petec

My downside protection is the meaningful fcf the businesses I privately own and manage generate at the end of each month. And I don't know of any other kind of downside protection that really works. Cheers, Gio I would entirely agree if I was in that position ;)

Didn't mean to suggest his reasons were applicable to everyone. And re: my fund managers, I want them to invest in whatever way works for them. If they have 90% in cash and invest 10% each year in one idea that doubles, they'll compound faster than the market averages over time even after a 1% fee. If it works for them it works for me! I invest in managers that are fully invested and some that are not.

Agree with Crip. We've all discussed the reasoning for the hedges. Whatever you think on that, they are gone, and although there wasn't the apology some wanted, there were several parts of the letter in which Prem acknowledged how costly they have been and also how their stockpicking hasn't been good enough. With the hedges gone, it should be possible to compound book value at 8-10% with underwriting and say 3% on the investment book, with significant leverage to that number if investing is better than that, which it usually was prior to the hedge period. I was also struck by the suggestion that they would raise the bar on acquisitions and emulate Henry Singleton's record at Teledyne, which implies that the days of big deals and rising share count are gone for now and that the share count might fall. I was also impressed by the value of Quess within TC India, and by the Fairfax India letter. Seems to me FFH has created significant value in India. I remain a very happy holder. My only problem is that now my downside protection is gone ;) P

Not explicitly, but Buffett is sitting on a lot of cash. I think cash has a lot to do with your personal psychology. If you hate watching the market go up while you're in cash, you'll be fully invested. If you hate the feeling of having no dry powder, or you prefer only to invest in a limited number of highly undervalued things and cash is the residual of your position sizing, you carry quite a lot. I'm in the latter camp and although I can't claim a 20% CAGR, I've outperformed. My point, really, is you're likely to make good decisions when you're psychologically comfortable, and so the best strategy for one person might differ from another's.

Read the last Fairfax India letter before you decide...I'm regretting selling mine ;)

But an entirely correct one.

100% agreed - it was a choice. Question is, was it a good one because the thinking was sound (there is a risk of a depression; history suggests a depression could cost us the company; we are prepared to pay a high price to avoid even a small risk of that); or was it a bad one because there wasn't a depression? Easy to argue both ways but for me the key is that 1. they were very clear about what they were doing so if you didn't like it you didn't have to own it, and 2. they didn't make hay on the long side when they should have done. I agree, I've just been a little tired of the "hedges were required" argument--Markel didn't do it, BRK didn't do it, and FFH varied the amount of hedges based on their macro whims (first 0%, then 100%, then they said it would slowly fall off as they grew, then it was 120%, then it was 50%, now it is 0%). I was in it for some of the hedges, but after one of the meetings where they said they were convinced you could make no money until the next crash and still beat the market--that was just too much. So I was out for the last 3-4 years. Just got back in now that the hedges are off. I just want them to do their bread and butter. Totally agree it was a choice and not required. Slightly disagree on the comparison with Markel and Berkshire given higher leverage and investing styles - the hedges were more of a requirement here but the same goal could have been achieved by investing in higher quality equities. The overall strategy - hedge and invest in crap - was very poor. I've lightened because I had a big position for the hedges but in terms of Fairfax itself I agree, want them to go back to bread and butter.

You say, Trump's policies might cause a depression. A depression!! But somehow a depression would only cause a garden variety stock market correction of 20-30%. I do not think depression means what you think it means. Vinod Perhaps I did not write clearly enough. A depression - causing a 90% drawdown - is what they have been hedging against. Trump's deregulatory policies reduce this risk. However they still see clear risks. One is that Trump's protectionist policies cause a depression. Another is a 20-30% drawdown in the normal course of business (i.e. not in a depression). This is my reading of what they said on the call. This comment was in response to the idea that since Trump they do not see risks. They do. That is why they are at high cash levels and duration down to 1. With that positioning, they no longer need the hedges. I am just dumbfounded. I had a rule before: Never debate with a Trump supporter. Now I am going to add one more: Never debate with a Fairfax diehard. Vinod Ha! You misread my post and decided that we have different definitions of depression. I explained my post, showing that we don't, and explaining what I think FFH's views are based on what they said on the call. This makes me a diehard. You are not the only one who is dumbfounded. FWIW I've reduced recently (FFH without hedges was too big a position for me). I've defended the hedges, yes, but attacked the stockpicking.

100% agreed - it was a choice. Question is, was it a good one because the thinking was sound (there is a risk of a depression; history suggests a depression could cost us the company; we are prepared to pay a high price to avoid even a small risk of that); or was it a bad one because there wasn't a depression? Easy to argue both ways but for me the key is that 1. they were very clear about what they were doing so if you didn't like it you didn't have to own it, and 2. they didn't make hay on the long side when they should have done.

You say, Trump's policies might cause a depression. A depression!! But somehow a depression would only cause a garden variety stock market correction of 20-30%. I do not think depression means what you think it means. Vinod Perhaps I did not write clearly enough. A depression - causing a 90% drawdown - is what they have been hedging against. Trump's deregulatory policies reduce this risk. However they still see clear risks. One is that Trump's protectionist policies cause a depression. Another is a 20-30% drawdown in the normal course of business (i.e. not in a depression). This is my reading of what they said on the call. This comment was in response to the idea that since Trump they do not see risks. They do. That is why they are at high cash levels and duration down to 1. With that positioning, they no longer need the hedges.

...But VERY long on cash and short on duration, and in no rush to invest it seems, so still very well positioned for a downturn. (Reminds me of Parsad's smart observation when they took the first block of hedges off: who needs hedges when you have that much cash?)

I didn't fully understand the hedges until I read Murray Rothbard's history of the Great Depression. To put the opposite case, which is what I think Prem at al are seeing: Debt deleveraging might finally start but in a positive way, by growing GDP faster than debt. Fairfax were worried it would happen in a negative way, i.e. by paying down debt in an environment of no or negative growth. Unlike the left, Fairfax seem to understand that growing GDP faster than debt cannot be done via stimulus; it can only be done by deregulating and letting free markets develop new products and services. That might finally happen in the world's biggest economy. They are still wary and stated on the call that Trump's protectionist policies might still trigger a depression. They also stated clearly that 20-30% drawdowns might become normal (again). But they also explained that if the US starts to grow strongly you need to worry less about Europe and China - which is right - and they have lots of cash and their deflation swaps if the worst happens. They are hardly going all in. They are basically sitting on cash waiting for individual opportunities. They're just saying that the risk of a depression is smaller when the President isn't trying to regulate and tax the life out of the private economy and replace it with public spending. And they are right. The policy mix seems to have shifted completely. It matters that you've fun out of monetary stimulus if monetary stimulus is all you've got. Trump doesn't seem supportive of monetary stimulus. In fact he would like to reduce it, and replace it with a booming private economy and a bit of upgrading infrastructure. If he gets that right, the inability to cut rates further won't matter. They clearly stated on their call that Trump's protectionism could start a depression and that the market might return to 20-30% drawdowns in the normal course of business. They have their eyes wide open to the risks. The point is that they think the risks of a depression have reduced - and they never cared about a 20-30% stock market selloff - in fact they probably want one. (They were hedging against a 1929-33 style 90% selloff.) I've spent a lot of time trying to understand these hedges and I buy the idea that they were to protect the company against a very specific risk, which has reduced. I find it much harder to accept the crappy stockpicking, and I find it very hard to square some of the stockpicking with their views of the macro risks (in some cases their stocks would have gone to zero and the hedges would not have come close to fully covering the losses). So while it may seem like I am mindlessly defending Prem, I'm not: I just think that those of you who are focussed on "the hedges were a bet and they haven't admitted they were wrong" are asking the wrong questions.

If a bad patch makes you incompetent, then yes. And admittedly it's been a long bad patch (after a stellar patch). But I don't pay them 1% plus a performance fee to beat the major indices. I pay them a salary (and not a particularly big one) to protect their company and compound book value at a moderate rate. I don't have serious complaints about the hedges. I do worry about the stockpicking. What really intrigues me is whether they will learn from their investing mistakes (as they clearly learned from their insurance acquisition mistakes).

Yes, they would. I'm not sure I would have done better though, because I'd probably have had a lot more cash (I used Fairfax as my "hedge" to help me sleep at night despite being close to fully invested). They were very clear that they were hedged and anyone who is disappointed in the performance of the hedges simply shouldn't have been invested in FFH. As Gio and others have said, the place to focus is on the poor stockpicking which is where they didn't do what they said they'd do.

Because the hedges were never a value-driven bet on where the market would go, but a hedge against another Great Depression, which they feel is less likely with a deregulatory/Randian government. I feel the messaging was always fairly consistent on this - hence how often they repeated the Ben Graham "if you weren't bearish in 1925..." quote. I agreed with them at the time but clearly it was a massive mistake - especially since as you say the deflation hedges would have covered it just fine. I'm inclined to agree with them now too, unless Trump goes all protectionist, in which case their timing may prove horrific.

I'm not advocating for anything illegal, but I think the world would benefit if *someone* photocopied this and shared this with the world, a la Klarman's Margin of Safety :) Wow - a purported value investor that doesn't understand what theft is. I've been thinking about this. If a book is out of print then who are you stealing from if you read a photocopy? Not the owners of the existing copies - they don't own the IP. And arguably not the author, who is not losing sales and seems to show no interest in satisfying the demand for his work. I'm approaching this from a moral standpoint, not a legal one.

This. The "FFH is a substitute for cash" argument works great for those who feel cash is burning a hole in their pockets. Some are comfortable holding cash, some are not. Understand which you are and act accordingly.

:o

Could you educate me? I missed this. Thanks! Well Prem runs Fairfax and will until he no longer can...be it physically or spiritually. But it looks pretty obvious who would run Fairfax if Prem could no longer do so. If you don't really know, time to do some legwork and figure it out. :) Incidentally, no one has ever said anything to me. But after watching it for all these years, I kind of have a pretty good idea of changes at Fairfax that may not seem like much, but are monumental shifts in planning or thinking. Cheers! Ha - OK! I also have a fair idea, although I am nowhere near as well informed as you. However I read your comment to mean that an announcement had been made, hence the question.

Could you educate me? I missed this. Thanks!

Thank you BP6, If I have understood correctly, the main risks you see are: 1) Their stock picking performance will continue to generate very poor results, 2) They are financing the acquisition of Allied in a way that won't maximize shareholders' return. You said you have discussed a lot about FFH with people you trust and who know FFH very well. And you have come to the conclusion there is something wrong at FFH. Do you see other risks beside 1 and 2? I am really interested to understand if people who know FFH very well see risks that I might have overlooked. Cheers, Gio Gio, Your summary of my comments are not entirely accurate however I will try my best to respond to your questions. My conclusion to sell a portion of the shares in FFH that I have held for 16 years was made after consideration of a number of factors however bottom line my ability to simply ``trust in Prem`` is not what it once was. I did not say that FFH`s stock picking will continue to generate very poor results. I do not know what the future holds neither does the FFH team or any poster on this board. I did say that Prem owes his shareholders a detailed explanation of his exit strategy for 3 of his largest losing equity positions (Blackberry, Eurobank, Resolute Forest). Others may disagree with this—that`s okay. I will not reiterate the numerous concerns that have been written about by other posters however they all factored into my decision. In addition however I have become concerned with the following items: 1) FFH`s leverage was often discussed as the reason for the equity hedges. I accepted this explanation. What disturbs me is that FFH did not take advantage of a sell-off in the preferred share market to lower their leverage by buying back the preferred shares in the market at well below their issue price. The various FFH preferred share issues were done at $25 per share and yielded about 5% at issue. They all traded down substantially to levels as low as $11-12 per share earlier in the year due to the drop in bond yields. Despite having the authority to buyback these shares in the open market FFH chose not to do so. I don`t know about you but issuing shares at $25 and buying them back at $11-12 seems like a good trade to me. 2) Prem continually touts the longevity and experience of the management team as a key positive for FFH. This was great when the team was in their 40`s however they are now approaching their 70`s. It is time for Prem to also articulate the succession plan for all the key members of the management and investment team. As one individual I know says—``when Brian Bradstreet retires I will sell all of my FFH shares``. Prem has agreed to stay on until at least his 75th birthday. Great---what about the rest of them. I do not believe we can count on all of the key members to stay around as long as Buffett and Munger have done at Berkshire. 3) Board governance is also an area I have some concerns with. The lack of diversity and new blood (and in my view Ben Watsa does not count) on the board cannot be overlooked. 4) What is the Eurolife acquisition really about. As we all know—life insurance is a vastly different business than property and casualty insurance. It`s okay if FFH is now diversifying into life insurance but tell us that. I suspect that FFH`s Eurolife investment was simply another capital raising exercise for Eurobank disguised in another form. 5) The conference call to discuss the Q3 2016 results was held on November 4, 2016. At that time Prem was still extremely concerned about the US and global economies and as a resulted maintained the equity hedges and deflation protection. One week later---after the US election---FFH announces that everything is all right with the world and reduces the equity hedges by 50% because of Trump`s election win in the US. Simply put---I call bullshit on that explanation. I could go on however I will stop here. I trust you get a sense that my decision to sell is well thought out and based on a detailed analysis of the issues as I see them. Hopefully these comments assist you in deciding what to do with your FFH shares. As Uccmal said in an earlier post---what Prem has created at FFH is amazing. I could not have done it. He is to be applauded for what he has accomplished. Despite this I can no longer give him a pass when there are a series of issues at FFH that I have grave concern with which are not being addressed to my satisfaction. BP6 Excellent post. I disagree with some of it, but excellent nonetheless. Probably the single thing making me most bullish on FFH is all the old guard shareholders throwing in the towel! I intend to hold my shares for a very long time and compound at a decent rate. My main concern for that thesis is succession.

He sounds like a cartain manic depressive fellow I want to sell some shares to... really strange. Yea - This is getting bizarre. I don't have any issues with the acquisition in and of itself, but the 180 degree turn on the U.S. markets as the result of the election with no commentary on rising rates, falling liquidity, strengthening dollar, declining corproate profits, levered corporations, and valuations that appear excessive certainly seems strange. If you read what he's said carefully, he hasn't done a 180 on the US markets but on the US economy. The hedges were not mainly explained in valuation (e.g. CAPE, Tobin's Q) terms. They were explained in terms of protecting the company from another 1929-33 type selloff, which would have destroyed the company in the absence of the hedges. They now feel that that kind of catastrophe has reduced in probability, because we have a quantum shift from a world in which politicians over-regulate and rely on central bankers to promote growth via leverage, to one in which (maybe) government gets out of the way and productivity drives gdp. So the hedges have gone. Doesn't mean they think the market goes up. All they've said on that front is that it will become a stockpicker's market again. Value starts to win again. I have a problem with this idea that productivity is suddenly going to go up and all ills are cured because of the election. This implies something along the following lines: As a business owner I have a project that I can execute that would that would improve productivity of my labor force and I can make me more money. Interest rates are low so I have cheap capital available. But I don't execute the project because I don't like the guy in the White House? In addition economies are large and complex mechanisms. They don't turn on a dime. You don't go from deflation risk and possibility of a great depression just because you had an election. The risk of a stock market crash definitely doesn't go down after you've had a 100% or so rally in stock prices. Re: productivity and economic complexity, I disagree. Deregulating and reducing taxes has an immediate impact. I'd direct you to "Job Creation" by Andy Pudzer, Trump's new Labour Secretary, for a description of why and how. However, so far all we have is ideas: these things need to actually happen and that's the risk. Re: risk of a bear market after a 100% rise, I agree. But FFH wasn't hedging against that - he started hedging in 2010. He was hedging against an apocalypse and thinks that risk is reduced. I'm not defending FFH here but I do think they have been fairly clear in communicating their strategy.

bsilly The only argument against your point (a) is that FFH themselves would likely value Riverstone above 0.7x and possibly about 1x BV, since they know it backwards and have a lot of faith in it. But broadly speaking I agree and I have no issue with them adding outstanding underwriting at a fair price. P

Pete, I agree. And basically I think the change is an healthy one and should be welcomed. Many people though disagree. And that's why I would like to know if they see risks that I might have overlooked. What can go wrong? How probable is it? And which will be the consequences on the whole company? Cheers, Gio I agree. I can't see a lot of risk in a cash heavy, underwriting-profitable insurer. Standard cat risks obviously. But key risk now is investing. They've limited absolute losses in the bond market and should see interest income rising. If they can go back to winning in the equity market this thing is a great investment at this price. If not...

Yes, I have wondered about that and need to ask them. At the very least they were so focussed on the downside risk that they underestimated the upside risk. Could have hedged that out easily I would imagine. But, had their equity portfolio outperformed the market (i.e. had they locked in their alpha via the hedges) I doubt we'd be having this conversation. It's the combination of protection proving so expensive and poor longs that got us here.