Brookfield's Greatest Investment: A Mountain of T-Bills

Of course the title is a bit tongue-in-cheek.

Brookfield indeed has a mountain of T-bills stashed away in its Brookfield Wealth Solutions business. However, what’s interesting is the story of how they got there.

OG Berkshire Hathaway’s Float

People about Berkshire’s use of insurance float - and how it turbo-charges returns on the investment side.

What is the “float”? And what does it do for Berkshire?

By obtaining premiums upfront from insurance customers, investing it, and then paying out less on claims than the premiums they took in (otherwise known as underwriting profit) they funded themselves at a negative effective interest rate. This worked out to an effective rate of -1-2% over the years on funding of somewhere in the hundreds of billions of dollars.

Berkshire’s insurance genius Ajit Jain, through strict underwriting, made sure that Berkshire, on average, earned underwriting profits - i.e. negative cost of float.

Berkshire then, through Buffett, used the float to hit home runs on the investment side. Their insurance operation also held far more capital than legally required, meaning they obtained free passes to invest high portions of the capital in equities rather than low-yield bonds (the fate that most other insurers face due to lower capital reserves).

So in summary - you had a freak on the insurance business, Ajit Jain, ensuring negative cost of float, and you had a freak on the investing side, Warren Buffett, taking the capital and achieving 15+% returns over decades.

But how could mere mortal benefit from the same favourable economic characteristics of float?

Warren Buffett and Ajit Jain

Mere Mortals: Apollo

It’s ironic to talk about mere mortals and then name a Greek God. But in this case, I mean “Apollo” the private equity firm.

Apollo pioneered the PE business model of guaranteeing annuity streams.

Side note: How does this work? For example, an annuity marketer sells $1B of annuities yielding 3% across 10-years to retirees or high-net-worth individuals looking for fixed income. However, the company marketing these products might not be equipped to manage investments to generate the guaranteed 3% return across 10 years. So they’d most likely reach out to Apollo, asking Apollo to guarantee 3% each year across 10 years while allowing them full use of the capital in return. 

In 2009, many financial companies exited the retirement market, forced out by shaky capital positions during the Financial Crisis. Apollo, through its Athene venture, swooped in with ample capital, guaranteeing a portion of annuities from American Equity Investment Life. The Fed stimulus at the time probably lowered interest rates in the annuity market, meaning that Apollo only had to guarantee low interest rates to AEL.

It was a good deal for savers who needed fixed income, a good deal for AEL - who found a new well-capitalised partner in a tough environment, and a win for Apollo that found an attractive use of capital.

So why do I call Apollo mere mortals vs. Berkshire?

Berkshire was able to do something amazing, and potentially unique: entering the tough business of reinsurance with far more equity capital than a normal insurer, a sweet deal from the regulators to invest more reserves into equities than competition, and had a genius called Ajit Jain running the whole thing. As a result they generated funds at a negative effective borrowing rate.

What Apollo did, through annuity guarantees, was effectively raise money at around 3% across 10 years, which, but nowhere near what Berkshire could do. But considering that this was 2009, where they could take the borrowed money and invest into great assets on the cheap, being mere mortal was not bad at all ;)

Private Equity Maturity

Firms like Brookfield and Apollo typically source their AUM (Assets under Management) from pension plans or endowment funds seeking to find suitable investments for their beneficiaries.

Over the last 20 years or so Private Equity has benefited from the tailwind of low interest rates making levered, illiquid returns attractive against an otherwise uninspiring investment backdrop. They took in higher allocations of endowments and pension funds with every passing year. No doubt, they used the increase funds to double down on sales and marketing to pensions and endowments - wining and dining, meetings, fancy marketing material, etc. to convince pensions and endowments to drive even higher allocations to PE.

The chart below shows a good example of this effect: Private equity allocations going from 15% in 1999 to 30% in 2024 at the Princeton Endowment

Why do I bring this up? I just think at some point there’s a limit to how much a responsible endowment or pension fund would commit to a single asset class with illiquidity risk (i.e. not being able to sell investments at a particular time to match outgoing payments to pensioners or students).

If so, that would mean lower go-forward PE AUM growth rates, leading to maturity of the overall industry. The industry has already started consolidating in response (allocators look for big brand names like Brookfield or Apollo) - and my guess is ultimately management fees start to get compressed.

So things look stale unless big PE firms can find a next act.

Side note: Most institutional investment operations, run by employees, have a bias to select nameplate PE managers like Brookfield or Apollo - as they seek to offload career risk that comes with sticking one's neck out for an obscure manager without a brand. Therefore, Brookfield would likely be a beneficiary of industry consolidation - however I'd be surprised if they escape industry fee compression over time.

The Big Pivot 🔀

Apollo’s Athene venture was an experiment to gain a new funding source: annuity guarantees with low interest rates. Brookfield most likely waited and watched from the sidelines - no doubt they had FOMO.

Big FOMO.

In 2020, they made their first big move into the annuity guarantee business, straight up copying Apollo and guaranteeing $5B of American Equity Investment Life’s liabilities.

On the investment side, however, there are guardrails (and rightly so) around what Brookfield should invest the annuity capital into if they have fixed liabilities at set maturities. Highly volatile equity securities was not the right way to go.

Luckily in 2019 they acquired Oaktree, a fixed income investment manager with expertise in generating decent returns. Oaktree would end up being the perfect destination for some of the new annuity guarantee capital.

American National Acquisition

It looks as though the experiment to copy Apollo worked well. In 2022, it was time to scale up.

Brookfield acquired American National for $5.1B, thereby gaining access to all of its annuity capital.

Then Brookfield acquired Argo for $1.1B, and then the original Apollo partner, AEL in 2024 for $4.3B - thereby taking total annuity capital to $100B after closing.

In addition, Brookfield put renewed emphasis on expanding AEL’s retail operations to sell more annuities to high-net-worth individuals looking to guarantee interest income over long periods. Brookfield estimated that they could raise around $1B per month from AEL from new annuity sales on top of the $50B that they got from the balance sheet upon acquisition.

The New Business Model

So here you have it: a new source of funding from annuity guarantees, copied directly from Apollo, combined with attractive destinations for the capital in Oaktree Capital fixed income investments.

Which leads us to their greatest investment - the mountain of T-bills!

The Greatest Investment 💰

In 2023, 90-day T-bills yielded around 5.4%. Brookfield had to pay 3-3.5% on the annuity guarantees - meaning that it could take the annuity guarantee capital (let’s call it $60B at the time) and put it into risk-free T-bills giving them an immediate spread of around 2%. That is incredible math for a risk-free deal!

= Annualised net income of $1.2B just from parking the guarantee money in T-bills.

This means they’ve paid off 1/4 of the American National purchase price ($5.1B) in one year with a no-brainer investment move.

What’s Next? 🔮

The track record for the Brookfield annuity arm (Brookfield Wealth Solutions) is exceptional. Here’s the trajectory they have planned from their 2024 Investor Day:

Today with their platform composed of Argo, American Nationl, and AEL, they stand at $110B capital to manage. Through a combination of organic and inorganic growth, they think they can take this to $300B in 5 years. I don’t know what to think of this - but if they end up remotely in that zip code with a 2% spread earned on assets, this would be $6B in annualised net income to the entity - of which a big part flows to Brookfield Corporation shareholders.

Attractive Investment Destinations 🤑

As mentioned before, Brookfield believe that the 2% spread (returns minus funding cost) is sustainable over the long term.

If they put the money into 90-day T-bills they can already cover the spread easily. However, if this spread collapses, Brookfield can put money into Oaktree funds - where they claim that they have generate >10% returns so far - but obviously comes with higher risk and lower liquidity than T-bills. So although Brookfield can find attractive destinations for money, it has to manage volatility and liquidity to stay friendly with annuity regulators at all times.

The Dodgy Stuff 🤨

You can’t call it a real PE operation without some element of self-dealing and dodgy activity. Thankfully Brookfield has also hinted at some of this too - consistent with their track record of being highly shareholder friendly, with some eyebrow raising activity.

Brookfield has a property arm - which contains commercial real estate, part of which is under real distress from a combination of lower occupancy and higher interest rates. These assets might need to be re-capitalised over time.

Brookfield has hinted at (or already) put some of the annuity capital into refinancing this property debt. Yes, it’s technically legal, and technically shareholder-friendly as it preserves the equity value of properties that otherwise be cashflow negative if they had to refinance debt at market interest rates. But it’s technically a wealth transfer - as Brookfield Property LPs now pay higher interest rates to Brookfield itself - but if Brookfield also owns senior debt through its Wealth Solutions operation, then it can dictate any re-capitalisation of the properties.

Again, it’s apparently not illegal or unfriendly towards Brookfield Property LPs, as Brookfield itself owns equity in the property assets through its perpetual vehicle - but it constructs an environment for Brookfield that is “Heads I win, tails I win”, whereas for LPs it’s still “Heads I win, tails I lose”.

Successful Pivot

It’s really hard to reinvent a business model generally. It’s hard to do it when your life depends upon it. But it’s even harder (in my view) to do it when your existing business is actually working pretty well - and one could just rest on their laurels and leave it to the next generation to fix when eventual problems show up.

So Brookfield, Apollo, and others, did something that is not only excellent for shareholders, but actually goes against institutional imperative in a lot of ways.