djokovic1

??? You have to match your liquidity needs while maximizing ROE. Liquidity is not the reason for their current posture (and Ben confirmed as much)

Because you need liquidity on the assets side to pay for your liabilities. So with that constraint your asset duration has to be less than liability duration.

No that’s incorrect. I don’t know where rates will go next. You lock in current rates because you can and they are so good for shareholders, you don’t need to worry about where they go next. Again a simple question to you, would you prefer a guaranteed 15-20% return for 2 years or 4 years?

Because at 4% interest rates, I get a pretty much guaranteed 15%+ ROE. I want to lock that in for as long a duration as I can (in this case close to 4 years). Would you rather be guaranteed a 15-20% ROE for 2 years or for 4 years? As I said before, when rates are 0-2%, the risk reward is very different. Then your fixed income book is not earning a healthy ROE for shareholders.

But that presumption is wrong. I am not arguing against the “macro bet” due to fear of lower interest rates. My argument is independent of future direction of interest rates.

Very simply because at 4% they earn a very healthy ROE for shareholders but at 0-2% they don’t. This takes away the element of trying to predict where future rates will be, which we know is very hard

No no… that isn’t the solution. You don’t have 3:1 leverage and negative cost of float/capital (ie underwriting profit) to get to 15%+ ROE. Buying long bonds gets you to 4% on your capital which is pretty awful without leverage.

Yes this is my view too. It makes sense to take a strong view when rates are 0-2%, not right now

Yes thats a nice table and thats how I like to compare the different insurers against each other. The big thing to notice there is how low a number all the others have in the investment return line (which is the big driver of ROE due to the leverage). And why is that? That is because most other insurers unlike FFH (except Berkshire, Markel and Protector) invest a very small amount of their float into equity likely because they dont have the long term alignment / skill and ability to withstand volatility. And additionally most others (including Markel) were naively long duration in a zero rate environment in 2021. So the insurance model really only works really well with great capital allocation on the investment side (and that too on both the fixed income and equity side).

@Hamburg Investor This is the way to think about Fairfax's compounding engine: (1-combined ratio) * (Net premiums written / average book equity) + Investment returns * (Investment portfolio / average book equity) - (central and interest costs) / average equity gives you an pre-tax ROE. Now the net premiums written / average book equity have historically been ~100%. So the ROE from your underwriting will be (1-combined ratio) or underwriting profit as they are no leverage on this side of returns, unlike the investment book. I assume 5% forward looking. But the majority of your returns come from your investing book because the investment portfolio / avg. book equity is ~3:1 (and has been around there for the last 10 years). The below is an example of their compounding engine using the logic above with some assumptions roughly aligning with current numbers. What that shows you is the underwriting profit is not a big driver of ROE it's mostly the investment returns (20% vs 80%). That being said you always want to see them being prudent and have a positive underwriting profit (and a negative cost of float) which they have consistently achieved over the last 10 years. Happy to answer anything else on this, as when I made sense of this by looking at their last 10 year returns, everything clicked for me.

I would have to disagree with most here and say it clearly is a macro view that they are reflecting through their positioning. I think most are having a negative reaction due to the term ‘macro bet’. The reality is Fairfax is not matching asset and duration liabilities which is the neutral stance (and important to say not necessarily the correct stance). They always have to take a forward looking macro view as they always have done in the past (just like they do in micro with specific equities). There is nothing wrong with that and they will continue taking a stance, that’s their job both on the fixed income and equities side.

Met Ben Watsa at a Europe value investor conference. Asked him why Fairfax was short duration at high rates. Mostly comes down to protecting the downside as they see potential for an inflationary spike.

Separately, I did this quick analysis as it came up in a recent discussion ->Why FFH over Markel? Last 5 year ROE (have just taken from CapitalIQ), no adjustments made: But if you look at current valuation: FFH at 9x 2025E EPS and Markel at 20x 2025 EPS

100% agree.

To be a little edgy, I will say, it seems a little silly to not lock in 4.5% on 5 year treasuries especially when your duration is well below liabilities

@Viking All your points make intuitive sense but the 2 year, 5 year and 10 year have all gone the other way the last 6months even though all your points ring true especially over the last 6 months. Who would have thought? What I think we can agree on is that macro is very very hard to predict. What would be your major worry if Fairfax had added 5 year treasuries at 4-4.5% yield a few months ago to increase duration to 3 - 3.5 years (in lieu of the 30 year)? And I say this in conjunction with noting their liability duration is ~ 4 years.

Yes agreed. My main point / question is that it is a macro call to have a 2 year asset duration at the moment where intuitively I would prefer a higher duration given where interest rates are, which provide a more than healthy ROE and a steady earnings stream for longer. Of course their judgment would be vindicated if we see a significant rise in interest rates (and vice versa if rates go down). Let's see where they land in Q3.

Additionally this accounting hit can have significant real world implications in extreme cases. Eg Silicon Valley bank. Where they were long duration at low rates and interest rates rose fast , impairing equity, causing a bank run and very quickly bankruptcy

Its an accounting hit in either case if interest rates went significantly up or down, so it doesn't affect cashflows but it does affect book value of equity and impact how much premium you can underwrite? I think it is super important. Just like the fact that they decided to be very short duration in 2021 was a pivotal decision that has led to the next few years of outperformance.

They explicitly say this in the Q2 earnings call: "We continue to stay on the shorter side of duration as we watch inflation and the Fed actions." They are explicitly making a call to be on the shorter side of duration as they think probability that rates will go higher is greater than what the market is expecting. The reality is, as they do not explicitly try match asset and liability duration, they always have to take a macro view on rates. And what if the exact opposite happens, that rates fall much more than expected and you take a loss on your equity / balance sheet due to being short duration (i.e value of liabilities increases more than your assets)? Tomorrow if rates fall much more than expected, Fairfax's equity and balance sheet will take a hit because of their macro positioning of being short duration. Hope that helps explain where I am coming from?

I think you missed the part when I said asset duration is significantly below liability duration. Any big mismatch is a macro bet. I am not arguing that they should always match asset duration to liabilities. They did a great job in 2021 going short duration when rates were 0. But right now I don't see risk reward of being short duration. We could just say, "In Bradstreet we trust..." and leave it there, but I would like to go deeper.

Sorry I don't understand. They are taking a macro bet and making a call about future interest rates by having their asset duration well below liability duration. I don't think there is a debate about that? Whether they are right or not in having that interest rate view, we can debate about.

Fair point but let me phrase it differently then to make my point clearer. At these interest rates (which provide for very strong ROE’s), I would try to match asset duration to liability duration, rather than making a macro bet by having a shorter duration of assets than liabilities.

@glider3834 thanks for breaking down their actions over the past on the duration and yield side. Useful. I generally agree with the sentiment that locking in these rates for 4 years (rather than 2) makes a lot of sense. In other words, I would much rather lock in currently yields for longer because it still produces amazing ROE and live with the potential risk of higher rates. Because the downside risk of exposing yourself to lower rates is much more, as the ROE and earnings power drops significantly. But its only a quarter and we will find out more in the Q3 results, if not will aim to ask them for their logic on the conference call.

Ahh thanks @Junior R I get overexcited when I see buybacks announced. Sounds like it is re-instating the annual NCIB that was already in place. But my general points still stand