more determined by genetic factors at this point in time.

      Reply
  6. DOn

    Do you have any thoughts on the FSA signaling that it will ban traded life insurance investments in the UK, it has warned advisers to stop selling these “toxic” products to ordinary investors….
    http://bit.ly/WGmNCm

    Reply
    1. Alpha Vulture Post author

      I don’t think it will impact this fund, it might new funds or the pricing of the underlying. I’m probably holding this to maturity, so don’t really care about new rules.

      Reply

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