Strategic buyers have dominated the merger and acquisition of financial services companies.
A financial interloper now has announced plans to muscle in on the business.
New York-based Argonaut Private Equity Management plans to launch the Global Financial Services Opportunity Fund, a $300 million partnership that will make significant or controlling investments in financial companies worldwide.
Buying financial services companies provides a leveraged macroeconomic investment, said Geoffrey Kalish, Argonaut managing director.
"When the economy does well, financial services do better," he said.
Argonaut also is drawn to the sector because of a confluence of factors worldwide that makes financial services companies attractive.
"The expansion of competitive free-market capitalism around the world and the resultant increase in global commerce has unleashed long-term secular trends favorable to the development of both global and local financial markets," states the Global Financial Services Opportunity Fund offering memorandum.
"The rapid and accelerating changes in the political, regulatory, economic and social landscape in economies around the world, combined with the revolutionary changes in information technology and communications, have fundamentally altered the way financial products are manufactured and delivered."
The Argonaut principals expect to make 10 to 15 investments in the first five years of the 10-year fund. One-third will be domestic financial services companies, one-third will be in companies in Western Europe and the final third will be in other regions of the world.
The Argonaut managing directors know of no other partnerships dedicated solely to acquiring financial services companies globally.
"There are people who dabble in financial services," said Managing Director Bruce MacFarlane. "Some have done some here and there."
The types of companies the Global Financial Services Opportunity Fund aim to buy are mortgage bankers, credit card companies, transaction processors, financial planners, banks and insurance companies, said Mr. Kalish.
"A lot won't have synergies," he said. "They will be in different sectors."
The principals already have identified 30 prospective deals.
Messrs. Kalish and MacFarlane are joined at Argonaut by David Gerstenhaber and Matt Grayson. The group has a collective 60 years of experience in financial services companies and has completed more than 550 transactions in more than 60 countries.
Mr. Gerstenhaber, president of Argonaut, is a hedge fund investor, and has worked with Tiger Management and Soros Fund Management.
"He (Mr. Gerstenhaber ) is our global investment piece of the puzzle," said Mr. MacFarlane. "He is the top-down guy.
"Geoff, Matt and I are investment bankers," said Mr. MacFarlane. "We are the bottom-up due diligence guys."
Argonaut doesn't expect to have much competition for deals among other financial buyers. Against a strategic buyer, they will make the seller an offer that would be hard to refuse: survival.
"When a trade buyer buys, the new business gets assimilated (into the existing business) and the new management goes away," said Mr. Kalish. "That won't always please the seller.
"We will offer a clear choice for the seller, particularly the management team," he said. "Stay on and get rich with us."
Profiting from catastrophes
What do earthquakes in California, typhoons in Japan and hurricanes along the eastern U.S. seaboard have in common, besides the loss of life and the billions of dollars in property damage each could cause?
The risk of financial loss has been quantified and securitized with instruments known as catastrophe bonds.
About $1.5 billion of CAT bonds -- as they are known by the industry -- have been issued in the past 18 months. Greg Hagood, a managing principal with Willis Corroon Catastrophe Management, estimates pension funds and endowments have bought about 45% of the bonds.
Most were bought directly from issuers like Morgan Stanley Dean Witter Discover & Co., Goldman Sachs & Co., Lehman Brothers Inc. and Donaldson Lufkin & Jenrette Inc. Traditional reinsurers like AON Group Inc. and Marsh & McLennan Inc. are also issuers, said Mr. Hagood.
"Pensions have been attracted to CAT bonds because they provide high yields and are uncorrelated to existing stock and bond portfolios," said Mr. Hagood, whose London-based company is the third-largest reinsurance broker in the world.
But these institutional investors are at a disadvantage because they lack a dedicated team that understands the nuances of these bonds, he claims.
To that end, Willis Corroon established the Willis Corroon Catastrophe Investment Fund LP.
The $50 million fund, which closed in April, seeks a target return of 15% to 18% annually by building a geographically diverse portfolio of insurance risk by buying CAT bonds or Chicago Board of Trade catastrophe insurance options.
A larger fund would have forced the principals to buy every issuance, said Mr. Hagood. A small fund allows them the be selective.
A follow-on fund, yet unscheduled, is dependent on an increase in the market for CAT bonds, said Mr. Hagood. There were no pension funds or endowments in the first fund, although a number expressed interest.
"Maybe when they raise a second fund, we will be an investor," said Mark Yusko, chief investment officer for the $800 million endowment of the University of North Carolina, Chapel Hill.
Mr. Yusko said he was in his job just six months when he met with the Willis Corroon principals and did not want to make CAT bonds the first investment. "I like the concept," he said. "I liked their ability to quantify the product.
"They (Willis Corroon) can run models to stress test the portfolio, based on 100-year and 200-year events," said Mr. Yusko.
Investors should use an adviser when purchasing CAT bonds, said Mr. Hagood, because insurance companies have an information advantage and could pass unwanted risks on to an unfamiliar investor.
It also is difficult for pension funds and endowments to obtain historical loss information and keep up with market terms and trends.
The standard terms and conditions in the bonds' documents contain exclusions of items an insurer won't cover in the event of a catastrophe. An insurer could sneak something in that the capital markets won't pick up, but a traditional reinsurer would, said Mr. Hagood.
"All we know and do is insurance and reinsurance, so they (investors) don't have to," said Mr. Hagood. "We are applying our traditional knowledge base.
"By investing in WCCIF, an investor can participate in the asset class through a dedicated fund managed by a reinsurance industry leader."
CAT bonds only came into existence in the past two years.
"After Hurricane Andrew, a lot of reinsurers couldn't pay claims," said Mr. Hagood. "It (the reinsurance industry) was undercapitalized for these huge events.
"So they tapped the capital markets."
The first CAT bond issuance occurred in December 1996 and raised $68 million. The largest transaction to date was a $477 million issuance last summer by USAA, a Texas insurer that sought to protect against losses from a huge hurricane along the East Coast of the United States.
The CAT bonds typically have maturities of one to three years, and the issuer can default on interest and/or principal payments if a catastrophe of a stipulated magnitude occurs.
In return for the risk, the bond holders receive a coupon that is significantly above mortgage- or asset-backed yields.
The coupon on bonds outstanding range from 450 to 950 points over the London interbank offered rate, even though most bonds protect against catastrophes that occur infrequently.