thepupil

By the way, I guess your numbers are backed by the assumption that 20 years from now FIH will be selling at NAV, right? Well… something that has grown NAV at 12% for 20 years?! Using a discount rate of 9%, it would be worth 1.72xNAV; using a discount rate of 10%, it would be worth 1.43xNAV. Gio yep, in order to value something that is going to grow at a rate that is above your required return, you have to somehow deal with the fact that, in theory, if you assume something will grow forever at an above RoR rate you would pay an infinite price (like something with above market earnings growth). An imperfect way of dealing with this is to say "I will make above market returns for 5, 10, 20...etc. years and then this thing will make market returns or be liquidated and worth NAV. 20 yrs is a long time. Over the past 20 yrs we've seen plenty of capital allocator/guru stocks fall from grace to prices at or below NAV. I think to assume a permanent premium to NAV on a fee laden vehicle is pretty optimistic, but faith/optimism is your style so that's fine. I would just note that you probably could've made an argument for great returns and big premiums to book/NAV on any of these when they traded at big premiums 10 -20 yrs ago. Loews (founders died, a shadow of what it once was, 80% of NAV) Berkshire (has re-rated from as high as 3X book to more reasonable multiple as it has matured, if you marked wholly owned subs to market, it would probably be at about 1X NAV) Leucadia (2X book to 80% over past 10 or so yrs) I don't think you'll hurt yourself at today's modest premium to NAV, but if I saw a manager double AUM with one capital raise right after a year of Modi-induced euphoria (India Small Cap was up like 90% last year, right?), I'd be wary, rather than get excited and say that 2X NAV may be the right price. I'm skeptical of everyone out there that is monetizing their track record; there seem to be more public GP's/asset managers and permanent capital vehicles every week. As for IKYA, I don't really see how 1 company's spectacular growth in earnings justifies anything or makes an argument either way. High quality fast growing businesses in India trade for lofty multiples in my limited experience (check out the subs of multi-nationals like Unilever and Nestle or some smaller cap niche businesses); it's not like the sellers over there are idiots and are going to give away companies for free. Now lots of those same high multiple companies have historically made great returns despite their valuations because they've grown at very fast rates, but that doesn't mean you'd want to pay a large NAV premium on top of fees for them at a time when every institutional investor in the world and every Indian out there is super bulled up and excited about India. But it's tough to argue about an investment that is 100% cash because there aren't many thingss to analyze here (except for HWIC India excellent track record on much smaller $). I could probably use a little more of your faith and optimism, but I'll venture to say you could probably use a touch more skepticism http://in.reuters.com/article/2015/02/06/hedgefunds-india-performance-idINKBN0LA1UY20150206 http://www.wsj.com/articles/india-hedge-funds-best-global-performers-this-year-1415789542 http://www.cnbc.com/id/102220187

Well, that clearly depends on the rate of growth we are expecting for the next several years. Take a look at IKYA’s rate of growth in attachment. Do you think FIH could be able to find just one business per year for the next 5 years, which could grow like IKYA? (or almost?) If the answer is yes, I think 2 x NAV could still turn out to be a worthwhile investment! ;) Cheers, Gio Gio, I realize you are just throwing numbers out there with a smiley but if one paid a 2X NAV multiple with an investment period of a full 20 yrs (assuming liquidation and or slowing down of compounding to be worth NAV at yr 20), FFH India would have to make a gross return of 20% in order for the guy who paid 2X NAV to generate a 12% return. The math is a 20% gross return becomes an 18.5% after mgt fees becomes 15.8% after incentive fees (assuming the 5% is hard hurdle after mgt fees, is it soft or hard?). $1 of NAV becomes $18.8 of NAV for which you paid $2 multiplying your capital by 9.4X which comes out to 12% annualized. Of course as your time period shortens from a lengthy 20 yrs to anything less, the math becomes even less favorable. 10 yrs of 15% gross returns before normalization/liquidation/rerating to NAV would come out to 11.8% returns on NAV after fees and a 4.3% return to investors who paid a 2X NAV multiple. 10 yrs of 15% returns is nothing to sneeze at. At a 1.3X NAV multiple and 15% gross returns, the return to the investor is about 9% (using 10 yrs again, at 20 it's 10.3%, at infinity it is equal to the net return of 11.8% since you have no re-rating effect). When you pay a premium for a NAV vehicle that charges decently high fees, you need very high gross return or multiple expansion to make a good return. I know you expect Mr. Watsa and crew to do very well in India and I have no reason to think they won't, but I wouldn't count on NAV multiple expansion since the math really starts to work against you as the multiple moves up.

I see new Kraft-Heinz as having a $79B MCAP and $31B of debt for about $110B EV today. Pre-synergies you're looking at about $6.6B EBITDA or 16.5X multiple at the current market. 1.2B shares @ $66 / share (KRFT less special divvy) = $79B equity market cap + $31B of debt / preferred http://www.businesswire.com/news/home/20150325005810/en/Fitch-Places-H.J.-Heinz-Rating-Watch-Positive#.VRL-qOGqkds

I think your calc is off. The $38MM is for every 10 basis points, not 1 basis point, so you need to divide your napkin calculation of $950MM by 10, to get $95MM. So if I understand it correctly, you think that because AXP can borrow in LIBOR and invest in assets (CC borrowings indexed to prime), decreasing LIBOR will help lower AXP's funding cost and increasing Prime from the Fed will help increase what they earn on their assets. Do I have that right? I don't think it's that clear. In my opinion you have the company telling you NIM will go lower if rates were to rise by 100bps and you have 2/3 of receivables at a fixed rate. Looking at the forest through the trees, to me it seems that in the grand scheme of things, NIM should decrease with rates a bit higher.

According to the section of the annual report to which you directed me, all else equal, rising rates would decrease NIM and 2/3 of their receivables are considered fixed rate. I understand there are other reasons to be bullish of AXP. I really don't understand why the specter of rising rates is one of them. All else equal, by the company's own calculation and my uninformed intuition, rising rates would hurt a lender that has funding costs that can't go any lower and charges relatively high interest rates (2/3 of which are fixed).

Schwab, can you walk me through how higher rates benefits AXP? I've never looked at the business in great detail. As I understand it, AXP makes money with charge cards and credit cards. For charge cards they make money by 1) charging an annual fee (not related to rates) 2) charging a swipe fee (not related to rates) 3) maybe a little float from membership rewards points Maybe some schmucks pay the 18% APR on the platinum card's pay over time option that they keep sending me in the mail, but I doubt it. For credit cards they make the annual fees + the interest rate spread after chargeoffs. Why would this go up with rising rates? As I see it credit card companies' funding cost could not be any lower right now and their high interest rates haven't come down like other forms of credit (corporate loans, mortgages, etc.) Just glancing at the balance sheet, I see they earn on average about 8% on their assets and pay about 1.7% on their liabilities, a very healthy and juicy spread of 6%+. Has this been higher in the past? ROE seems pretty stable over the past 10 yrs which includes different rate environments. Like I said, I don't know a lot about the business other than as a customer. I'm just trying to understand the logic of higher rates = better AXP results.

it isn't market timing for an individual to not own bonds when CD's pay you the same or more with minimal duration. GE Capital 5 yr CD's return 2.25% and have a 1.7% early withdrawal penalty. Therefore, their return is 2.25% and have very little duration and no credit risk (assuming you have faith in GE and FDIC). The Barclay's Agg yields 2% with a duration of 5. The intermediate term investment grade index fund offered by vanguard is at 2.4% with duration of 6. I see no reason to get paid less (in the case of agg) to take on more duration risk or to take on IG credit risk for a meager 20 additional bps. Default adjusted high yield returns (even with lower than normal defaults) also don't give you enough spread or absolute return when compared to the GE CD's. I-bonds offer a pre-tax 0% real return (the same as 5 yr tips). Once again, no duration (you have to hold them for one yr then you have a 6 mo. interest penalty in yr 1-5), no credit risk, same return as AGG (assuming 2% inflation). But you can only buy $10K / year. In my opinion it is rational for all but the wealthiest of individuals to only own CD's and I-bonds as a substitute for bonds. No individual should own AGG or IG credit funds or high yield or anything of the sort. Leave that to the liability matchers who need to deploy massive sums in fixed income Schwab, I don't understand why the thought of rising rates "freaks you out" or what exactly would be "deadly to all portfolios". Can you elaborate? The duration of the barclay's AGG is 5 ish and will generally decrease as rates rise (except for the large % of it in mortgage backed securities since those are negatively convex). If rates rise 400 bps in one year, bonds will go down 20% (actually less because of convexity) and then will be earning more from there. unless you own a bunch of agency mREITs and zero coupon treasuries, or growth stocks with lots of duration because their cash flows are way out, who cares? I'm not saying we shouldn't worry about the indirect affects on the economy or owned companies, but bonds going down with rates rising does not scare me at all and I don't understand why it would scare any indiividual investor who doesn't have to own bonds.

In my opinion, "backing out investments per share" is analytically flawed and will always overvalue Berkshire. I'll start off by saying Berkshire has been between 20-40% of my portfolio since I started investing in 2011; I am almost completely out now but maintain a smaller "hold forever" position and continue to own for diversified accounts that I manage for my family. I am by no means a Berkshire hater, quite the opposite. Investments / share is a shortcut to add back the deferred tax liability and the insurance float. Financial debt is accounted for in the other column from the deduction of interest from earnings, so all the assets and liabilities are accounted for. The deferred tax liability from unrealized appreciation and the PP&E DTL related to accelerated depreciation at BNSF and BHE. I think this DTL has VERY low present value and agree with adding it back. Investments per share also adds back the float in its entirety. This doesn't really make sense because the float has always been invested in cash and short term bonds. Because of this the value of float is limited to the profit it can generate from low return investments. In a ZIRP world the float does not create enough value from the spread of underwriting profits/losses to interest income to justify a valuation that allows you to just add it all back. Let's take 2014, pre-tax underwriting profit was $2.4B on about $80B of float, so its like borrowing money for -3%. I would love to borrow $80B for negative cost; that ability has positive value. But Berkshire held around $80B (the value of the float not coincidentally) in treasury bills (0% yield) and short term mostly sovereign fixed income (0-1% yield). Let's just say they made 1% pretax on all that so that's $800MM. Berkshire's fixed income is and always has been short, low yielding paper; you can confirm this by looking at the sensitivity to rate shock tables (and Buffett says that's how he likes it). So in 2014 the income generated from the ability to borrow $80B (the float) at -3% was about $3.2B pretax, -2.4B from underwriting and $800MM (estimated) in interest from cash and fixed income. I would certainly not pay $80B for $3.2B of pretax income generated by insuring disasters and investing in cash and short term fixed income. Would you? If not, investments per share is flawed and will overvalue Berkshire. Even if you normalize for increased interest rates, it's tough to get to $80B. Note: I owe much of my thinking on this topic to brooklyn investor http://brooklyninvestor.blogspot.com/2013/03/value-of-investments-per-share.html http://brooklyninvestor.blogspot.com/2011/12/so-what-is-berkshire-hathaway-really.html

His initial math on the KO options was just dumb and reeked of attention grabbing. I honestly don't see how a money manager could forget to account for the cash received upon exercise of stock options. I think he just made a strategic decision to be factually incorrect and get more press insulting KO and Buffett than he would if he made a more measured argument. If I didn't know anything about his attention whore feud with KO, I'd say he's a fine mutual fund manager with a sound strategy (global consumer high quality company's, low turnover, buy and hold) with too high of expenses and cash. I don't think the S&P 500 is the right benchmark for a guy with 2/3 of his fund in international stocks and a decent sized cash holding (looks like about 15% for the past 4 years or so). Since inception he's outperformed the MSCI world by about 40 bps net of a 1.8% (that's way too high!) expense ratio. More recent performance is obviously not great. Still, outperforming the relevant benchmark over 10 yrs with a hefty cash and fee drag indicates some level of skill or luck.

not really...my 2 yrs as a trader ON ANOTHER PART OF THE FLOOR certainly did not make me an expert by any means. I have a very basic internship+training program+needed to know a little bit of knowledge beyond my very silo'd area. I left because I had read Security Analysis twice before getting through a chapter of Fabozzi. Clearly my passions were elsewhere. I view agency mREITs as just a way of getting levered long duration and short rate and prepayment volatility; you are also playing the steepness of the yield curve. I don't have a view on what the right multiple of book to pay is because even though many of them have de- levered and de-rated, these are still pretty levered vehicles. I view them as publicly traded trading desks; at the right discount, I see them as efficient ways of getting long bonds and earn high carry by taking those risks. My only impression of AGNC versus other REITs is that AGNC sticks to Agencies and buys further out on the curve than most (takes more duration and extension risk), whereas others have tried to focus on other areas (non-agency, 15 yr's, IO's, ARMs, etc.) to try to diversify away from the big extension risk and very negatively convex on the run low coupon 30 yr securities. My impression could be totally wrong and outdated. I hope AGNC does well so it can drive fees to ACAS but that's another story. Sometimes I buy mREIT preferreds (December 2013 several were available at 80% of par and 7-9% yields, made for a good ~30% TR as taper tantrum fears abated over 2014) and REIT preferreds in general. I like those because you can get 8+% carry plus yield compression optionality in exchange for insuring blow-up risk. Illiquid and retail owned = decent trading opportunities.

I suspect mortgages last longer when the general trend is rising rates and shorter when the trend is decreasing rates. In a rising rate environment people would not refinance as often. Amen Brother! Negative convexity at work. Increasing duration when you don't want it (rates rising) and decreasing duration when you don't want it (rates falling). I forget who said it but the no prepayment penalty fixed rate 30 yr mortgage "would not exist in nature". all the optionality is in the borrower's hands. Another way to prepay is to default. I agree. But even if the no prepayment penalty 30 year fixed rate mortgage has to exist because of government regulations, I always wondered why there wasn't an enormous difference in rates between the fixed rate products and the ARMs? You would think the market would set the rates in general and on average to make all types of mortgages an equally attractive deal to both the buyers and the sellers. It seems to me that the fixed rate mortgages are always cheap compared with the ARMs (unless you know for sure that you will have the mortgage less than 7-8 years), which leads me to think that some form of government regulation is also involved somewhere in skewing the rates in an unnatural direction to the consumers benefit. the reason that there is not a huge variance between fixed and floating is that would imply too large of a spread between the treasuries and agency debentures and agency MBS. these are government sponsored entity (basically govt guaranteed and actually full faith and credit in the case of ginnie mae) guaranteed cash flows deserving of a no credit spread. So the spread is to compensate for prepayment volatility and weighted average life variability of being short the prepayment option and rates vol. To have fixed mortgage rates well in excess of long term treasuries would allow for an arbitrage where you could buy MBS and hedge out some of your rate vol with payer swaps and swaptions and earn a shit ton of excess carry particularly on a levered basis (which you can get hefty leverage on Agency MBS because it's super liquid and has no credit risk, with the exception that defaults are prepayments so they are a risk if you pay high premiums to par). Now spreads on pass thru's have been very low relative to their history lately, but that's because the fed having a virtually unlimited bid. i haven't been an mortgage bond trader for almost 2 yrs now (and was only one for a couple years), and I was not an agency pass through trader (was on a different side of the floor) so I'm not up on my mortgage bases and where things trade so I'm a little rusty here. But in general, there is a place in the fixed income world for this paper. Now I'm not sure if there is a natural buyer for 3% 30 yr's, but the Fed is the bagholder there, for the most part. And things like AGNC. But as rates move up, it will once again make sense for a broader swath of the fixed income community to own plain old agency MBS.

I suspect mortgages last longer when the general trend is rising rates and shorter when the trend is decreasing rates. In a rising rate environment people would not refinance as often. Amen Brother! Negative convexity at work. Increasing duration when you don't want it (rates rising) and decreasing duration when you don't want it (rates falling). I forget who said it but the no prepayment penalty fixed rate 30 yr mortgage "would not exist in nature". all the optionality is in the borrower's hands. Another way to prepay is to default. I agree. But even if the no prepayment penalty 30 year fixed rate mortgage has to exist because of government regulations, I always wondered why there wasn't an enormous difference in rates between the fixed rate products and the ARMs? You would think the market would set the rates in general and on average to make all types of mortgages an equally attractive deal to both the buyers and the sellers. It seems to me that the fixed rate mortgages are always cheap compared with the ARMs (unless you know for sure that you will have the mortgage less than 7-8 years), which leads me to think that some form of government regulation is also involved somewhere in skewing the rates in an unnatural direction to the consumers benefit. empirical studies show that most people are better off taking the floating rate, actually (I'm once again spouting generalizations from memory, feel free to fact check this). What free market? A non-economic buyer has been waving in the issuance coupon for the past 3 yrs. The Fed is the one who loves buying 30 yr maturity mortgages at 3% coupons after g+s fees. It's huge stimulus.

I suspect mortgages last longer when the general trend is rising rates and shorter when the trend is decreasing rates. In a rising rate environment people would not refinance as often. Amen Brother! Negative convexity at work. Increasing duration when you don't want it (rates rising) and decreasing duration when you don't want it (rates falling). I forget who said it but the no prepayment penalty fixed rate 30 yr mortgage "would not exist in nature". all the optionality is in the borrower's hands. Another way to prepay is to default.

to be clear, I'm referring to Agency MBS. Banks still own a lot of them. It's the largest, most liquid fixed income product in the world after treasuries. Everyone who's anyone owns them. Just a quick glance Wells Fargo 114B BoA 180B I doubt there are many people who own the bond index or whatever, but I would just point out that 28% of the Lehman Agg is is MBS pass thru's. Not all of them are 30 yrs of course. But everyone who has a big bond book owns agency MBS. You can't not own MBS if you are a large insurance company, bank, etc. But I would point out that the Fed was vacuuming in a huge chunk of new issuance for the past several years so it's not like wherever you see MBS it means super high duration low return negatively convex 30 yr 3.5% pass thru. It could be dwarfs (15 yrs) or high loan balance seasoned ones with high coupons and burned out borrowers. It could be 5/1 ARMs or this or that. It could mean a lot of different things.

From memory (the order may be wrong) 1. The Fed (you know that whole QE thing) 2. Banks 3. Overseas 4. Mortgage REITs (these are the most levered and sensitive) 5. Everyone else You can google around for the exact percentages. While they are certainly very risky, I think it's important to remember that the weighted average life of a 30 yr amortizing mortgage is about 18 yrs and that is assuming full extension to 30 yrs. Because people move, die, get divorced, etc. the average amount of time an individual mortgage is outstanding is closer to 10 yrs I believe. I don't mean to dismiss the risk. They are high duration, negatively convex, hard to hedge pieces of paper. But it's not as if they are actually 30 yr bonds. amort and prepayments shorten the life and duration significantly.

I agree with you guys that rights offerings would be preferable, but that presents an element of uncertainty that the bought deal financing does not. They probably could find some shareholders to have backed the rights offering as an alternative to the bought deal route, which would offer certainty and allow for everyone to participate, but maybe that wasn't in the cards. I don't follow fairfax closely at all. So the $394 BVPS is the $550 US shares so they are actually issuing at 1.4X book?

deals like this make me want to own fairfax. issue equity at 1.6X to pay for a high quality insurer at roughly the same price. I feel like Mr. Watsa is really good at monetizing his stock price when it is right to do so, and if you believe this insurer is high quality, then this deal upgrades the quality of the insurance businesses with minimal dilution in BVPS. I see it as quite shareholder friendly because it likely builds long term value (assuming nothing goes wrong with the insurance acquisition).

Tetragon Financial Group : Amsterdam listed PFIC (so US taxpayers beware), owns hedge fund interests, CLO equity tranches, and a growing alternative asset management business, trades for 58% of fully diluted NAV, 50% of gross NAV, big management discount because current management raped the company during crisis and abused fee structure that lacked high water mark, also a related party buyout of asset mgt co didn't help, they've been harvesting their book of pre-crisis CLO equity at good prices and have been diversifying the business and asset mix (was 90% CLO equity), progressive dividend policy that pays you 30-50% of steady state earnings, 6% yield, management is highly incentivized to get the stock px up in the next two years because of a large amount of options struck at $10 (where the stock is) that expire in 2017. will do a more thorough writeup sometime but VIC author covers it well. http://www.valueinvestorsclub.com/idea/Tetragon_Financial/125503

maybe he sold because the price / near term earnings power rose by a lot. I understand he is super long term, but he is not completely blind to valuation and near term fundamentals either. XOM is still primarily an upstream company in terms of profitability. The stock is arguably more expensive than ever.

all that being said, it is likely that tax efficiency and low costs will be a side affect of a reasonable approach to investing. But they shouldn't be the goal, at least until you are making/have a lot of dough and don't have any in accounts with no tax friction.

berkshire, you mentioned on another thread you spend $7K / year and save 80% of your income. Solving that math problem means you make around $35K. why on earth are you worried about taxes on what you make from investments? You are not tax particularly tax sensitive at your level of income (and I'm guessing assets). With regards to "higher fees", I'm assuming you mean commissions. Interactive Brokers has very low commissions and I see promotions to sign up for places like Chuck Schwab and Merrill Edge and get 100 or 200 free trades all the time. You have to fiendishly turnover your book for commissions to matter as a non-professional; professionals actually still pay a good amount in commissions. I would ignore taxes and commissions for now and focus solely on investing. When you're making $200K living in high tax state and paying a 50% all in tax rate on short term gains, then maybe you should worry about taxes. Generally returns you see for guys like Ackman and Loeb are net of fees, gross of tax. No one pays the same tax rate so it would be impossible to show after tax returns. Lots of investment $ don't pay or care about tax (including our personal pensions like 401ks and IRA's).

hey race, i was just curious if you ever updated your cash returns to reflect the yield of short term treasuries rather than 0? Did it change your findings in a material way?

I'm confused Tim. Assuming the index performance is positive over time, how does an index hurdle result in charging more if outperformance is significant? Structure A: 1% and 20%, no hurdle Structure B: 1% and 20% over index Substantial outperformance year Index return 5% Manager return 20% Structure A: 1% mgt fee + 20% * (20% gross) = 4% fee Structure B 1% mgt fee + 20% * (15% outperformance) = 3% fee Unless the index is negative, isn't structure B always going to pay less (and therefore more LP friendly)

oh and it takes a very confident manager to have an index hurdle! If you can raise money at unhurdled fees, why bother with more LP friendly terms?

highest* I've seen is 40% above S&P. this was one of 6 or so fee structures offered by a manager who was very senior at a multibillion hedge fund and was starting out w/ 20MM of his own money in fund and 5mm of working capital to fund operating expenses (4-5 analysts, IR,rent, etc.) for a few years if they didn't raise money. I think he had an option that was lower % (like 25 or something) if you locked up for 3 yrs. The reason you don't see this structure often is because 1) allocators are adverse to paying such a high %, even if it is for outperformance AND in particular if there is no lookback or if is earned fully over a short period of time (like a year). this creates a lottery payout structure where one year can make someone inordinately wealthy or possibly inspire the manager to take "shoot for the moon" bets. Even with a high water mark, if the fees vest in a year, you pay out a ton for short term performance that may prove illusory. There is also an aversion to paying an incentive on long-only money. 2) most managers need a management fee to pay the bills, the math of a management fee + a BIG incentive, even if hurled, is a huge headwind to net returns; you need to have a low or no management fee if you are going to do the "high percentage over good hurdle" route. The example I provided did not need a management fee in this offering since he had several years operating expenses capitalizing his firm and was already worth 8 figures. He also offered a 2% mgt. fee class, I believe. *this does not include the heavily levered trading shops like Rennaissance, SAC, Millennium who charge ungodly fees + expense pass thrus. they are different animals with 100's of employees and teams, more like owning a prop desk of a bank.