The fast-growing Norwegian insurance company Protector Forsikring sees both its investment income and underwriting profits as core earnings drivers. Both areas are core businesses, just as in famous insurance/investment companies like Markel or Fairfax Financials.
Historically, Protector’s insurance business has been very profitable with a long-term combined ratio of 93% (ten-year average). Despite this, 75% of the total after-tax income has been generated by the investment returns.
In 2014 Protector started to in-source its asset management to get more control of the investment part of the business. Previously most of the assets were managed externally by large Nordic asset managers such as Carnegie, Handelsbanken and DNB Asset Management. Today Protector manages all the money internally and has developed an interesting setup and approach that defers from most other insurance companies. The in-sourcing also helped to lower the cost of managing the investments.
Insurers receive premiums upfront and pay claims later. This collect-now, pay-later model leaves them holding large sums, called float, that will eventually go to others. Meanwhile, they get to invest this float for their own benefit. By the end of Q3 2018, Protector had a float of NOK 6.6 billion. The total investment portfolio was valued at NOK 10.2 billion, with 11.1% invested in equities and the rest in fixed income. This compares to a book value of Protector’s equity on the balance sheet of NOK 2.3 billion and a market cap of NOK 3.7 billion.
I visited Protector Forsikring to talk to Chief Investment Officer Dag Marius Nereng. He explained how he and the team invest, how they work, and how they educate themselves to become even better investors.
The focus in the article will be on the equity part of the investments business. Quotes are translated and edited for clarity.
A team of investment enthusiasts
CIO Dag Marius Nereng heads the investment team. He joined the company from a position as Senior Portfolio Manager in Handelsbanken, and has more than 20 years of asset management experience.
With a concentrated equity portfolio of currently 13 holdings and a six-person investment team, they can do in-depth analysis on each investment. Given the portfolio turnover, each team member needs to come up with less than one idea that leads to an investment each year.
On the equity side, Nereng is the portfolio manager. Three analysts cover specific sectors and the chief analyst, Jonas Backman, looks at all the cases. So at least three persons look thoroughly at each case, and the whole team is present at the pitch meetings and encouraged to think about and challenge the cases. On the fixed income side, Andreas Høye is the portfolio manager.
The whole team is characterized by a strong passion for investing. As Nereng puts it: “Everyone on the team is extremely passionate about investing. When you are passionate, you go home and continue to read about a company or an industry, or about investing in general. We spend a lot of time, we use a lot of energy, and we think it is incredibly fun… It varies a bit in the team, some are extreme. I don’t understand how they can have time for a family. Some are more balanced. But all have a true passion for investing.”
The investment team shares an office at the Protector headquarters at Aker Brygge in Oslo, Norway. On the wall of the office hang two large pictures of Warren Buffett and Charlie Munger. The inspiration from these two is important to the way they think about investing and what they look for in a company. Between the two hangs a picture of Nereng. He makes sure to explain that it is not because he thinks that highly of himself. They have an investment-related competition within the team and the winner gets the honor of having his picture up on the wall between the two icons. Nereng won last year. In this year’s competition, he is currently second behind Backman.
Portfolio characteristics: Concentrated, small cap, Nordic
The investment universe is made up of companies from within the EU and EEA. Norwegian companies are not taxed on capital gains from equity investments in these areas. The portfolio has become more international as the team struggles to find enough attractive cases in Norway, especially cases that are not too cyclical. In December 2014 all holdings were Norwegian. In October 2018 only three of the top ten holdings were in Norway. Four were in Sweden, two in Finland, and one in the UK.
Nereng prefers to buy companies with a strong and emerging moat, high future growth rates, and an attractive valuation. He says “These are not easy to find in an all-time high market… When we can’t find this kind of investment, we look for companies with less moat but with a large margin of safety. It is often companies that have declined in value due to temporary issues or concerns. These investments are a bit more Howard Marks than Warren Buffett. But we prefer the Warren Buffett type of investments. We prefer to find great companies like Compusoft (the only privately held company Protector owns) or Schibsted (the online classified ads company) at attractive prices.”
The concentrated portfolio allows them to do thorough analyses and get a very deep understanding of the companies and industries they invest in. The information advantage is also one of the reasons Protector owns a high proportion of small cap equities. Nine out of the top ten holdings have a market cap below EUR 350 million. “We think that less competition and fewer people following a stock are better for us. We believe we can do the analysis on Schibsted and do it well, even though a lot of people are following it. But if we can find companies like eWork (the Northern European consultant supplier) with zero analysts following it, then it is interesting. The company has a strong moat, even an emerging moat, the stock came down a bit, insiders started buying. A lot of things looked good. The downside is, it takes more time to buy the shares and you have some liquidity risk. To compensate we increase the hurdle rate to get a larger margin of safety.”
Protector often owns large parts of the small cap companies they invest in. They own 16.3% of the shares in B3 Consulting Group (the Swedish IT consultancy company), 6.3% of Majestic Wine (UK’s largest specialist wine retailer), and 5.4% of eWork Group.
In the last 10 years, the equity weight in the Protector portfolio has been between 10% and 20% most of the time. In 2009 it was 25.1% and in 2012 it was 8.9%. At the end of Q3 2018, it was 11.1%. The weight is to a large extent a residual of the number of attractive investment cases they are able to find. Nereng says: “We can have 0% in equities. If we can’t find any attractive investments then we go to zero weight, that’s okay. There is no pressure to be invested, but of course, we believe we should be able to find something. The equity weight is quite low at the moment, it is more difficult to find attractive cases now.”
When you look through past holdings in the Protector portfolio, you find a number of holdings in areas such as online retailing and asset-light advisory businesses. In online retail, Protector own or have owned companies like Zooplus, Dustin, and Majestic Wine (where they believe most of the value is in the online business). Within advisory businesses, they own companies like Bouvet, Multiconsult and B3 Consulting group.
Idea generation and investment process
The team splits its time roughly equally between finding new ideas and monitoring and thinking about current holdings. Nereng explains how they look for new investment ideas:
“We’ve each got our personal approach to idea generation. One person likes to go through value investor blogs, look through the portfolios and purchases of great investors and find inspiration that way. Another tries to go through as many companies as possible, you know to turn a lot of rocks. He spends five minutes on the case to see if he can kill it or if he should spend some more time on it.”
“One person uses a kind of screen where he follows 1000 to 1500 companies. He often looks for companies that came down a lot and he scores them on a number of criteria. I screen for great companies with high historical growth rates and that kind of thing. We are also working on an overall watch list with companies we would like to own, and will monitor for attractive entry points.”
If a case is too hard to assess, the Protector team passes and looks at something else. They prefer only to “swing at the fat pitches” and the flexibility in equity weight allows them to be picky and patient. Nereng explains how the process works after the initial idea identification:
“When we look at new ideas, we try to get to the point quickly. Is it attractive or not? Is it too hard? Shall we continue to work on the case or not? If it’s interesting, we take it into something we call a pitch meeting. We hold these weekly. The person responsible make a short presentation. Before he presents, everyone spends five minutes thinking about the case and what they believe will be the key investment points and the key risk factors. We do this separately to train the ability to identify these factors quickly.”
“Then we discuss the case, if it’s very interesting, we go into a deep dive. This usually takes a couple of weeks. We go through all the annual reports and all the conference calls. Are they conservative in the guidance? Are there any accounting issues? We try to get a very deep understanding of the company and the industry.”
“We don’t have to do all the work – we’ll stop if we find something that kills the case during the deep dive. But if it looks good, we take another meeting and discuss the case. I don’t remember the exact number of deep dives, but we bought three companies in the first half of 2018. We went through around 600 cases and did pitch meetings on 60. Some of the 600 companies were just very quick assessments, you cannot do a lot of work on that many companies.”
Assessing and monitoring the investments
The investment team at Protector uses a framework they call Financial Underwriting. This is a checklist approach to support the investment evaluation. It is used in the research process to assess new ideas, to monitor and follow up current holdings, and to track past decisions.
The company assessment includes financial factors, organizational factors, industry-specific factors, and risk factors. Each category has a number of checklist items and areas that need to be examined. This leads to a traffic light score depending on the attractiveness. It all sums up to a list of key investment points and key risk factors which also get a traffic light score.
Nereng says: “Key risk factors and key investment points are where we spend most of our time. What is the reason for owning the stock and what are the key risks? We go through these points at least once every quarter on all our holdings. We discuss whether something has changed or if there is anything we need to pay extra attention to going forward. We try to think very deeply about these points and we try to attack the case from all angles, all the time.”
“The framework also includes an intrinsic value calculation. The expected return is modeled based on a number of different scenarios and an assessment of the company’s results within a range of probabilities. We are aware that many experts get the forecasts wrong and we focus on the emotional biases that can impact our forecasts. Being aware of these things makes it easier to avoid overconfidence and makes you more willing to accept new information into your forecast.”
“We try to forecast on quarterly earnings. These are not really important to us, but it gives us immediate feedback and reminds us how little we know and how difficult it is. The five-year earnings forecast is important. When we track our forecasting, over time we will get feedback for calibration of confidence levels. We try to make small changes along the way and not wait until we need to make big changes. We do the forecast individually and then discuss them to avoid group thinking.”
When the team monitor and follow up current holdings, they upload their investment notes in FactSet. “Every time we write a note we upload it, then the whole team has access all the time. We make updates at least once a quarter but more often if something important happens, if we update our intrinsic value, or if we have some interesting thoughts on the case.”
“We try to monitor the investments as thoroughly as possible. Then we are at least on par with those who know the case best. Everyone says they track their holdings closely, but most people don’t do it like this. If one or two persons manage a portfolio with 60 holdings you can’t do it. We are 6 persons and have 13 holdings.”
A focus on downside protection
Nereng and the rest of the team have a strong focus on the downside risk. They look for a wide margin of safety and do a lot of analysis on the key risk factors. If they invest in cyclical companies or companies with high regulatory risk, they make appropriate adjustments to limit the downside.
“If we invest in something the government doesn’t like, like betting or consumer loans, we always calculate with a high chance of negative regulation. If we invest in something cyclical, which typically has lower forecastability, we put a downturn into the estimates. One example is our investment in the Finnish construction company Lehto. Housing starts in Finland are 30% higher than the 20-year average. We put in a 40% decline within the next few years into our forecast and then slowly build up the volume from there. That’s a way to make sure we have a margin of safety.”
Another tool they use to manage the downside risk is an investment premortem. This helps to highlight potential warning signs and increases the chance of seeing them early. Nereng explains: “This was very helpful in our Bank Norwegian investment (Norwegian Finans Holding, the leading Norwegian player in consumer loans). A number of the risk factors started to play out and we spent a lot of time following the development and thinking about the case.”
“In our premortem analysis, we said, “2020 – Bank Norwegian is bankrupt”. Then we did a story around it. What could have happened to lead up to this event? It included things like they had become more aggressive to keep up the high loan growth and a lot of new players entered the market. This pushed up the customer acquisition cost and made them increase the acceptance rate. The government started to regulate the area and property prices declined so borrowers could not be bailed out by increasing their mortgage.”
“Obviously, it has not turned out that bad. But, a lot of the things we had discussed started to show up. At the same time, the stock price continued to increase, and we started to sell down the position. It was a very large holding for us and we made a lot of money on it. An interesting finding was that the interest rate level did not matter much to the people who took up the loans, it was the absolute level of monthly payments that mattered. So, when the government proposed a maximum down-payment period of five years and the stock price reached NOK 100, we sold our last shares.”
Doing a premortem
Gary Klein wrote about project premortems in the 2007 Harvard Business Review article “Performing a Project Premortem”:
“Research conducted in 1989 by Deborah J. Mitchell, of the Wharton School; Jay Russo, of Cornell; and Nancy Pennington, of the University of Colorado, found that prospective hindsight—imagining that an event has already occurred—increases the ability to correctly identify reasons for future outcomes by 30%. We have used prospective hindsight to devise a method called a premortem, which helps project teams identify risks at the outset.”
“Unlike a typical critiquing session, in which project team members are asked what might go wrong, the premortem operates on the assumption that the “patient” has died, and so asks what did go wrong. The team members’ task is to generate plausible reasons for the project’s failure.”
Read the whole article on how and why you should do a premortem here.
Focus on continuous learning and improvement
One area that seems to be as big a passion for the team as investments is the focus on constant improvement and learning.
The investment team has its own book club. And unlike many readers, they are good at implementing the key learnings in their work. They have incorporated a number of best practices inspired by books or by leading investors and experts.
One example is the inspiration from Cal Newport’s book Deep Work. Nereng says: “We don’t talk to each other before 12 o’clock. We do deep work. We have to be quiet, concentrate, and focus. We do not answer the phone, we put it away. We are not even allowed to say ‘hi’ in the morning. We are six people in the office. So, if it takes five minutes to say ‘hi’ and regain your focus, then you can lose almost half an hour every day.”
“Then we eat lunch together and have meetings in the afternoon. We have gained a lot from this way of working. We also became better at focusing and doing deep work after 12 after we implemented it.”
In the office, they have a ‘wall of shame’ with their biggest investment mistakes. Learning from past mistakes is a key focus. Nereng talks about the learnings from the Pandora case: “Pandora (the jewelry company) was one of our biggest mistakes so far… It’s not a great case for us, but you learn a lot by focusing on your mistakes. You don’t learn as much from your successes.”
“The big mistake was that we did not see that the forecastability was very low. We thought we had an idea of how much they would earn in five years and we were very wrong. This became clear after a while. But we did not see it from the start. It’s a bit embarrassing.”
“It’s helpful to go back and see what we thought when we bought it. We go through our comments and notes to see what we thought along the way. We can see the forecasts of each team member with scenarios and comments. My forecast was very bad. I thought they would make DKK 14 billion in 2022, now the consensus expects closer to 7.5 billion. Andreas’s and Jonas’s forecasts were a bit better.”
“If you look at the comments in some of our bad scenarios, we were thinking a lot of the right things. But we underestimated the level of downside and had not done enough analysis in that area. Their margins were also exceptionally high, there were almost only downside risk in the margins. We committed a number of mistakes and the case was simply too hard and the forecastability too low.”
The team also has a strong focus on more structured education and improvement. They break down areas of expertise into smaller chunks and do deliberate practice. They set specific goals to improve their skills and performance. They have identified the building blocks they believe are most important to master in order to be a great investor.
They have a resource list with sources for each building block. A list of books, studies, concepts, and so on that is updated along the way. Everyone gets both a self- and manager evaluation on their skill level within each building block. Each person works specifically to practice a certain block to a new level of mastery. When a person has gone through a building block, he shares his findings and takeaways with the team and shares which books and sources he found most useful.
The building blocks include areas such as Moat, Accounting, Forecasting, Creativity, and Independent thinking.
Protector Forsikring’s total investment portfolio has a value of NOK 10.2 billion at the end of Q3. Five years ago, it was NOK 4 billion and 10 years ago it was NOK 1.2 billion.
The management owns 4.0% of the company. The largest shareholders are: Stenhagen Invest 8.74%, Global Portfolio Investments 5.36%, Odin Norden 4.61%, Awilhelmsen Capital Holdings 4.16%, and Ojada AS 4.14%.
The total investment return has been better than peer average in 9 out of the last 10 years. The equity portfolio has outperformed by around 100 percentage points since it was insourced in 2014.
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