racemize

Thanks for the meeting notes. Common share holder equity is about $7 billion and Stock/Preferred stock investments are about $5 billion. So I cannot see how even a 50% loss on equity/preferred stock would wipe out Fairfax. It does not make sense to consider a loss of 25% on the entire investment portfolio consisting of stocks, bonds, cash. The hedges only protect the equity portion. Vinod Yeah, I was referring to the whole portfolio. It does seem highly unlikely (particularly given their cash portion), but there have also been large mark-to-market bond losses. Although it seems like it would be unlikely to have a quarter/year where both bonds and stocks went down at the same time...

Nice post. I will echo, however, what a previous poster said, they are focused on total debt, not government debt, and it looks quite a bit worse. That does not mean, however, that I think macro calls are a good idea. With regard to the hedging, I have had a large problem understanding them. This year, I think I might understand them a bit better. Here are some notes regarding them that I remember: 1) There were lots of questions about this at the railcar and at the dinner. One thing that came up is when they would exit the hedges. The answer was: a) if everything goes down as they expect, they'll cash out and invest the cash; b) if everything goes up, they will realize the gains and take off a corresponding amount of hedges, as they did this year (I interject here that I agree with the comments regarding selling of long term positions, particularly WFC). 2) Pabrai also commented on this and I asked him a couple of questions about it the next day. Basically, his view is that there is an incredible amount of leverage in FFH, and that they are preserving the equity portion. Running some math, if their investment portfolio had a mark to market loss of ~25%, the equity would go to zero (I think, please correct me if I'm wrong here). If I were in that situation, I'd be pretty frightened of such a loss. At the same time, however, they have had periods of unhedged investing, so if that were truly the whole story, why did they unhedge ever? I don't really know. 3) Following on, I think Gio a couple of questions that were quite good, and at one point during the answer, they said as their equity portion gets larger, they will have more flexibility (e.g., for buying companies or doing other interesting things). From this, it is my impression that they will stop hedging past a certain amount of capital (e.g., 6-7 billion, I think), which relates back to the leverage issues in 2). After piecing together those, I think I understand the hedging a little more, or am willing to give some benefit of the doubt. However, it seems as though they did not need to be 100% hedged and there is at least some element of macro calling going on, which I am uncomfortable with. I think the communication on the hedges has been very confusing. I want to know how much is based on macro calls or the capital levels/leverage discussed above. They never spell this out, and everything is in vague phrasing like "protect our capital" and "grand disconnect". I want the actual rationale, e.g., if it is the capital levels, they are concerned that the leverage could kill them without the hedges; if it is a macro call, just say "this is a macro call". I don't think we should have this many people be confused about the whole strategy and reasoning. I don't feel like we're getting straight answers, or at least I feel like I shouldn't be constantly confused about what exactly the purpose of the hedges are. Finally, I generally have a historical hedging question: does anyone know how often they have been hedged over their entire career, and to what extent? Moreover, the equity returns with hedging is terrible over 5 years and is barely above market over 10. What is long term if not 5 and 10 years? Perhaps everything will suddenly start working, but I find it very confusing.

Thanks for pointing them out, I've started reading their public letters and they're interesting so far. Wow, pretty amazing. I guess there's no way to see what they've been buying?

maybe I'm reading it wrong, but the performance doesn't seem that great (also, that is a horrible format to present performance in): http://abcfunds.com/en/our_funds/performance_review.shtml

payday lending (maybe rightfully so) for-profit education (also maybe rightfully so)

Ok, I've spent a stupid amount of time on this, but regardless, I've made a pretty robust testing model, for any desired market timing strategies. I've still found nothing that consistently beats the market. The testing model can do the following: 1) incorporates taxes; 2) incorporates turnover; 3) handles partial investment; 4) Goes back to 1890 with a buffer from 1871 for calculating history/percentile information prior to starting. Feel free to duplicate and use it. The only thing you really need to do is modify the In/Out category to indicate how invested you are (between 0 and 1) per year. (One tip, highest returns can be generated by determining if the next year is going to go down, and not investing that year.) Report on the spread timing model: I reproduced their outperformance (though to a lesser degree) using spreads to the 1 year (this is what I had data on) and only calculating annually instead of monthly (which I prefer due to short term capital gains taxation). Their time period was 1970-2000. It also outperformed from 1970-2013. It appears to have some outperformance up to 1920. It definitely does not outperform from 1920-1970. Thus, it does not appear to do all that well out of sample, and/or it appears that the 1970 period is somewhat unique (particularly the degree of outperformance). It does not appear to be trustworthy. Did not find any reasonable CAPE uses that resulted in outperformance. Feel free to duplicate the spreadsheet and test whatever you want. I'm interested in any reasonable models that work (and not just fine tuning variables until it works). It's also fun to play with. Let me know if you have any ideas/questions/notice any problems with the spreadsheet. https://docs.google.com/spreadsheets/d/1i8Q6QKJe_BrJ9LJ0vYvIgpfNKUt0HRzHQevE0ODRF1Q/edit?usp=sharing

He didn't like that it involved a cartel.

I realized I should have put some context for these things, here's descriptions: Holding Period, Taxes, and Required Performance: This essay focuses on the impact of taxes on pre-tax returns over various holding periods, from less than a year to 20 years. Initially, the essay shows the required pre-tax returns required to generate 10, 12, 15, and 20 percent after-tax returns for holding periods from 1 year to 20 years. After some discussion of this relationship, the essay then turns to holding periods of less than a year, and similarly calculates required pre-tax returns to generate 10, 12, 15, and 20 percent after-tax returns at different tax rates from 20% to 39.6%. The Hurdle for Active Investors: Building on "Holding Period, Taxes, and Required Performance", this essay focuses on determining how much an active investment must outperform a passive investment, such as an index fund, over the same investment period under various situations. Initially, the essay determines appropriate scenarios for comparing the active investor to the passive investor, based on a history of returns and dividend yields from 1871 to 2013. After determining these scenarios, a representative set of variables, including annualized gains, turnover, investment period, dividend yield, and tax rate, are modeled in order to determine the hurdle for the active investor.

I looked it up myself on multpl.com. I'm not quite following, what did you look up on mutlpl.com? Are you talking about the spread here?

Where did you get the 2008 one from, another paper? I'm working on recreating the model on a yearly basis from 1871 to see how it does.

Hi All, I've just finished my second essay on the effects of taxes on investing. I'm posting both, since one is the foundation for the second. If you see any typos, let me know, there might still be some hanging around. Hopefully, this is of some use to you fine folks. First Essay: "Holding Period, Taxes, and Required Performance": https://www.dropbox.com/s/yvmnoyo7v7nseov/2013-09-22%20Holding%20Period%20Essay.pdf Second Essay: "The Hurdle for Active Investors": https://www.dropbox.com/s/sk01jpe257e8rgy/2014-03-25%20Hurdle%20for%20Active%20Investors.pdf Disclaimer: This is not an advertisement of any sort. I am only posting this as I thought my work on this topic might be of some interest to forum members.

They have done it with 1% spread costs and stil came out ahead. Today you should not have a lot of spread or transaction costs. Taxes are surely a concern, but i don`t intend to hold my value investments forever so its a good hint at when to switch to cash and you have a good timing method to hedge with puts to avoid taxes. It worked in 1974, 1987, 1999 and 2008 and it makes totally sense, when i would time the market i would do it exactly that way and i think WB did it that way either when he has done it. Why invest in a risky asset when the riskfree asset gives a greater return? The short spread (S&P Earnings yield - tbill yield) under -1% looks like a good barrier to act and at 0% we should start to be very careful. This implies that we are currently in safe waters and are at least 1-2 years away from a major downmove. :D Taxes can have a large effect, but it depends on your time horizon. I'm just finishing two essays on taxes, which should help figure out whether their outperformance would still have worked. One issue, in particular, is how much short term gains they had to deal with. Overall though, this is the best timing-outperformance I have found so far. I do wish it was used over the entire 1871 period. I guess I could recreate that if there were 10 year and tbill rates that far back...

Interesting paper, but they probably should have compared the earnings yield with the t-bill or 10 year treasury yield instead of a fixed yield. It should be obvious that the switching points depend on current inflation. Here's a paper on that. It is the only one that I've found with actual outperformance. However, it does not take into account transaction costs or taxes. I think this may erase the outperformance, but I'm not too sure. https://www.dropbox.com/s/cm788kdkxdwwp0r/Spread%20Timing.pdf

The 16.4 number has extreme hindsight bias issues, which I think they acknowledge (or at least did in another paper). Using rolling medians, instead of the future median, they underperform. Additionally, they show the number is very sensitive, so it is almost impossible to replicate.

Still working on this in general. Here's a good paper on this topic: https://www.dropbox.com/s/q11vsobd8ubr2bx/market%20timing%20at%20home%20and%20abroad-031505%20%28Fisher%20Statman%29.pdf Probably a month or so before I'll finish it.

I'm visiting Seattle and will be there from the FFH meeting until ~May 14, so if it happens in that timeframe, I'm in.

But yes securitization is the symptom of society looking to screw things up during propsperous times. So yes guns don't kill people, people do. And we will keep finding ways to shoot ourselves. hence I believe the markets are not getting more efficient... I believe mortgages were quite common in the US before the 1950s. They were a different form, much like Canadian mortgages currently are. They would be fixed rate for 5-10 years then would either float or balloon with the balance due. The current 30-yr US mortgage is a direct result of the Depression. Too many homeowners lost their houses when they couldn't refinance or pay off their loans quick enough. The 30-yr mortgage was created to lower payments and give homeowners time and security to pay down their debt. My understanding has been that debt in all forms has been relatively common for hundreds if not thousands of years. Yes just googled it, you are right. Although I always thought a mortgage is you basically pay it till it is all paid off (hence MORT-gage) There were even mortgage securitizations of a form in the 1920's. There was a striking paragraph in Security Analysis that reminded me of 2008, with regard to certain mortgage bonds that individual investors would hold. I can't find it off hand though. There was also this: http://www.nber.org/digest/may10/w15650.html

I used Shiller's data from 1871 to now, and made various hindsight bias assumptions (e.g., hold a certain amount of cash all the time until a significant drop occurred, having the insight to only invest at the bottom and invest for the next 1-3 years, and then go back to cash again, or similar). I did similar studies from 1970 until now. I did not come up with a scenario, assuming near-perfect timing (but holding cash until that timing was required), where holding cash made any sense.

Does anyone have a good market timing record? Can they show that it would have done better if than if they hadn't timed and that it wasn't luck? Is there a good market timing system? If so, how does it work?

+1 I am interested in this too me too, that guy really needs to stop being so lazy and... oh wait. I'm in final revisions of my second essay on investing and taxes (mostly focused on the amount an active investor has to beat the index to have equivalent after-tax returns). The next essay will be the cash one. It will take me a while to put it into the right format and get it into shape, but in the mean time, here's the executive summary: I've found almost no fund or individual that should not have been fully invested. The only person that I think it made sense for is Pabrai's second and third funds (not his first one, with a longer track record). I've studied hindsight bias S&P market timings, mechanical screens, various individual people's returns, and fund returns that I'm aware of. Essentially, 95% of people would not have beaten the opportunity cost of having held cash. The only time that it works out better is if you have an extremely volatile portfolio (much more volatile than the S&P). When you are volatile, holding cash through the down turn is a bigger deal, and the corresponding upswing is also a big deal, which can lead to higher overall returns. I am desperately in search of any evidence that contradicts the above. If you are aware of any strategy where not being 100% invested all the time gives higher returns over the long term than being 100% invested, I want to hear about it. It also needs to be reasonable/applicable (obviously).

I have generally not found that to be true with most investors (at least looking at cash holdings, not shorting). It is true for 2/3 of Pabrai's portfolios over their life span though.

Yes, I agree, I was mostly talking about the cash comment from stahleyp.

How much cash is he holding at DJCO today? Well, it wasn't cash at the time, it was much higher yielding bonds, which turned out to be genius in retrospect. Now, he doesn't have decent yielding bonds, and his bank holdings are paying higher dividends than the bonds would anyway.

Carol gets to pre-release portions of his letters from time to time. I think they did this last year at least?

Does anyone know of a study where any of the proposed valuation measures could be used to determine asset allocation between stocks and cash with market-beating returns? If not, I just don't understand the point of articles like this. I would love there to be such a study, but I strongly suspect that the opportunity cost of waiting for the reversion would be much higher than the cost of predicted downturns.