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Recreating the "Fireman's Fund Arb" in Smart Loans

NEW IDEA: Invest in underfunded government programs, get the government guarantees for free, earn a super high return with low risk. Double the size of your business.

Years ago, Sandy Weill fired the entire investment department at Fireman’s Fund Insurance Company in San Francisco to cut costs. He then put an inexperienced 33 year old portfolio manager, and the cheapest guy Sandy could find (yours truly) in charge of all investments. (What was he thinking?)

While unfortunate for the 53 people fired, it was a big break for me.

Fireman’s Fund was losing business to Executive Life that priced their policies off the higher yield of junk bonds, and I had some new market based ideas on how to compete with them.

Shortly thereafter I launched a new government backed mortgage strategy that delivered the high yield of junk bonds but with US government based credit risk. One key to the strategy was to control credit risk by focusing on government backed loans. The second key was to generate higher returns by exploiting market inefficiencies. Called it the “Fireman’s Fund Arb.”

The high yielding strategy allowed Fireman’s Fund to decrease the price of their life policies and increase the yield offered on their single premium deferred annuities which were sold through American Express.

Sales skyrocketed. Assets doubled to $1.5 billion. Small by today’s standards, but, substantial for the time.

Think about that for a minute, and the implications and potential for you and your investments.

While difficult, if you can figure out ways to increase the return on your investments while managing risk you can double the size of your financial business like Fireman’s Fund did in a short period of time. Seems like something to spend time on.

Does the Fireman’s Fund Arb work today? No. The market inefficiencies that powered the Fireman’s Fund Arb are long gone, and Executive Life went bankrupt chasing yield (just as investors are desperately chasing yield today).

However, be not discouraged! This story has a happy ending. I have uncovered and tested over five years several global market inefficiencies that are allowing Seagate Global to recreate the glory of the Fireman’s Fund Arb: high yielding investments based on investment grade government credit risk and market inefficiencies.

Fast forward to 2014. Location: Malaysian Embassy, Washington DC. Meeting with Malaysia’s Ambassador to the US, Ambassador Dr. Datuk Awang Adek. He tells me that banks in SE Asia reduced lending due to the 2008 financial crisis to the point that even the Government of Malaysia, a stable A3/A- investment grade rated country, had many solid programs that were underfunded. Things like government employee affordable housing, government supply contracts and solar projects. Hmm.

The chart below supports the Ambassador's assertion that banks cut lending. Bank lending in Europe dropped from almost 80% of loans to almost 20%. Same around the world.

Why? Since the 2008 financial crisis traditional global financial market disintermediation has become much less efficient due to new regulations, increases in risk based capital, anti-money laundering laws, know your customer laws and fines large enough to bankrupt even Deutsche Bank (BCG estimates banks have been fined over $300 billion since 2008).

The result is that many global financial institutions have reduced lending in fast growing markets that have projects with high returns, while cash remains trapped in low and even negative interest rate accounts in surplus countries around the world.

I asked the Ambassador; “What kind of returns are there on deals?” He said, “for the suppliers and developers the returns are 20%+, so there should be plenty of spread to work with to get a fair return.” Size? “Billions.” He also said many other countries are in the same situation.

Bingo. Investment grade government guarantee. (True, not the US, but investment grade.) High margins. Lenders cutting capacity by 10% while demand is growing by 10% per year. I wanted to see if it was possible to create a new updated version of the Fireman’s Fund Arb.

Went to Malaysia to find out. Everything the Ambassador told me was true.

Our plan: Start a pilot program to originate, fund and service high yielding Government of Malaysia backed loans. Once proven, scale up.

On the origination side we created the Seagate Global Smart Partnership Agreement. This agreement places Seagate in the Sponsor role for government projects and contracts.

To fund the Smart Partnerships Seagate developed the Seagate Global ESG Government Smart Loan Program.

Smart Loans are designed to deliver a high level of income with superior risk-adjusted return backed by Malaysia’s sovereign related government credit. Smart Loans are an alternative fixed income investment that Seagate believes is “smarter” than currently available fixed income instruments because:

1. It uses an investment grade government program as the credit, so repayment is assured;

2. In addition to the government’s promise to repay, loans are collateralized by the underlying real estate and/or supplies, so Smart Loans provide extra principal protection;

3. Smart Loans can turn a longer-term obligation into a lower risk short-term receivable;

4. Smart Loans pay a significantly higher return than most loans or bonds of similar credit risk due to the high demand for funds in the local market and inefficiencies in the financial system;

5. Smart Loans make a positive social impact.

How was the performance for the first five years? Much better than the Fireman’s Fund Arb, and most other strategies:

Percent return by strategy, 7/15-4/20.

Seagate Smart Loan returns compare favorably to the S&P 500, the Barclays Aggregate Bond Index, and all HFR indices, including the best performing index, HFR High Tech Index (HFRITECH) using simple uncompounded monthly returns added monthly for 7/15-4/20. (*See performance footnote below.)

These results include all loans made. There were no losses. 63 transactions were completed. Average return was close to 30%. Concept proven. Time to scale up. How?

The biggest challenge has been to develop an institutional size pipeline. In preparation, Seagate obtained various licenses in Malaysia, including Registered Bumiputera, Registered Money Lender, Registered Solar Investor, Member Malaysia Factors Association, registration with the Malaysia Ministry of Finance and Bank Negara, Malaysia’s central bank.

Then, late last year, the pipeline issue was resolved after the government asked Seagate to help finance 15,000 government employee affordable housing units worth around $1 billion, as well as applications from developers for another $1 billion in deals.

So, Seagate is now in scale up mode in Malaysia, and preparing to expand to other countries.

What does this mean for you? Depends on how smart an investor you are.

Most financial organizations will continue doing what everyone else is doing, and produce average returns like they did over the past five years, oblivious to the massive structural changes, risks, and opportunities today.

Or, you can investigate Seagate’s updated “Fireman’s Fund Arb,” Smart Loans, potentially turbo-charge your investments, and maybe even double the size of your business like I did at Fireman's Fund. Can happen.

Seagate Global can offer Smart Loans to investors with annual rates of from 9%-15% in US dollars. We can do some size. Seagate Global is open to collaborate with select financial organizations, either on a one-off investment basis or up to and including an exclusive relationship.

There are few new ideas out there that actually work in this market. This is one of them.

This is a turnkey country scale business opportunity that can deliver massive amounts of alpha and drive a lot of growth. The more resources and partners we have the faster we can grow the Smart Loan Program. If you represent a financial organization that is driven by investment returns such as an insurance company, private equity company, or hedge fund, contact me, you may be pleasantly surprised.

Oh, and did I mention that Smart Loans are socially responsible? They primarily finance affordable and sustainable solar housing. That is why we call them ESG Smart Loans.

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