This is Alleghany Our objective is to create value through owning and managing operating ...

15 Pages·2012·0.17 MB·English

This is Alleghany
Ourobjectiveistocreatevaluethroughowningandmanagingoperatingsubsidiariesand
investments,anchoredbyacorepositioninpropertyandcasualtyreinsuranceand
insurance.Wearemanagedbyasmallcompanystaffwhichseeksoutattractive
investmentopportunities,delegatesresponsibilitiestocompetentandmotivated
managers,setsoperatingsubsidiarygoals,assistsmanagersintheachievementofthese
goals,definesriskparametersandappropriateincentives,andmonitorsprogressagainst
long-termobjectives.Theoperatingsubsidiariesfunctioninanentrepreneurialclimateas
quasi-autonomousenterprises.
Conservatismdominatesourmanagementphilosophy.Weshuninvestmentfadsand
fashionsinfavorofacquiringrelativelyfewinterestsinbasicfinancialandindustrial
enterprisesthatofferthepotentialtodeliverlong-termvaluetoourinvestors.
Ourprimaryoperatingsubsidiariesinclude:
• TransatlanticHoldings,Inc.—aleadingglobalreinsurer
• RSUIGroup,Inc.—anationalunderwriterofpropertyandliabilityspecialty
insurancecoverages
• CapitolTransamericaCorporation—anunderwriterofsmallcommercialproperty,
casualtyandsuretyinsurancecoverages
• PacificCompensationCorporation—anunderwriterofworkers’compensation
insuranceprimarilyinCalifornia
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Financial Highlights AlleghanyCorporationandSubsidiaries
(inmillions,exceptforpershareandshareamounts)
YearsEndedDecember31,
2012 2011 2010
Revenues $ 4,753.2 $ 981.8 $ 985.4
Netearnings $ 702.2 $ 143.3 $ 198.5
Basicearningspershareofcommonstock(1)
Operations(2) $ 38.96 $ 7.14 $ 15.76
Securitygains(3) 6.52 9.12 6.09
Netearnings(1)(2) $ 45.48 $ 16.26 $ 21.85
Commonstockholders’equitypershare(1) $ 379.13 $ 342.12 $ 325.31
Averagenumberofsharesofcommonstockoutstanding(1) 15,441,578 8,807,487 9,081,535
(1) Amountshavebeenadjustedforsubsequentcommonstockdividends.
(2) 2012persharefiguresreflecttheimpactoftheTransatlanticHoldings,Inc.merger,includinga$494.9milliongainon
bargainpurchaseandtheissuancebyAlleghanyof8,360,959sharesofitscommonstock.
(3) Includesnetrealizedcapitalgainsandotherthantemporaryimpairmentlosses.
Per Share Net Earnings (Losses)(1)
YearsEndedDecember31,
Reinsurance
and
Insurance Corporate
Segments Activities Total
2012(2)
Operations $12.26 $26.70 $38.96
Securitygains(3) 4.84 1.68 6.52
Total $17.10 $28.38 $45.48
2011
Operations $12.71 $(5.57) $ 7.14
Securitygains(3) 5.62 3.50 9.12
Total $18.33 $(2.07) $16.26
2010
Operations $17.90 $(2.14) $15.76
Securitygains(3) 5.76 0.33 6.09
Total $23.66 $(1.81) $21.85
(1) Amountshavebeenadjustedforsubsequentcommonstockdividends.
(2) 2012persharefiguresreflecttheimpactoftheTransatlanticHoldings,Inc.merger,includinga$494.9milliongainon
bargainpurchaseandtheissuancebyAlleghanyof8,360,959sharesofitscommonstock.
(3) Includesnetrealizedcapitalgainsandotherthantemporaryimpairmentlosses.
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ToOurStockholders
Alleghany’scommonstockholders’equitypershareatyear-end2012was$379.13,an
increaseof10.8%fromcommonstockholders’equitypershareof$342.12atyear-end2011.
For2012,Alleghanyreportednetearningstocommonstockholdersof$702.2million,or
$45.48pershare.ForthefiveyearsendedDecember31,2012,Alleghany’scommon
stockholders’equitypershareincreasedatacompoundannualrateof6.1%,comparedwitha
compoundannualrateofreturnof1.6%fortheS&P500overthesametimeperiod.
ThechartbelowsummarizesAlleghany’slonger-termperformance,withallvaluesindexed
toDecember31,2002.ForthetenyearsendedDecember31,2012,Alleghany’scommon
stockholders’equitypershareincreasedatacompoundannualrateof8.8%,comparedtoa
compoundannualrateofreturnof7.1%fortheS&P500overthesametimeperiod.
Alleghany’ssharepriceappreciatedatan8.5%compoundannualrateofreturnoverthepast
decade(adjustedforstockdividends).
AlleghanyCorporation
IndexedPerformance2002=100
300
250
Book value
200
Stock price
S&P 500
150
100
50
02 03 04 05 06 07 08 09 10 11 12
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Thetablebelowsummarizesthechangeincommonstockholders’equityin2012
($millions):
Netearningsbeforeitemsbelow $ 375
Netrealizedinvestmentgains 101
Changeinunrealizedinvestmentgains,other 79
LossesfromSuperStormSandy (268)
Subtotal $ 287
Bargainpurchasegainonacquisition 495
Shareissuanceinconnectionwithacquisition 2,696
Increaseincommonstockholders’equity $3,478
ThevastmajorityoftheincreaseinAlleghany’scommonstockholders’equityin2012was
duetothefinancialeffectsoftheTransatlanticHoldings,Inc.(“TransRe”)acquisition,which
washighlyaccretivetoourearningsandcommonstockholders’equitypersharein2012.
Additionally,theacquisitionofTransRehasdiversifiedoursourcesofearningsandadded
internationalexposuretoourspreadofrisk.
Includingtheamortizationofcertainintangibleassetsassociatedwiththeacquisitionof
TransRe,our2012resultsreflectedasmallunderwritingloss(somethingwegenerallyseekto
avoid),offsetbytheinvestmentincomegeneratedbyasubstantiallylargerinvestedasset
base.Althoughthepropertyandcasualtyinsuranceindustryremainedcompetitivein2012,
wedidseesomeupwardmovementinrates,andthemarketplaceprovidedsome
opportunitiesforprofitablegrowth.
OnaGAAPreportedbasis,Alleghanyhadaconsolidatedunderwritingprofitin2012of$220
million.However,whenweacquiredTransRewewrote-offthecompany’sdeferred
acquisitioncosts,whichnormallymaketheirwayintotheincomestatementascommission
expenses,andreplacedthem(moreorless)withanintangibleassetcalled“valueofbusiness
acquired,”orVOBA.VOBAwasthenamortizedintotheincomestatementasamortization
ofintangibles,whichdoesnotmakeitswayintotheunderwritingaccount.Incomparingour
underwritingresultswiththoseofothercompanies,webelievethatstockholdersand
prospectiveinvestorsshoulddeductthisamortization,whichtotaledabout$266millionin
2012.AfterdeductingamortizationofVOBA,ourconsolidatedunderwritingaccount
producedalossof$46million.
OurunderwritingresultsreflectedsignificantlossesresultingfromSuperStormSandy,which
madelandfallnearAtlanticCity,NewJerseyonOctober29th.Sandyiscalleda“Super
Storm”becauseeventhoughthemaximumsustainedwindspeedsofthestormwereonly
thoseusuallyassociatedwithacategoryonehurricanejustpriortolandfall,itinteractedwith
anupperleveltroughtoproduceanextremelylargeamountofenergy.Inaddition,thestorm
tookahighlyunusualleftturnoffthecoastofNewJerseyandheadedwestinsteadof
northeast,increasingthewindspeedofthenorthwestquadrantofthestorm.
Asthesecondmostpowerfulstorminrecenthistory,Sandyproducedastormsurgethatwas
unprecedentedinthemetropolitanNewYorkarea(includingNewJerseyandConnecticut).
LowerManhattan,anareawithasignificantconcentrationofinsuredvalues,sustainedhighly
damagingflooding,inadditiontothewide-spreaddamageinNewJersey,NewYork,and
Connecticut.
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SuperStormSandycostTransRe$251million(before-tax),anditresultedin$161million
(afterreinsuranceandbefore-tax)oflossesatRSUIGroup,Inc.(“RSUI”).Excludingthe
impactofSuperStormSandy,ourconsolidated“adjusted”underwritinglossof$46million
wouldhavebeenaprofitof$366million.BothTransReandRSUIwouldhavehadalow-
teensreturnonequityin2012absentSuperStormSandy;includinglossesfromthestorm,
TransRehadanannualizedreturnonequityof9.8%,andRSUI6.1%.
Our2012resultswereagainnegativelyaffectedbyweakresultsattheCapitolInsurance
CompaniesandPacificComp.Capitolproducedanunderwritinglossof$20.5millionin
2012,largelydueto$23millionofadversedevelopmentthatresultedfromaspecialty
programdiscontinuedin2011.Additionally,Capitol’sunderwritingresultsreflecteda
$5millionchargeduetoachangeintheaccountingrulesfordeferredacquisitioncosts.
Absentthesetwoitems,Capitolhada$7.5millionunderwritingprofit.Webelievethe
reservesthatCapitolnowhasforitsdiscontinuedspecialtyprogramsegmentareadequate
andbelievethereshouldnotbeanyfurtheradversedevelopmentinthefuture.PacificComp
hada$31millionunderwritinglossin2012.Mostofthislossrepresentsourcontinuing
investmentinthebusinesswithoutsufficientrevenuestocoveritsoverheadcosts.In
addition,PacificComphad$5.6millionofadversereservedevelopmentin2012.
*****
TransRe
OnMarch6,2012,AlleghanyacquiredTransReforapproximately$3.5billion.Because
Alleghanywasnotinthereinsurancebusinessinanysignificantwayimmediatelypriortothe
acquisition,theintegrationofTransRehasbeenrelativelystraightforwardandhasbeen
largelyconfinedtotheactivitiesofthestafffunctionsofthetwocompanies.Aspartofthe
transaction,werevisedthecompensationplansofTransRe,makingkeyexecutivesand
employeesco-ownersofthecompanythroughaphantomrestrictedstockplanthatawards
themwithaneconomicinterestinTransRe’sbookvalue.
TransReisledbyMikeSapnar,whoseknowledgeoftheglobalreinsurancebusinessis
secondtonone.InhisfirstyearasCEO,notonlydidhehavetodealwithanewparent
company,butalsotheeffectsofSuperStormSandy,whichresultedinsignificantlossesto
TransRe’scustomers,thelossofaccesstothecompany’sheadquarters,andconsiderable
personaldisruptiontothecompany’sexecutivesandstaff.Mikeandhisteammanaged
admirablythroughthisperiod.Wearefortunatetohavesuchacapablemanagementteamat
TransRe,andbelievethatthecompanyiswell-positionedtoproduceunderwritingprofitsand
growthinthefuture.
TransRe’spremiumswrittenfortheyear2012weredownabout10%(onafull-yearbasis)
duetounderwritingdecisionsmadein2011and2012tonon-reneworreduceparticipationon
certaincasualtytreaties,shiftingfromproportionaltonon-proportionalexposure,andreduced
businessfromasignificantclient.Thesedecreaseswerepartiallyoffsetbysomerate
increasesonpropertybusinessingeographicareasaffectedby2011catastropheevents.
TransRe’slossreservesdevelopedfavorablyintheaggregatein2012,andthecompany
furtherstrengtheneditsbalancesheet,ending2012withapproximately$4.3billionof
stockholder’sequity,whichisanincreaseofover$300millionfromMarch6,2012whenthe
acquisitionclosed–despiteSuperStormSandy.Thisrock-solidbalancesheetenables
TransRetoprovidesuperiorsecuritytocedingcompaniesthroughouttheworld.
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RSUIGroup,Inc.
RSUIproduceda$5millionunderwritingprofitin2012,andacombinedratioof99%.As
mentionedearlier,theseresultsreflectaloss(afterreinsuranceandbefore-tax)fromSuper
StormSandyof$161million,or25percentage-pointsonthecompany’sannualcombined
ratio.AbsentSandy,RSUIwouldhaveproducedanunderwritingprofitof$166millionanda
combinedratioof74%.
Grosspremiumswrittenincreasedby13.9%to$1.1billionin2012.Alllinesofbusiness
exceptforUmbrellaposteddouble-digitincreases.Asa“reactive”market,RSUIthrives
whentheindustryatlargeisfacedwithdifficultlossconditions.Importantly,RSUI’sstrong
growthin2012wasaccomplishedwithafairlymodestincreaseinpeakcatastropheexposure.
Premiumgrowthwasduetogoodrenewalretentionrates,strongnewbusinesssubmissions,
andmid-single-digitpriceincreases.
RSUI’slossesfromSuperStormSandywereinlinewithwhatwewouldexpectfroma$25
billionindustrylossevent.Thecompanyisinthebusinessoftakingseverityrisk,andits
grosslossesfromalargeeventinageographicareawithsignificantaccumulationsofinsured
exposureareexpectedtobeintherangeof1%oftheindustryloss.RSUI’scatastrophe
reinsuranceprogramoperatedasexpected,withlossesconfinedtothelowerlayer,forwhich
thecompany’sreinsurersarepaidasignificantpremium.
Inearly2012,DavidE.LeonardbecameCEOofRSUI.Davehasalonghistorywiththe
company,awealthofunderwritingandwholesaleinsuranceexperience,andhasalready
demonstratedstrongleadershipinchallengingtimes.WebelievethatDaveandhisteamare
well-positionedforprofitablegrowthin2013andbeyond.
RSUIended2012withcashandinvestedassetsof$3.0billionand$1.5billionof
stockholder’sequity.SinceouracquisitionofRSUIinJulyof2003,thecompanyhas
producedover$1billionofcumulativeunderwritingprofit.
CapitolInsuranceCompanies
Overthepastfiveyears,CapitolInsuranceCompanieshasupgradeditstechnology
infrastructure,enablingittoprovidebetterserviceofferingstoindependentandgeneral
agents.Asaresult,thecompanyhasbeenabletogrowitspropertyandcasualtybusinessby
providinghighlycompetitiveturnaroundtimestoagentswhilemaintainingpricingdiscipline.
Althoughthecommercialsuretymarketishighlycompetitive,Capitolisleveragingitsstrong
producerrelationshipstoexpandintotheconstructioncontractsuretymarket.
Unfortunately,duringpartofthesameperiod,Capitolhasalsohadtodealwiththe
consequencesofaforayintothespecialtyprogrambusiness.Oneprograminparticular
producedsignificantlosses,andalthoughlargelydiscontinuedovertwoyearsago,ithas
continuedtonegativelyaffectthecompany’sresults.In2012,Capitolhadtoagainaddto
reservesforthisprogram,aslossemergenceinthefirsthalfoftheyearexceededprevious
actuarialexpectations.Onamorepositivenote,however,lossemergenceappearedto
stabilizeinthesecondhalfoftheyear.Althoughthereareneveranyguaranteesinthis
business,webelievethatCapitol’sreservesrelatedtothisprogramareadequateandthe
programshouldnotaffectfutureresults.
Iftheunderwritinglossesfromthisdiscontinuedprogramandachangeinaccountingfor
deferredacquisitioncostsareexcluded,Capitolhada$7.5millionunderwritingprofitin
2012andacombinedratioof95%.Netpremiumswrittenoncontinuingbusinessincreased
8.7%in2012,withpropertyandcasualtybusinessup12.1%andsuretyup2.8%.
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Capitolconcludedtheyearwith$308millionofstockholder’sequity.Thecompanyremains
stronglycapitalizedfortheamountofbusinessitwrites,allowingustoinvestaportionofits
capitalinequitysecuritiesthathave,overtime,producedadditionalgrowthinthecompany’s
bookvalue.
PacificCompensationCorporation
TheCaliforniaworkers’compensationmarketcontinuestobechallenging,astheindustry
hasbeenunabletoachievesufficientpricingtooffsetescalatingclaimscosts.Accordingto
theWCIRB1,theindustrywrotebusinessatclosetoa140%combinedratioinboth2012and
2011.Fortunately,PacificCompwaslargelyoutofthemarketduringthosetwoyears.
Althoughithasnotbeenpleasanttosustainoperatinglossesduetoinsufficientrevenue,the
alternativewastowritebusinessatmarketpricesthatarelikelytoproduceevenlarger
underwritinglosses.
InDecember2012,JanetFranktookoverasCEOofPacificComp.Janhasawealthof
experienceinthismarket,havingworkedatanearbycompetitoraswellashavingheadedthe
StateCompensationInsuranceFundfortwoyears.WebelievethatJan’sstrongreputation
amongCaliforniainsuranceagentsandbrokersandherconsiderableunderwritingexperience
willhelpPacificCompreturntoprofitability.
PacificComphadgrosspremiumswrittenof$19.4millionin2012,comparedwith
$4.1millionin2011.Marketconditionsareimproving,withmanycompetitorsfilingfor
significantrateincreases.PacificCompentersthisimprovingmarketwithover$100million
ofsurplus,$127millionofstockholder’sequity,newmanagement,andadequatereserves.
Homesite
Homesite(33%ownership)hadadifficultyearin2012,withelevatedweather-relatedlosses
inthefirsthalfoftheyearfollowedbytheimpactofSuperStormSandyinthefourthquarter.
Forthepastthreeyears,Homesite,alongwithotherhomeowners’insurancecompanies,has
experiencedrisingweather-relatedlosses(hail,thunderstorms,etc.)thathaveoutpacedthe
company’sabilitytoincreaserates.Managementissingularlyfocusedatthispointon
increasingrateadequacy.In2012,Homesiteproducednetpremiumsofslightlymorethan
$500millionandhaddisappointingunderwritingresults.Rateadequacywillcontinueto
improvein2013,andunderwritingprofitabilityispossibleaslongasweather-relatedlosses
donotcontinuetoincreasefromalreadyelevatedlevels.Homesitecontinuestoofferits
partnersthroughwhichitmarketsitsproductsanexcellenttechnologicalinfrastructure,
superiorcustomerservice,andconsiderableproductexpertise.
*****
AlleghanyCapitalPartners
Asprimarilyaninsuranceandreinsuranceholdingcompany,mostofourcapitalisinvested
infinancialbusinesseswherethebestcaseisthatwecollectpremiumandareabletomakean
underwritingprofit.Theworstcaseisthatwelosealotofmoneyifwefailtocontrolrisk
properly.ThisiswhatNassimNicholasTalebreferstoasa“negative-skewbusiness.”2
1 Workers’CompensationInsuranceRatingBureauofCalifornia.
2 NassimNicholasTaleb,Antifragile:ThingsThatGainFromDisorder.
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Becausethisistheessentialnatureoffinancialbusinesses,theymustbeapproachedwitha
conservativemindsetandanemphasisonunderwritingprofit,notgrowth,astheonlyviable
long-termobjective.
AkeypartofAlleghany’sstrategyistocombinethis(re)insurancechassiswith“positive-
skew”businesses.Suchbusinessesmayoperateatalossinthenear-term,buthavethe
possibilitytomakelargeamountsifthebusinessissuccessful.
AlleghanyCapitalPartnersisprimarilyresponsibleforfindingandoverseeingthesenon-
insurancebusinesses.Abriefupdateoneachisshownbelow:
• Bourn&KochisaRockford,Illinois-basedmanufacturerandremanufacturer/
retrofitterofspecializedmachinetools.Thecompanyhasaprofitablereplacement
partsbusinessforlegacymachinetoolproductsthatproducesconsistentprofits
throughouttheeconomiccycle.Italsomanufactureshighlyspecializedmachine
toolsthataddtoearningswhenitscustomersinvestinnewcapitalequipment.The
companyhasrecentlyhadconsiderablesuccesswithadoubleheadedgearshaper
forherringboneanddoublehelicalgears.Bourn&Kochhadstrongearningsinits
firstyearunderAlleghanyownership(80%).
• ORXExplorationisaLouisiana-basedoilandgasexplorationcompanyinwhich
Alleghanyownsa38%interestfollowingasecondroundinvestmentduring2012.
Thecompanyhassecuredanddevelopedanumberofon-shore,sub-saltoilandgas
resourceopportunitieswhichitcalls“theLouisianaHeritagePlay.”Workingwith
itsdrillingpartner,ORXexpectstospuditssecondsub-saltprojectwithinthenext
year,andcontinuestomarketitsotherLouisianaHeritagePlayopportunities.In
addition,ORXmadeseveralinvestmentsin2012thatsignificantlyaddedtoits
legacyproductionandreserves.
• StrandedOilResourcesCorporationwasformedin2011andisonitswayto
developingitsfirstmajorproject.Thecompanyacquireslegacyoilfieldswiththe
goalofimprovingtheamountofoilrecovered.Wehaveaneconomicinterestof
approximately80%ofStrandedOilResourcesCorporation.
• ArticleOnePartnersprovidespatentvalidationsolutionstohightechnology
companies,amongothers,byusingacrowd-sourcingmodel.Alleghanyowns
approximately40%ofthecompanyfollowingasecondroundinvestmentinearly
2012.
*****
Investments
Alleghany’sequityportfolioreturned4%in2012,adisappointingperformanceinamarket
thatreturned16%.Atyear-end2012,wehadapproximately$19billionofcashandinvested
assets,$1.4billionofwhichwasinvestedinequitysecurities,withthebalance($17.6billion)
investedincashandfixedincomesecurities.
Aswehavenotedinthepast,ourorientationininvestinginequitiesistoemphasize
industriesthatcanbeexpectedtoperformwellifbondsdon’t.Thismeanswetendtofavor
commodity-orientedsectorsandde-emphasizeinterest-ratesensitivesectors.In2012,as
globalfearsmountedthatEuropewasabouttoimplode,andasevidencemountedthatgrowth
inChinawasslowing,theenergyandmaterialssectorsweresoldandinvestorsrotated
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towardsectorswithdirectandindirectexposuretotheU.S.housingmarket–including
financialsandconsumersectors.Withoverhalfofourportfolioinenergyandadditional
exposuretomaterials,wewerenegativelyimpactedbythisrotationininvestorpreference.
Wecontinuetobelievethatourconcentratedequitystrategymakessense,andwillproveto
besuperiorovertimetoastrategyofall-bonds.Idiscussmyperspectiveontheenergy
industrylaterinthisletter.Ascanbeseenbythetablebelow,Alleghany’stotalinvestment
returnonitsbondsandstockportfolioshavesignificantlyexceededthealternativeofanall-
bondportfolio,asshownbythetotalreturnontheBarclaysIntermediateAggregateBond
Index:
Alleghany
Total Barclays Excess
Year Return Index (Shortfall)
2004 13.2% 3.7% 9.5%
2005 10.8 2.0 8.8
2006 6.8 4.6 2.2
2007 9.4 7.0 2.4
2008 (4.1) 4.9 (9.0)
2009 11.4 6.5 4.9
2010 8.7 6.2 2.5
2011 7.1 6.0 1.1
2012 5.4 3.6 1.8
Cumulative 92.5 54.2 38.3
Annualized 7.6 4.9 2.7
Inlightofthesignificantlyincreasedsizeandcomplexityofourfixedincomeportfolio,
AlleghanyisexpandingitsexecutiveleadershipteambyseparatingtheroleofCFOfrom
managementofour$16.0billionfixedincomeportfolio.IampleasedthatRogerGorham,
whohasbeenourSVP–FinanceandInvestmentsandCFOsinceMay2005,willbringhis
expertiseanddedicationtothemanagementofthisportfolioinhisnewroleasSVP–Head
ofFixedIncomeandTreasureronceanewCFOisnamed.
InvestmentOutlook
Theworldeconomycontinuestostrugglewiththeforcesofaglobaldebtdeflation.Private
sectorborrowingcapacityremainsconstrainedandOECDgovernmentsaredealingwith
unsustainabledebtburdens.Aswehaveobservedinthepast,inadebt-basedmonetary
system,themoneysupplycanincreaseonlyifaggregatedebtoutstandingexpands.Withboth
theprivatesectorandthegovernmentsectoratborrowinglimits,theFederalReserveand
othercentralbankshavebecomethemainsourceofmoneysupplyexpansionthroughasset
purchases–althoughsuchpurchasesclearlyhaveamixedrecordofsuccess.
MuchlikeTheodoricofYork,theMedievalBarberonSaturdayNightLivewhosesolutionto
everyhealthproblemwasmorebloodletting,centralbankerscontinuetoforceliquidityinthe
bankingsystemwithoutanyobjectiveproofthatitishelping.Wedoknowthatitisn’t
helpingretirees,pensionfunds,orinsurancecompanies,asinterestratesaresuppressed,
penalizingsaverstothebenefitofthebankingsystem.
TheFederalReserve’spolicies,ifpursuedinavacuum,wouldlikelyresultinaweaker
U.S.dollarandmoreinflation,asexcessdemandissupportedbytheindirectmonetizationof
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governmentdeficits.However,whenallmajorcentralbanksaredoingthesamething,the
pictureisnotasclear.Muchofthemovementinexchangeratesthereforewilldependupon
relativeGDPgrowthrates,aswellasconfidenceineachregion’spoliticalenvironment.In
particular,iftheU.S.governmentisabletomakeprogressinnarrowingthedeficit,
confidencecouldimprovewhichinturncouldaideconomicgrowth.However,ifthe
U.S.governmentremainsparalyzed,thepoliciesriskacollapseinconfidenceinthe
UnitedStateswhichcouldcausecapitalflightoutoftheU.S.dollar.Needlesstosay,itis
extremelydifficult,ifnotimpossible,topredicthowthiswillunfold.
ThesituationisfurthercomplicatedbythefactthattheUnitedStatesenjoysapositionof
“exorbitantprivilege”astheworld’sreservecurrency,whichmakesconfidenceintheU.S.
government’sfinancesallthemoreimportant.AlthoughsomearguethatFederalgovernment
deficitsshouldnotbereducedtooquicklyduetotheriskofrecession,itisclearthatannual
deficitsof7-8%ofGDParenotsustainableandwillultimatelyleadtosevereproblems.
Anadditionalissueisthatmoneysupplyexpansionthatoccursduetogovernmentdeficits
thatareultimatelymonetizedbyacountry’scentralbankisnotaproductiveallocationof
capital.Thisis,inmyview,atthecoreoftheeconomicdebate.
Whiletheequitymarketremainsexpensivebyhistoricalstandards,itappearstobeless
overvaluedthanthebondmarket,whichnowdiscountsallbutthemostextremedeflationary
scenarios.Inmanycases,wearefindingthatwecanachieveahighercurrentreturnona
qualitydividend-payingstock,especiallyconsideringpreferablecorporatetaxationof
dividendincome,thanwecanachieveonacomparablequalitybond.Ifthisenvironment
persists,wewouldexpectovertimetoincreaseourallocationtoequitysecurities,subjectto
externalregulatoryconstraints.
Equityinvestinginthisenvironment,however,isnotthesamegameasitusedtobe.Unlike
the1980sand1990s,whentheeconomiesoftheUnitedStatesandEuropeweregrowingata
healthyrateandcreditwasexpanding,today’seconomicgrowthisnearstall-speed,creating
moresectorrotationwithinthestockmarketasinvestorsseektoavoidholdingthe“hot
potato.”Itfollowsthatthisrequiresmoreportfolioturnovertoremainproperlypositionedfor
ashiftingmacroenvironment–especiallyaspurevalueopportunitiesarefewandfar
between.
Energy
Attheendof2012,Alleghanyhadover$500millionofinvestmentsinpublicly-traded
energyinvestments,inadditiontoourtwoprivateenergyventures.Here’sourperspectiveon
theindustry.
WithOECDeconomiesbarelygrowingintheaggregate,marketshavebeenunwillingto
placemuchvalueonthehistoricallycyclicalearningsoftheenergyindustry.Itisinteresting,
however,thatdespiteweakeconomicgrowthintheUnitedStates,Europe,andJapan,oil
pricesremainedatafairlyhighlevelin2012.Asofearly2013,crudeoilistradingatover
$90/barrel(WestTexasIntermediatebenchmark)andabove$110/barrel(Brent(North
Sea)benchmark).NorthAmericannaturalgasprices,whichwereaslowas$2.27/mcf
(“thousandcubicfeet”)inearly2012,havereboundedto$3.30/mcf.Attheseprices,most
majorenergyproducerswithatypicalmixofoilandnaturalgasarereasonablyprofitablebut
withlimitedgrowthprospects.
Sentimenttowardtheenergyindustrywasextremelynegativein2012forseveralreasons.
Earlyintheyear,theweakeconomicperformanceoftheEurozoneraisedfearsthattheworld
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