How You Can Invest in a Hedge Fund

Longing to have a super-genius, wildly successful hedge fund manager invest your money? Yeah, me too. But unless you are an institutional investor, sold your Internet company at the top of the last tech bubble, or happen to be said fund manager, your odds have historically been low.

Surprisingly, within the insurance industry -- one of Warren Buffett's favorite industries – there hides a way to have a hedge fund manager invest your money without having sold your company for millions.

How do insurance companies "float" to the top?
Buffett and his holdings company Berkshire Hathaway (NYSE: BRK-B  ) have been successfully investing in insurance companies for years. Buffett was initially drawn to insurance for a unique feature called "float." Float is the money that the insurance company takes in each month from premium payments, but has not held in reserves for future payouts.

Float is invested into securities to earn a yield while it waits for future payouts. The way the float is invested depends on the types of events it is insuring against and the expected duration. Some insurers, such as Aflac (NYSE: AFL  ) have a short duration and keep the bulk of their assets in liquid fixed-income securities. Others, such as re-insurers, have a longer duration and can take their float outside of the lower-yielding fixed income range.

21.5% annualized?
Hedge Fund manager David Einhorn saw this opportunity and founded a re-insurer, Greenlight RE (Nasdaq: GLRE  ) , in 2004. Greenlight RE is named after Einhorn's hedge fund Greenlight Capital, which as of 2010 had returned an astonishing 21.5% annualized over the past 14 years. Einhorn has made recent news for his call for Microsoft (Nasdaq: MSFT  ) CEO Steve Ballmer to step down and also for his negotiations to purchase 49% of the New York Mets franchise. Einhorn made a name for himself shorting Allied Capital and proclaiming the fall of Lehman in a speech in April 2008, as recounted in his book Fooling Some of the People All of the Time.

How you can invest with Einhorn
Einhorn set up Greenlight RE in a way so that the float is invested into his hedge fund. This has had the benefit of adding additional capital to his fund and at the same time compounding the float of the insurance company at a high rate.

Greenlight RE is publicly traded on the Nasdaq exchange. Greenlight RE had a net profit margin of 23% last year, and currently trades at a reasonable 16 times P/E and a low 1.3 price-to-book value ratio. The stock is unfortunately not a pure play investment into Einhorn's hedge fund, since it operates as a standalone business and has operating costs to pay, but a significant component of the returns come from the float that is invested into Einhorn's hedge fund.

Since the earnings from the float stay in Greenlight RE -- which is a Cayman Islands-based company -- they are not taxed as earnings. This tax benefit adds up over time and allows you to take the regular gains from Einhorn's hedge fund untaxed until you sell your position in Greenlight RE.

So what exactly is re-insurance?
If you're intrigued by a chance to invest with Einhorn, but are leery on re-insurance, here's how it works: Re-insurance is insurance that is sold to insurance companies. The insurance companies will buy insurance on their own underwriting to help accommodate risk, smooth their income, or take advantage of an arbitrage opportunity (buy insurance at a cheaper rate than they sell the insurance to their customers).

Greenlight's not without its risks, but for everyday investors intrigued by David Einhorn's track record, it could be your best way to invest in a hedge fund without being a millionaire.

To stay updated on all things Greenlight RE, add the company to our free My Watchlist service.

Eric Bleeker owns shares of no companies listed above. The Motley Fool owns shares of Microsoft, Berkshire Hathaway, and Aflac. Motley Fool newsletter services have recommended buying shares of Aflac, Microsoft, and Berkshire Hathaway. Motley Fool newsletter services have recommended creating a diagonal call position in Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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