petec

Remember the 15% is local fx, including inflation. The real numbers are going to be different. Exactly. Indian rates have exceeded US rates by about 6-7% in the last 15 years, and by 8-9% in the last 5-6 years, so a 15% nominal return would get FIH only about 6-7% in USD. Of course, there's still the 1.5% management fee. Investing in FIH is tantamount to expecting at least 2.5% alpha. If FIH gets 17.5% in INR instead of 15% in the SENSEX, that might be 9.5% in USD, and FIH would pay FFH 1.5% + (9.5-5)*20% = 2.4%, and FIH would break even with the Indian market index; higher alpha is gravy. Assuming, of course, that the Indian market continues to do what it's done before ;)

I would guess a) PE is all about maintaining a high CAGR so once you've got the multiple appreciation, maybe the intrinsic returns of the business are less attractive; and b) I wonder if they can invest so well within the restrictions imposed by regulators and ratings agencies - float investing is in large part about outperforming the bond markets within tight balance sheet constraints, which isn't the same skill as PE. But I am only guessing.

Look at pp 90-91 of the final prospectus, available on sesar.ca. Basically, the starting highwater mark is the NAV at the IPO, i.e. About $9.63 per share. Then NAV + total distributions in the just completed 3-yr period is calculated, the first calculation date being Dec 31, 2017 and then every 3 yrs. The difference between that amount and the current highwater mark is the appreciation. If that appreciation is positive, a performance fee of 20% of the amount exceeding 5% per annum goes to FFH, and the current NAV becomes the new highwater amount. If the NAV + distributions is not higher than the highwater mark, then there is no performance fee and no modification of the highwater mark. That's what I thought - I just found the wording confusing. Thanks.

Does anybody understand the way the high water mark is calculated?! P90?

I agree. It's also worth pointing out how big this is: it will be comfortably their 2nd biggest insurer by net premiums written (after Odyssey) and will generate ~20% of net premiums written and closer to 25% of underwriting profit given the below-average combined ratio.

Quite hard to figure out how to normalise annual earnings from the 1H results, given IPO expenses and big changes in investment and fx line items. But both years suggest 15% RONTA would be do-able, in which case I think the price paid is quite justifiable. FFH have certainly kept their promise to buy higher quality insurers. And on a side note, when criticising them for hedging their listed equities too early it's worth remembering that if you include the money they've poured into buying this sort of equity, they have been nowhere near 100% hedged.

Remember the 15% is local fx, including inflation. The real numbers are going to be different.

He's not saying there isn't. He's saying that the money flows out of Germany into the peripheral states were caused by imbalances within Germany, and that there is no reason to believe that states with a different culture would have handled them better, because historically states with difference cultures have handled them just as badly, including Germany 140 years ago. He also makes good points about how perceptions of different cultures change according to the state of the times. Confucianism is currently thought to bestow the Chinese with an incredible work ethic, but it's not all that long ago that it was thought to make the Chinese lazy. By the way: the Chinese don't have a lot of savings if the projects they've been invested in are malinvestments (as seems likely given the incredible pace of investment and credit growth). And I'll be stunned if the economy is actually growing at 7%, despite what the official stats say. And the demographics are awful. China probably has a great future, but I think you're oversimplifying the outlook ;)

I agree with this 100%. Except that again in action we differ: I prefer to make implicit macro bets, instead of explicit ones. Meaning that I still prefer to invest in businesses that will thrive if my macro bets turn out right, instead of playing the game of asset allocation. I find asset allocation too hard, because I never can muster confidence enough to average down in a position that is going against me. And whenever I cannot do that, I know something is wrong. Gio I agree entirely. I probably misworded it - by explicit, I just mean that I try to think through the implications of all sorts of macro outcomes on every investment. I then try to have a portfolio that'll survive everything.

I think this is a crucial point, but misunderstood. I'm on ni-co's side of the macro arguments in terms of the state I think the world is in. But I have no idea what will come of it. Well, I have a lot of ideas, but no conviction. All sorts of things could happen. But my contention is that most people who say 'you don't know what'll happen' then invest as if the next 40 years will be like the last 40, in other words they act as if they know what will happen while telling themselves that they are not making any macro assumptions because they don't know what will happen. That strikes me as a good way to get killed if the world throws us a curveball. And if elevated debt levels does anything, it elevates the probability of a curveball. To put it another way, you often can't invest without making macro assumptions. I think it's better to make them explicit, so you understand what risks you are taking, rather than implicit, in which case you might not have thought them through.

What are the chances a recession comes in the next decade? I think the odds are higher than rates rising. +1

Surely it's the direction of rates that matters, not the level? My underdstanding is that pretty much every bubble has been preceded by easing monetary policy. But clearly the teenager/beer psychology is also key - the two interact with each other.

That's possible, but I don't think interest rates have to rise for sentiment to change (at least in Canada, I'm less familiar with other markets). The current oil crash could be the final nail in the coffin. Mining (esp. junior) has been depressed for a few years, and now this. That's a big chunk of the Canadian economy, and especially, a very visible chunk. Bad news are hard to ignore when you have no margin of safety (record debt levels, etc). I don't think interest rates have to be the trigger either. But (speaking for the UK, and specifically London) I think the psychology of ownership is so strong that it will take time, or a real crisis, to change it. It's just been so long since anyone really got hurt owning property here that people don't consider the downside. I'm not even sure most have any way to visualise the downside and the leverage. And they don't have to because so far every dip has been temporary since the 1970s. Housing is a) basically the only investment option most laypeople have, b) a surefire winner in the popular psychology, and c) an essential that seems only to get more expensive. You can understand why the mindset exists and I do think it will take time, or a crisis, to turn.

Interest rates are similarly low in many other places, yet houses aren't as expensive as in Canada. I think what will matter in the end is that house prices have completely disconnected from wages. People are barely able to afford housing even with the help of super low interest rates. Most people justify buying because they think prices will keep rising and 1) if they don't buy now, they'll never be able to and 2) over time they'll make money on their house. As soon as sentiment changes and people realize that trees don't grow to the sky, I think things can start to happen fairly quickly. +1 and I fear the UK is in the same position. Although, I do think that a decade or so of ultralow rates is a possibility, as per the previous post.

No, they would not, because if it only had a 10% chance of being successful then 90% of such endeavours would go bust and destroy capital. That's as bad (for the economy and shareholders) as buying back stock above IV. That's why it's very important that management teams make the right capital allocation decisions, and there is an argument that cheap debt + option compensation + tax skews = a distorted incentive to buy back stock rather than invest in productive enterprise. Stockman makes this case powerfully.

Depending on the valuation!

I accept the logic but I don't think it's this simple. When you put my theory of skewed incentives together with Ni-Co's ideas about cheap debt driving buybacks, this is what I think you get: a) I believe tax rates on dividends are much higher than those on capital gains so this isn't just a timing issue, it's a skewed incentive. b) It may be so skewed that management have an incentive to buy back stock even when reinvestment opportunities are actually quite good. Management have a huge incentive to forgo high tax rates on dividends earned over a long period of time in favour of low tax rates on capital gains made quickly on stock options, juiced in two ways by buybacks funded by cheap debt: first they get more options awarded for eps growth driven by buybacks, and second the stock price is higher with the buyback given the supply/demand dynamics of the stock market. c) Finally, the economic impact of a buyback has everything to do with the valuation of the stock and its future returns, while the economic value of a dividend has nothing to do with the valuation of the stock. Management teams in aggregate have a poor record of buying back well, and bad buybacks destroy value. Dividends can't destroy value. When raising the payout ratio there is therefore a huge difference, which has nothing to do with tax, between a buyback policy and a dividend policy. Opportunistic buybacks by value-oriented management teams are different, but they seldom happen. I would argue that this is at least partly because when stock is cheap, options tend to be out of the money and debt costs may well be high, so the buyback doesn't create a huge, immediate payout for management.

I think they're aligned over the long-run and if you look at the whole (ie. shareholders are part of the economy). I hope that you are right but I have a nagging doubt. To draw an analogy with consumers, if enough people decide to postpone spending on "optional" goods, we risk entering a vicious deflationary spiral. If too many companies decide to deploy their cash on stock buybacks instead of investing in expansion, does that not stifle economic growth? Yes, it does - though there is another way to look at this, which that if there was less debt and more demand in the world companies might *want* to build factories, rather than be in a position where they have more capital than need for capital. But, it all comes back to incentives. I have no problem with buybacks when a) there is no better use for capital and b) the stock is below IV. I just have very serious doubts that that is actually how managements are incentivised. Why build a factory that will generate value over 30 years when you could juice your stock option value with a buyback today?

The difference for me is that buybacks (above IV) destroy value as surely as building and then burning down a factory does, and most managements are notoriously bad at buybacks so I suspect a lot of capital is getting destroyed this way. Dividends don't destroy value unless the shareholder makes a poor decision. Clearly a shareholder has better alignment with himself than management does with him. And the incentives are key here: I think management would be better at buybacks if a) dividends were taxed at the same rate as CGT (there is a powerful incentive to buy back stock and boost share prices when you have a lot of options that can be realised at low rates of CGT) and b) management compensation was based on eps growth + dividends rather than just eps growth or total shareholder return, which provides an incentive to juice the multiple.

Interesting! ;) But what do you mean exactly by “restructuring company”? Thank you! Gio Sorry - they basically close or restructure companies that are bankrupt, for a fee. Ought to be countercyclical! Business has been hard because low rates allows dead companies to live on.

+1 Gio +2

Agreed. I also own Begbies Traynor, a British restructuring company that will do well if all our zombie firms go bankrupt and in the meantime trades at 12x and pays me a 5% dividend. It's not bulletproof, but I'm content with the risk/reward.

Once again racemize, thanks for the hard work, the clear writing, and taking the time to answer all the questions. It's a very interesting piece of work and one that will inform my investing in the future. I also agree that the future is unknowable and that people would have predicted dark times at various points in the past and been wrong. I feel fairly comfortable with the statement that "when starting levels of debt are high growth will be slower and more volatile than when starting levels of debt are low, all else equal" but that's about it! Thanks again, Pete

It might be… But it seems we have become exceedingly efficient in engineering permanently high asset prices… I don’t know… We will see! ;) Cheers, Gio Are you suggesting that "stocks have reached what looks like a permanently high plateau"? ;)

For a counterpoint, I'd recommend Stockman's The Great Deformation. It's overlong and it's a rant, both of which are irritating, but it made me seriously question the received wisdom (and the Lords of Finance version) about the great depression, it puts what's happening today into the context of long run monetary policy history, and it is stuffed full of interesting facts and figures. Pete