benhacker

Cageyone, Don't take my word for it, but I believe the $17 / share cost was prior to the convertible investment, which again (just my rough guess) is probably showing $300m of (paper) profits. They did sell some common at a loss as well, so that has to factor in, but I think they are close to breakeven.

Fairfax's portfolio has always been strange IMO. However, you also need to realize that when you see these SEC filings, you are basically seeing reporting of Fairfax's, non-OTC, US listed equity (and some bonds) portfolio only. You aren't generally seeing any foreign names (unless Fairfax is buying ADRs, etc). So if you look at one of the nice sites like Datarama or Whale Wisdom, they will show you that Fairfax has like 30% of their portfolio in BBRY, and RFP, etc, but their total listed portfolio via the SEC is only ~$1.5B USD... their equity portfolio (including everything) as of the last quarter was >$8B USD (this number includes several consolidated but not wholly owned businesses as well). So if they have 30% in a few names that make you scratch your head, just remember that they may be right or wrong, but the "bet" on those names usually isn't as big as it seems. I like to bring the large investments back to a % of book value in my mind so I can understand the downside better in my mind. So in this case maybe RFP is ~5% of Fairfax book... does that seem more reasonable? Probably (I don't have a great feel for the RFP investment myself, but it seems reasonable). Anyway, this is just another way to say that Fairfax has huge exposure to things we don't see directly in the 13HR, and also to some investments that we don't even know about. If you want to track their exposure more accurately, you can track THRE.TH, BKIR.L, and their other global investments. I'm not sure that is necessary to invest in Fairfax, but probably at least understanding the scope of what you don't see in the 13HR form is needed. Perhaps you already made this mental adjustment and still think they are concentrated in too many low quality businesses (you would not be the first to think so!), but my guess is that because the US investments are so well disclosed and so easy to find via the websites I mentioned above, they get relatively too much focus and the perception is that their US portfolio is a greater % of the overall equities than it really is. Just my perspective. Ben PS - The BBRY investment also needs to be adjusted for the Converts FFH owns which are probably marked at ~$750-800m ($500m cost) or so now, so that investment is actually larger than what is reported, but still not 30% of book). PPS - On a related note, I think Fairfax tends to buy into more leveraged, or seemingly "binary" businesses generally because of two reasons: 1) they (I think) prefer the leveraged nature of equities with massive upside because of their conservative portfolio (I guess you could frame this as leveraged businesses being good inflation hedges) and 2) they have a unique ability to wait out other investors and to not have to worry about death spirals because they can always (assume assets are still backing the investment) double down via debt, converts and even DIP financing in BK, so I think the fat tail negative outcomes for Fairfax aren't as bad as perhaps they are for us as retail investors because Fairfax won't even be diluted (if they don't want to be) - they will be the ones diluting. This may or may not be their mindset, but I think it makes some amount of sense from what I've seen over the years. BBRY is a great case in point, they are I believe M2M profitable on their BBRY investment at this point (+/- a few % maybe) I would estimate (obviously not a good IRR, but we'll see how it plays out). Same thing with LVLT... for years it was considered one of their big failures, but even when the stock was just in the crapper, their IRR was 7-9%, and their IRR over the life of the investments now I think is low teens (not certain here), due to their selling as well as doubling down in debt, converts, etc.

I generally agree with your perspective Eric (7% investment returns is not a low bar - it's hard), and I think FFH does need underwriting to be respected by the market to get / earn a premium valuation. I have been assuming for sometime that underwriting is sound, but it just hadn't shown through in the financials just yet. I think your recent move is likely timely as you are more closely aligned with the likely catalyst for higher valuation (the presumption of both investment returns at an adequate level + underwriting working in tandem to deliver good ROE, and that result being apparent to Mr. Market). I've held through all of this, but I can see the logic of really waiting for the catalyst as it were. I think we can perhaps get a confluence of good events here (debt refi, underwriting staying sound, investment returns being good / reverting, and perhaps even some tail insurance events playing out partially in FFH's favor). If it all comes together the rating agencies will act, and I believe those on the fence or unsure about Prem and team may have a change of heart in small numbers which could help to provide a revaluation. All nice to have things (not necessary), but if book can grow in the low / mid-teens, and we get a more premium P/B multiple, it could be pretty nice.

Zach, running a long / short portfolio is hard. If you are 100% hedged, and then your longs outperform your shorts ... does that mean you short more to bring your hedging back inline? Sell longs? Some of both? Fairfax had the opposite problem when their shorts outperformed their longs (do you close losing shorts? Do you add to losing longs?)... it's the nature of the beast. One of the reasons shorting really sucks / is hard! For insurance pricing, AON Benefield and Marketscout have some commentary, and other insurer conf calls are helpful. Pricing has been rising (in general) for insurance... not so much for RE, but nothing dramatic. I think we are just seeing Fairfaxs true results without the legacy reserve additions from 10+ year old business.

This was better than I expected, very nice! I'd like to see a few more years of insurance results (preferably with some cats) to see that insurance is fixed (my belief for a long time)... we'll see. Good to see the results (insurance and investing) starting to work together. it's just a quarter, but it makes me smile.

There are many reasons for a long bias: 1) We generally invest (in stocks) because we have money to buy something with. We don't normally approach the world from "I have an idea, and I'd like to fund it with a variable inverse-equity loan"? (maybe we should... but...) 2) Shorting is leverage. Many prudent investors shy away from leverage for obvious reasons (many of those below) 3) Shorting is logistically challenging - shorts carry a borrow fee above and beyond the rate of return of the underlying. Short borrow can be taken away from you at no / limited notice. The borrow fee can change, etc. 4) Shorting is likely very difficult to make profitable *unless* you use short proceeds to buy additional longs. This introduces basis risk which even for a good short seller and investor could be challenging at times of market distress. (Shorting is often considered a hedge but when short names are crowded, there is actually positive correlation with long / short trades and the market in times of distress) 5) Shorting requires use of a margin account, which may be considered higher risk for securities ownership in street name when armageddon comes. 6) Skills for shorting successfully and going long successfully are quite different - position sizing, future / present value estimates, etc are very different for long vs. short, and many longs forget this and I think blow themselves up. (for example, A short position where you are wrong grows as a % of your portfolio, whereas a long shrinks. This probably is the least understood aspect of shorting by those who haven't done it... it makes risk management and averaging down (up) very much different than going long) -- I personally don't view Long and Short as two sides of the same coin. A typical long investment is one where there are many unknowns but even if you don't know / have an opinion, the investment can have a margin of safety (aka, the right price) and you will do ok. A short is very hard because you may see a business that has what you perceive to be a very slim chance of achieving something amazing, and thus you see it as priced to perfection... however, the buyers of the shares may be idiots buying a story, or they may be very sophisticated investors who have realized that the chance isn't slim, but in fact large... and they are going to make a lot of money off your hubris. Basically, calculating max downside is much easier than calculating max upside. My 2 cents at least. Ben

Nate, Thanks, and I agree with the duration limit that banks will take. I had heard a few things about CUs being willing to take more duration risk with mortgages, but I hadn't looked up the data, I'll do that as its curious if so.... thanks! Petec, Related to the above, I agree that a 30yr mortgage isn't naturally occurring (if that's a thing in markets :) ), I just think if the Gov / GSEs stepped back *now* (after we have had a many decade history of 30 FRM), it would have enough demand (in the US) to encourage some creative financial types to create the product (of course at higher pricing). Here is the thing, if 30 yr mortgage rates went up say 1.5%, there would be a lot of extra padding in that rate to pay for some long term hedges on rates, or other sweeteners to make it worthwhile for the lender. The question I would have is if the first term of our 30yr mortgage that would go away would be the ability to prepay at any time vs. the 30 year term... I think the free options (for the borrower) attached to our 30yr mortgages are what make them a strange product (harder to hedge)... Perhaps I am wrong though and no bank / finance company / consumer would consummate a mortgage like we have today at 1.5% (my WAG) above today's rates... but there is enough fear of rate rising in this country by regular folks that I think it would be a product that would at least be offered.

Nate, Banks aren't making these loans, they're originating them then selling them to the US government. Based on a cursory glance at a number of banks they aren't holding anything on their balance sheet past 10-15 years at the most. Almost everything is dumped on the US Gov. The government is the real patsy here, they're subsidizing the housing market, but they have been all along. Unless by "US Gov" you mean "Fannie and Freddie", I think this is wrong (and even so, it's mostly wrong). Both the GSEs have a large mortgage (owned) portfolio, but a larger guarantee portfolio, where the underlying mortgage (MBS) is sold to 3rd party investors, and the GSEs guarantee payments (they don't take IR risk). The US Gov (aka, the GSE + Ginnie Mae) in these cases are on the hook for "Credit Risk" but not "Rate Risk" which lies with the ultimate end investors. You could argue that the retained Mortgage portfolio of the GSEs is effectively the US Gov's at the end of the day (true) but it's much smaller than the guarantee portfolio. There are buyers of 30 yr mortgages at today's prices (mortgage REITs are among them, as well as pension funds, Sov wealth funds, etc), with the Gov backstopping the credit risk... so there are buyers out there who own a duration time bomb for sure (and do so with full knowledge of the risks)... the US Gov isn't on the hook for all this, but I think this is a common misconception. Also, because of the above (just as a related thought), I think the fact that a 30 year mortgage wouldn't exist without the GSEs is actually a bad assumption. I think it would, it would just price much higher (due to the additional risk and lack of capital) but there would be demand, and a market clearing price (similar to Jumbo loans, or perhaps with a higher rate). I agree that it probably isn't a product that would be naturally occurring withe gov in the first place, but now that it's here, something similar would remain. My 2 cents. Ben

Well, I guess we'll get to see what the wind down of a large bond fund looks like now, I bet $50B in assets leaves in the next few weeks... The total return strategy is managing about $200-250B right now. I hope all those derivatives are pretty liquid. :) Gross leaving to Janus (seems strange...). Ben

I think there are two elements to this: 1) Obviously, if the market starts desiring deflation protection, FFH's derivatives may be able to be sold high (even before deflation actually occurs). 2) The valuation of the deflation derivatives on FFH's books, are unlikely to have large M2M swings in value if deflation FEARS are high, but inflation remains positive. I may be wrong on this, but FFH seems to be valuing the entire deflation swap bucket as Level 3 assets, and their model doesn't seem to be related at all to dealer quotes, and it much more conservative than what they have been paying (I haven't checked recently, but historically they had several swap purchases that were marked down (by model) 50% within one month in an environment where deflation and deflation expectations weren't changing.). So I would assume, unlike CDS which have significant observable inputs into their prices (corporate bonds do trade frequently, and are strongly related to CDS), the deflation derivatives will be marked conservatively based off models... until they are sold or expire. I could be wrong, and certainly level 3 assets have a lot of flexibility in how FFH could value them...

Yeah, this data point as well as country stock index return and country level GDP growth levels not correlating are two of the real big things that trip investors up from time to time. Thanks for sharing your spreadsheet. I shared a version of the data you attached at my 2008 annual meeting (held in may of 2009) and clients founds it very helpful in answering "how can you be so bullish, but not think the economy will do great?". It's not so much that I think the data is predictive, but it helps to show clients that sometimes their gut reactions are wrong.... once you feel shitty, stocks are already down, competition is already down, and there is a lot of upside without much optimism baked in. Buffett's quote about greed and fear from his 20's is still pretty apt. Thanks again.

Picasso, thank you.

Good discussion. I think Muscleman is looking for a bigger hit than more staid bond returns, but I appreciate the lower return / safer ideas. Great to know, I'd been looking for BHAC PR issues (can you share the 10 yr CUSIP? I'm only seeing '41 issue), I hadn't seen them... thanks. By the way, you may know this, but BHAC != Berkshire. BHAC could go under (I'm not saying it will or is even remotely likely, and I have bought BHAC issues before)... Berkshire won't. Thanks, Ben

I agree the article wasn't great Zach. My main beef is that Gross seems to consistently be selling out of the money derivatives (whether on rising or falling rates, bond insurance, etc). I'm certain that he is hedging some, but from what I can make of the holdings, it seems mostly unhedged. I think my main concern is just how dramatically outflows + illiquid bets can turn if a few odd things happen. I guess we'll see, at least the fund is now shrinking which makes me feel better... I truly do think the size of the fund could cause problems if something were to go wrong.

Another tidbit. Just seems to me like a classic strategy to blow up when done in their size, and in a mutual fund structure: http://www.talkmarkets.com/content/us-markets/pimco-steals-aigs-playbook?post=46014 Ben

There is a Muni board rule that there has to be a certain # of asks on similar munis for you to place a bid, but at IB, you can indeed plug in a CUSIP and submit a bid even with no bid/ask (assuming the prior condition is made). Liquidity is shit, and you shouldn't have high hopes, but I have purchased two munis through IB this way... using limit orders to leave the buy open. The alternative, is to use a broker that uses bond desk, and Schwab, Etrade, etc should have reasonable inventory available. You will note the spreads are out of this world bad (makes the complaints about HFT look like lunch money by comparison).

I think this topic is always confusing in the investment context, because engineers (I am one) bring an often-flawed or incomplete perspective to the discussion, but they bring it with a didactic style that makes the discussion more charged than needed. Generally, I see this issue raised by people who understand math, but not economics. 1) It is true and obvious (I hope to most reading here), and also helpful to point out that geometric average returns are indeed not the same as arithmetic average returns. As Heilko said... 2) And indeed, mathematically, the more volatile the returns are by year, the bigger difference there will be between the two return measures. 3) The jump that seems to be made by some above in the thread, is that returns in the stock market by real assets are then somehow path dependent on their volatility... hence the injection of Buffett's lumpy vs. smooth return comments. I think #3 is the odd jump that leverages math, but doesn't understand economics properly. Real asset (stocks) returns are not (by and large, exceptions due to capital raising and buybacks we all agree do exist) path dependent. If next year stocks drop 75%, the ultimate value in 20 years (on aggregate - eg, for an index) won't change... so yes, high volatility will make the arithmetic / geometric return spread increase, but it won't do so by lowering geometric / realized returns, it will actually increase arithmetic average returns to compensate. Thus, the beautiful and famous quote below has a two edged meaning: "A 50% loss requires a 100% gain to get back to even." This quote implies you want to avoid 50% losses at all costs (obviously) because they are nearly impossible to make up, but also inverting the statement is a wonderful reminder that a company / index that goes down 50% for a non fundamental reason must double to reach "fair" value. Two sides to every coin. Ben PS, there are a class of investments that are path dependent, and of course volatility is catastrophic to their returns (3x ETFs).... that hasn't been show to be true to aggregate stocks over time, in many countries, and many market cycles. PPS, further to the original article's point about "time diversification" (and the linked article from 2000) and the fact that cumulative return differences actually widen with time whereas annualized / geometric returns narrow.... Again, I think this is an engineering mindset "explaining" something for the sake of sounding smart, but missing the whole point. *Yes* if you hold stocks for 15-20 years, there is a DRAMATICALLY wide range of outcomes (measured cumulatively), but I think we can all agree that the fact that those outcomes (in the US markets, in the last 100 years, disclaimer disclaimer, etc etc) are all positive is a pretty big deal, and also they are all positive with regards to the majority of alternative investments that could be made... this is the point, not that stocks don't have a wide range of outcomes. Someone once said that risk is permanent loss of capital, not a range of expected outcomes. In this context, it seems that Time Diversification (is that a phrase?) is real, and works (for stocks - certainly behavior may be different in other countries for various reasons)... At least, to me, that's always been the point.... you can invest in something highly like to give you a positive real return after tax over a long time horizon. Sorry for the length...

Borrow is unavailable at IB, with an indicated rate of 120% annualized to borrow. Short squeeze kids... massive short squeeze. Anyone who actually owns shares in this and isn't selling I would love to know why. Ben

1) Intelligent Investor 2) When Genius Failed (surprised not mentioned... I found it excellent and a stark warning of overconfidence in yourself and the system) 3) Margin of Safety 4) One Up On Wall Street 5) Making of an American Capitalist -- 6) Fooled by Randomness (good for thinking, despite his arrogant tone throughout)

Hey Josh, I know you aren't expecting to get a lot of love by posting anything positive on this thread, so don't take this as piling on. I was there back in the day with the short raids and I believe I have a reasonably unbiased view - I can represent positive aspects of Hempton, and I have (a flashback --> http://www.cornerofberkshireandfairfax.ca/forum/fairfax-financial/have-any-of-the-ffh-short-sellers-said-their-analysis-was-wrong/). Let me just address this comment you made though because it gets to the heart of the way we form views, and I feel strongly about it: I just want to be clear, that I think you are smoking here (on the part in bold). :) Hempton said in those letters to OSC and SEC "...I'm doing this for the minority shareholders..." or something similar. Give me a break, he was doing it to make money. Period. This isn't to say he's bad, I truly believe HE BELIEVED that FFH was a fraud as I said (others may disagree, and regardless, I disagree with some of his methods of course). But let's be real, he was trying to get an "investigation" announced, and this was his path. He did this only AFTER his short wasn't working... He even to this day admits that he is not shorting out of the goodness of his heart. He actually has said publicly that he tries to follow fraudulent people so he can make money off their future (fraudulent) businesses that they take public... and he doesn't want to make those people known!!!! He openly holds this up as some kind of demented virtue (for investment reasons). His didactic letters to various regulators and auditors were social engineering attempting to be listened to (according to my eyes; soft threats about the SEC scooping the OSC, it was passive aggressive all over it). He said the words that he felt would make them listen. This is an investment board, and we are all out there trying to make a buck at the end of the day. I believe personally though that there is more than one way to get paid in this business, and there are many ways that are less desirable than others. We all can have our own opinion and my own on this topic is likely rather complex, but when I see someone like John Hempton being shown as an example of an investor doing the right thing when it comes to ethics, I just kind of want to barf. He is smart. He is a good (great?) analyst. I would bet he would outperform going forward. I read his blog and I do find his opinions to be sometimes refreshing and unique... But giving him props for doing the right thing by trying to profiteer by getting a securities suit or auditor involved in a situation while claiming to be doing gods work? Sorry, I've got say, the guy has a large body of work online, and that doesn't fit the profile. Sorry for the rant. ;-) I really do think the shorts had some analytical correctness on FFH (that doesn't excuse their actions) as I posted 3 years back in the thread above - being analytically correct in whole or in part doesn't make you a good guy. Ben (I try to be a good guy, but I'm human to; I'm not trying to condemn Hempton, but I'm closer to condemnation than the alternative. I do short, and think it's a good thing for market.) PS - Note the timelines by the way on WHEN he sent those supposedly altruistic letters to securities regulators... it's AFTER his short didn't work out... he was trying to make something happen... he didn't do it early on because he didn't (and likely never did) give a F#$% about anyone else. And that's fine, but let's not pretend otherwise. Still long FFH...

Thanks guys, that's probably it. Ben

Has anyone talked about this company with Fairfax? They have a typo (I assume) in their annual: I assume this is something along the lines of "...they support businesses with a total of 65k employees." Just seems like a glaring error, so I'm curious if there is some technical definition of employee that applies to this business that I'm not aware of (some SEC / SEDAR rule). Any help? Thanks, Ben

Taibbi's new book has a section on the Fairfax saga and the interesting thing was that many of the shorts (according to the book's writing) seemed to genuine turn when FFH started the big lawsuit. They didn't seem to turn because they were afraid of Fairfax's accusations against the shorts, but they turned because Fairfax started disclosing details during the lawsuit about European subs and supposedly shady dealings as part of the lawsuit. At that time, it seemed that many shorts realized that what they thought was a fraud was not (you don't disclose where the bodies are buried in a lawsuit asking for discovery right???). I haven't read the whole Taibbi piece, but this make intuitive sense to me. Fairfax cleary had some seriously bad actors working against it, but I've always believe that many / most of them must have genuinely felt they were a fraud or destined to fail.... you just don't attack a company you believe is viable to make a buck on the short side (unless you are doing a short term trade)... it's just not rational. I'll be reading through these, but I think Hempton believing they were a fraud was my expectation. The guy was wrong, probably overly aggressive, and way too lose with words and probably shady in some actions, but I think he truly thought he was right. My 2 cents, thanks for the link. Ben

This looks like a $10m USD acquisition... hopefully they can get some good growth there over time. Ben

He highlights: 1) Selling order flow to "HFT" (really, order flow is sold to all kinds of firms) -- I personally don't think this should be legal. It has nothing to do with HFT. Generally RETAIL order flow can be sold, because most market makers WANT it because retail orders are on average dumb money. The spreads in the exchange have to price in a risk for trading with smart money, the spreads to retail can be lower because in generally you can be safe you aren't trading with a knowledgable party. I personally don't like selling order flow because it reduces market liquidity (centralized liquidity).... so I would be happy if the SEC decided that this is a hidden cost to the system, but I struggle with how much regulation should be added here... I think IB using this (not selling to internalizers) as a selling point, so perhaps that's a market based solution that will win out over time. 2) Brokers not handling orders properly is another thing he highlights (at least as I understand it) -- I believe this is separate from selling order flow, basically this is EXCHANGES paying for routing flow to them. (from big institutional brokers like JPM, etc) but again, I haven't read the book, so I'm not clear. Perhaps some exchange is closest to NY, so they want the orders smart routed there first so they can arb other exchanges through direct pipes, with lower latency? I don't know. Seems like this should be "legal", but in reality market participants should understand what exchange they should route to to get the best fill... if brokers are playing money managers, it seems that money managers could pretty quickly determine which broker gives them the best fills. The stories about JPM not doing what the customer says in terms of order routing should immediately result in a lawsuit and a loss of business... but it didn't seem like that was happening. The whole behavior of people involved here in this story is mystifying to me honestly. ---- He says a lot of other stuff, but I'm not really seeing a clear statement. Writster says he made some comments about complexity and fragmentation... I think those are probably valid, but other than saying that big investors didn't understand the structure of the market they were operating in (I find this amazing for TROW / Fidelity to say by the way, I would think they would be held liable if that is the case). I personally think 10 exchanges is crazy, but I don't know if legislating fewer exchanges is the right answer... seems the most transparent liquid exchange will win... it's a natural monopoly... I'm curious to read the book to see if there are more details on this. He commentary from that video is really just confusing to me. He says nothing. In the end, this issue seems really minor to me. It's only been 20 years since you only really could buy / sell with full priced commissions, and spreads were 1/8th minimum. I'm all for improving things, but it seems not that relevant for long term investors (even large ones) which is what the SEC should designed to encourage / protect. If you just route your order to NYSE or NASDAQ and look at their order book as all the liquidity there is, there is no issue. Perhaps the solution is that NYSE / NASDAQ will have to lower their fees to stop the erosion of share in the industry... maybe the market is working? Overall I would put other basic regulatory functions way ahead of this issue (short selling disclosure, pump & dumps, fraud)... that's not to say improvements can't be made. If I missed a clear statement that ML made, please feel free to repeat. I find this area interesting, last year I began doing some research on this space coupled with my position in IBKR and read a few textbooks on exchanges, and I truly feel only moderately educated here, but I really think a lot of this is overblown and well within the realm of "reasonable people" could disagree on how to go forward. Thanks in advance for any follow up discussion. Ben