Horos Asset Management, an investment management firm, published its second-quarter 2021 investor letter – a copy of which can be downloaded here. Horos Value Internacional gained 6.3% over the quarter, compared to 6.4% in its benchmark index, while Horos Value Iberia returned 4.8%, beating the 4.2% rise of its benchmark. You can take a look at the fund’s top 5 holdings to have an idea about their top bets for 2021.
In the Q2 2021 investor letter of Horos Asset Management, the fund mentioned MBIA Inc. (NYSE: MBI) and discussed its stance on the firm. MBIA Inc. is a Purchase, Harrison, New York-based financial company with a $596.2 million market capitalization. MBI delivered a 66.57% return since the beginning of the year, while its 12-month returns are up by 74.80%. The stock closed at $10.86 per share on September 21, 2021.
Here is what Horos Asset Management has to say about MBIA Inc. in its Q2 2021 investor letter:
“The last addition to this financials theme is MBIA, a US company well known in the value investing community for being, at the time of the credit bubble at the beginning of this century, the bearish bet that catapulted the brilliant manager Bill Ackman to fame.17 But what does MBIA do? Basically, the company has two subsidiaries: National Public Finance Corporation (“National”) and MBIA Insurance Corp (“MBIA Corp”). These subsidiaries were spun off in 2009, when MBIA decided to clearly delineate the “good” business of National from the troubled business of MBIA Corp. Both are currently in run-off mode, i.e., they are not accepting new business volume, for the reasons discussed below.
In the case of National, the firm provides financial guarantee insurance to investors in bonds issued by state and local governments to fund essential services or infrastructure, as well as other entities. This is a business that, historically, was very profitable, as government defaults were (and are) very infrequent. The reason? Ultimately, they could always squeeze the taxpayer a little more in the form of higher taxes or public spending cuts on other items. Basically, this a business with very low risk, given that, to a certain extent, the taxpayer is the one who is actually insuring the debt. Given this, why take out insurance with National or any other insurance company in this market? Because it helped lower the cost of financing. By having insurance to back up the potential default, the rating agencies gave higher ratings to these municipal debt issues, so investors were willing to accept a lower return for them (a higher rating is associated with lower risk).
However, the last few years have not been great for National. On the one hand, since the Great Recession of 2008, central banks’ low (or negative) interest rate policies, as well as their balance sheet expansion measures, have made the cost of funding for public debt issuers much cheaper, thus greatly reducing the potential savings from insuring their debt. On the other hand, the rating downgrade suffered by the United States a few years ago triggered a consequent downgrade in these entities, so that their financial capacity (at least in the market perception) was also diminished, thus limiting their capacity to insure the public debt of their potential clients. The final straw for National was the bankruptcy of Puerto Rico in 2017, one of its insureds and the largest municipal bankruptcy in U.S. history— several times larger than Detroit’s 2013 bankruptcy. All of this led National to go into run-off mode and let its business continue to shrink as insured municipal issues mature.
As for MBIA Corp., it also provided financial guaranty insurance, but in this case in the structured finance market (such as the well-known CDOs). This business, very lucrative at the time of the credit bubble, became a nightmare when it burst. However, more than thirteen years have passed since that crisis and MBIA Corp. has a reduced balance sheet, has not been generating new business for years and the structures that remain insured, as well as the pending litigation, will not have a significant impact—either positive or negative—on its parent company. Why invest in a company with two subsidiaries that do not generate new business? For two reasons. On the one hand, its valuation is very attractive, even under a conservative scenario. Taking into account the annual cash burn of National (remember that it does not generate new business), the corporate expenses of the parent company and putting a zero value on MBIA Corp, MBIA should be worth more than three times what it is trading at today’s price. However, we are aware that this valuation only makes sense if some entity acquires the company and takes advantage of cost synergies to take over the asset portfolio, so we do not expect MBIA to reach that theoretical valuation and prefer to apply a significant discount to it. In fact, this is not something we are assuming. The management team itself has been very clear about this and expects, once the Puerto Rico bankruptcy process is over, a possible corporate transaction (there have been similar transactions in the past).”
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Based on our calculations, MBIA Inc. (NYSE: MBI) was not able to clinch a spot in our list of the 30 Most Popular Stocks Among Hedge Funds. MBI was in 17 hedge fund portfolios at the end of the first half of 2021, compared to 16 funds in the previous quarter. MBIA Inc. (NYSE: MBI) delivered a -8.30% return in the past 3 months.
Hedge funds’ reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn’t keep up with the unhedged returns of the market indices. Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by 115 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter.
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Disclosure: None. This article is originally published at Insider Monkey.
