giofranchi

Well, in today's environment I would follow Mr. Templeton’s advice: “Go long the best stock you can find, and go short the worst stock you can find”. That’s also what Mr. Watsa said at the 2011 AGM. Bottom up analysis is useful also to spot overvaluation. And possibly profit from it! In a secular bull (1982-1999) a long/short strategy won’t lead you to outperformance (probably, it will lead to underperformance!). Vice versa, in a secular bear and when aggregate statistics point to high valuations, a long/short strategy strikes me as very sensible. And the chances to outperform your benchmark are reasonably good. So, when to employ a long only value based strategy, and when to employ a long/short value based strategy? How much capital to deploy in long ideas and how much in short ideas? Imho, that’s where a little bit of macro reasoning might prove to be helpful… giofranchi

Packer, this is just an example, but, as you can see on page 9 of the letter attached, the evidence shows that Mr. Grantham forecasts are very accurate. Good results in the mutual fund industry, which I don’t like, are as much dependant on a good management as on a good clients base. If your reasoning is right, but your clients think otherwise, and you don’t have locked in capital, like Mr. Marks fortunately has (one of the reasons I decided to invest with him, even if I don’t like the mutual fund industry), your results will surely suffer. Ask Mr. Berkowitz, who last year was forced to liquidate very good investments at ridiculously low prices, to meet all the redemptions! It doesn’t matter that those investments will prove to be spectacular successes in the years to come, and that Mr. Berkowitz’s reasoning was outstanding, because he was forced to sell at the worst time possible! It is well known that Mr. Grantham suffered many times from this same weakness during his long career (once redemptions were almost 50% of AUM). Many times Mr. Grantham has posted the accuracy of his forecasts, and his track record is pretty darn good! I am not sure I have understood correctly the second part of your post… please, be patient with my poor English! Anyway, you end up saying: the company/security parameters being much more predicable than aggregate data. Well, I know this is self-evident, and that’s why I most probably have misunderstood you, but, if each component of the S&P500 taken singularly is somewhat predictable, then the same degree of predictability belongs to the S&P500 as a whole as well. giofranchi JGLetter_3Q09.pdf

Packer, I have read Mr. Mark’s book, and I hold him in the greatest regard, to the point that I invested with him: OAK is my firm’s fourth largest holding. And I agree with you: my idea of paying attention to the big picture is not at all trying to forecast what is unknowable. Instead, just like you said, it is to gauge where we are. And, imho, during a secular bear and a deleveraging you don’t want to see Mr. Grantham forecasting a +0,2% annualised return for the next 7 years in US large caps, and a negative –0,3% annualised return for the next 7 years in US small caps, and just think: “well, that doesn’t apply to me, because I am a bargain hunter! The stocks I pick cannot be affected by the general behavior of the markets!”. Maybe in a secular bull, maybe in a leveraging period… but I wouldn’t do that now. The trailing P/E of the Russell 2000 is almost 30… Probably, I will be proven wrong, but I really don’t like to be greedy at this point! giofranchi

What does "think about the big picture" mean? Well, I guess it means, for instance, to make the effort to read and study what Mr. Dalio has to say about deleveraging periods. Thinking that maybe you could find something useful in his work. And not casting it aside, just because it is macro… and, if it is macro, then it surely cannot help us! Ray Dalio is a genius. He writes and talks about investing in his own unique way. I really think it will pay off big time to listen to what he has to say. giofranchi Delevergaing_Studies_BridgewaterDraftConfidential.pdf

I couldn’t agree more! But the assumption implicitly made is the presence of bargains… Now, the July 31, 2012 GMO Asset Class Return Forecasts foresee a 0,2% annualised return for US large caps, and a negative –0,3% annualised return for US small caps (negative!). Even high-quality companies are forecasted to return an anaemic 4,5% annualised, while the long-term historical US Equity Return is 6,5%. If you think of the long-term historical US Equity Return as “Fair Value”, even high-quality companies as a group are trading above fair value. Instead, everybody on this board likes to see things trading at least 30% below fair value! Right? It doesn’t seem to me an environment ripe of many healthy bargains! Paraphrasing Mr. Cummings and Mr. Steinberg, “opportunities meeting our investment criteria are few and far between” (2011 Letter to Shareholders). I am not saying don’t buy a true bargain, if you can get one! Far from me! I am just saying buy a true bargain AND buy some protection: buy AIG (if you know it well), and short a bunch of US small cap. I am just saying that in this environment I prefer a long/short strategy to a long only strategy. Well Vinod, in the rest of you post you have answered to that question better than I could have!! ;) I like John Hussman and I respect his work very much! But I wasn’t thinking of a cyclical bull or a cyclical bear. Instead, I was thinking of structural, secular markets. I guess everybody on this board has read “The Snowball”. Well, you might remember that it begins with the Sun Valley speech Mr. Buffett made in July 1999: Dow Jones Industrial Average December 31, 1964 = 874,12, December 31, 1981 = 875,00. He implied that, just the way it had happened during the 1964-1981 stretch, for the next 15-20 years stocks returns would most probably be sub par. And that was from Mr. Buffett, who has always despised macro! Of course, the 1964-1981 stretch was not the first secular bear market in history: the 1931-1949 stretch comes obviously to mind, or also the 1900-1919 stretch. But, if you read, for instance, the wonderful biography of Andrew Mellon by David Cannadine, you realize that the 19th century was characterized by as many difficult, long and deep secular bear markets as the 20th century was. Not a single one of them ever ended with valuations as high as they were in March 2009, and not a single one of them ever ended in so short a time as the 2000-2009 stretch. If history is any guide, all I know about the history of the financial markets tells me that we still need one more shoe to drop. Then I will be glad to employ a long only strategy. For the time being, I stick with a long/short strategy and, if I am wrong, better be late to the party than be sorry! As an aside, it should be noted that Mr. Buffett closed his Partnership in 1969 and went working on his “new venture”, Berkshire Hathaway. In the early 70s Mr. Buffett acquired See’s Candies through Berkshire, and See’s Candies began distributing all its earnings to be allocated by Mr. Buffett: that is another wonderful way to invest in a secular bear market! Control value investing in a secular bear market is great! If you control a very good business, that each month generates a lot of free cash and pays you all its earnings, of course you could afford the luxury to invest them with a long only strategy and just wait (that’s part of the reason why I like BH). giofranchi GMO_7-Year_Asset_Class_Return_Forecasts_July_31_2012.pdf

Far from me criticizing an investment that I haven’t either studied! I did not express myself correctly! In my original post I referred to BAC and AIG, just because they are two of the most talked ideas on this board. What I was trying to say is that the timing of even the best long micro ideas, in this case BAC and AIG, is hard to predict. You all have studied BAC and AIG very well, and you know that the value is there, and that sooner or later it will be recognized. But I guess it is very hard to say exactly when. Isn’t it? So, refusing to even think about the big picture, because anyway macro events are impossible to time correctly, is not an argument that I agree with. Nothing can be timed with great precision! But: can you have an idea of secular bull or secular bear markets? And where are we now? Yes! Can you know if markets in general are richly priced or are cheap? Yes! Can you know if there is too much debt in the system? If we are leveraging or deleveraging? Yes! Can you recognize a bubble? And avoid its burst? Yes! Can you study history and see if similar patterns were repeated in secular bull and bear markets of the past? In richly priced and cheap markets of the past? In leveraging and deleveraging periods of the past? In past bubbles? I think you can! And I think it can be useful, even if you cannot time events. giofranchi

Thank you PlanMaestro! I don’t understand why you say that GLRE’s CORs are below average. If you look at pag.10 of the GLRE’s presentation, and you sum the CORs of the last 4 years, you obtain: 399,6 for GLRE, 404,2 for THR, 405,6 for RE, 396,3 for PRE, and 397,6 for PTP. It looks that GLRE is not above average, but neither below! And, while THR earns net premiums which are 40% of surplus, precisely in line with GLRE, RE earns premiums which are 70% of surplus, PRE earns premium which are 75% of surplus, and PTP earns premiums which are 95% of surplus. So, the equities of RE, PRE, and PTP are much more negatively affected by a COR > 100%, than GLRE’s equity is. It seems to me that GLRE is an average underwriter, which runs a lower premiums risk than the competition. All in all: average CORs + below average premiums risk = above average reinsurance operations (I mean safer than average). Not below average! I do not claim to know every participant in the reinsurance market! And it is possible that the comparisons chosen by the GLRE management are the four worst performers in the whole industry! If that is so, I was fooled by Mr. Einhorn, Mr. Hedges & Co. … and I will sell my shares tomorrow morning! giofranchi

Thank you tombgrt, always can count on you for great insights! And who could disagree with the 10 commandments of insurance investing?! I really would like to know what Harry Long thinks about FFH and GLRE. I always look for people who could warn me about dangers to which I might be oblivious. giofranchi

Well, I have read The Intelligent Investor and I am always trying to find the time to read Security Analysis from start to finish. Although I keep reading parts of it, I have never really had the time to read Security Analysis from the first page to the last! Of course, I have also read many papers on Mr. Graham, but they are all centered on his investing ideas. Instead, I was curious to know something about his life! And “The Einstein of Money” seemed to be ok… I will give it a try! Thank you, giofranchi

Unfortunately, I have already bought it! Anyway, thank you for posting: it was at the top of my pile... now it will go to the bottom! giofranchi

I don’t think it is only fear. I also think there is a lack of 15%+ investment opportunities. Quoting Mr. Cumming and Mr. Steinberg: "We continue with the same lamentation as in previous years. There are hordes of private equity and hedge funds chasing low returns. While short term rates are very low, long term rates for non-investment grade borrowers such as Leucadia are quite high relative to expected returns. As a result, opportunities meeting our investment criteria are few and far between. We would prefer higher interest rates and less availability of money, making acquisitions more attractive. We employ leverage in a careful way and do not intend to fall into the traps of employing too much leverage or borrowing short term and investing long. We will leave that silliness to the hedge funds. Given the above, we have reduced Leucadia’s leverage by calling $511.3 million of long term debt in 2012 and retiring other debt during the last three years in market transactions. With those steps, we have cut Leucadia’s leverage by over 40%. Borrowing money at 7% without a clear path to make 15%+ is not attractive and we don’t see many opportunities to make at least that return. This cautious approach was evident in the purchase of National Beef; although banks were beating down our door to lend us more money, we paid cash. A world-wide recovery in the near future is not a foregone conclusion. Europe and the future of the Euro are far from settled. Growth in China is slowing and the risk of a “Chinese Spring” cannot be ruled out. Iran is a big problem. In an environment of slow growth at home and a dysfunctional government, we believe that less financial leverage is better. We expect many other companies and investors share this view. We emphasize that we are not pessimistic, just cautious. We are enthusiastic about the future of our broad array of operating businesses and investments and have our eyes open for additional acquisitions. Never fear, if a good deal comes along we will find a way." When 15%+ investment opportunities are "few and far between", prices must come down… When prices come down, the economy inevitably slows… I don’t think it is only psychology, I don’t think it is only fear. Now, I know, many of you hate me!! There is a lot of optimism on this board and you must think of me as a joy killer… but, paraphrasing Mr. Cumming and Mr. Steinberg, I am not pessimistic, just cautious. giofranchi

Thank you very much Paker! Actually, the most important thing for me is to sleep well at night… then comes capital appreciation. I believe that in an insurance business the quality of management is paramount. And, before investing in an insurance company, I require to know what they are doing and why. I think I know and I think I understand what Mr. Watsa and Mr. Einhorn are doing. PlanMaestro wrote: “you are making a big assumption that he knows what he (Einhorn) is doing on that macro front. To me it looks more like public relations stunt with those small positions.” Actually, since the formation of GLRE, average gross exposure was 90% long and 53% short. It doesn’t really look like the shorts were/are such small positions after all! And, as he said, macro reasoning help him choose the right long-short exposure ratio. His exposure to gold derives from a macro reasoning, and it surely is not a small position (at the end of Q2 2012, gold was GLRE third largest position, after Apple and General Motors)! Vice versa, I will not pretend to know what AIG’s management is doing. But I agree with all of you: for anyone who understands well what AIG’s management is doing, and reckons that they are doing a great job, AIG today is a wonderful opportunity! One more thing on GLRE: the 11,7% CAGR in book value they achieved from 2004 to 2012 is, of course, after paying Mr. Einhorn. Results from investments are after management fees. And one last thing about macro reasoning: talking about EMT, Mr. Buffett once wrote (quoting by hart, because I do not have his letter with me right now): “we are in great debt to those academics who taught so many investors that, in what is essentially an intellectual game, reasoning is useless”. I know it is odd to quote Mr. Buffett AND defend macro reasoning… Mr. Buffett has always despised macro reasoning… Anyway, I believe that what Mr. Buffett said about EMT also readily applies to macro reasoning! giofranchi

One’s knowledge and experience are definitely limited and there are seldom more than two or three enterprises at any given time in which I personally feel myself entitled to put full confidence. I invested in GLRE, because I think I know and understand what they are doing. Instead, I have no particular insight in AIG… It is very tempting to follow Mr. Berkowitz and many of you, who are great investors, in AIG at half book value! It is just that “I personally DON’T feel myself entitled to put full confidence” in AIG. Anyway, why do you judge GLRE a below average company? Please, look at pag.7 of the file attached: they achieved a 11,7% CAGR in book value per share from 2004 to 2012. And it was not an easy time! Furthermore, look at pag.9: they achieved that CAGR while being significantly under leveraged, if compared to other insurers/reinsurers. Then, please look at page 11, 21 and 38: GLRE’s combined ratio has stayed well below 100% in 2007, 2008 and 2009, and was slightly above 100% in 2010 and 2011; investment return was an annualised 9,6% since formation of GLRE, but it was not an easy time! In the GuruFolio attached you can find that Mr. Einhorn had achieved returns of 29% from May of 1996 through August 2006. On page 38 you can see that, if the combined ratio stays around 100%, and Mr. Einhorn compounds capital at 10%, and GLRE stays very under leveraged, a 13% CAGR in book value per share will be achieved in the future. What if Mr. Einhorn will compound capital closer to the 29% he achieved in the 1996-2006 period? What if the GLRE will get a little bit more leveraged? It has still very ample room to grow its float an to write more premiums! What if an hard market finally arrives and their combined ratio falls below 100% (like in 2007, 2008 and 2009)? After all, even Markel, which is a very good underwriter, had a combined ratio higher than 100% in 2011. I think we are talking about CAGR in book value per share ranging from 20% to 30%: not exactly my idea of a below average company! What if the market recognizes the potential for growth and price GLRE at 1,3 or 1,4 x book, instead of book value? I know you will now demolish my thesis… you are welcome!! That’s what I look for! giofranchi Greenlight_Re_2012_Investor_Meeting.pdf GuruFolio_DavidEinhorn_2012-06-30.pdf

PLANMAESTRO, I have read an insightful book about how Mr. Keynes invested: “Keynes and the Market” by Justyn Walsh. And I recommend that book too. Maybe I am wrong, and my investments in FFH and GLRE will turn out to be poor investments. Then, my firm will suffer much, because they are our largest investments by far… Anyway, they are made on the assumption that both Mr. Watsa and Mr. Einhorn have the right temperament to be very good investors. Even though they do not disregard the big picture. If this assumption is correct, I do believe that FFH and GLRE will turn out to be worthwhile investments. giofranchi

[amazonsearch]The Era of Uncertainty[/amazonsearch] I know that many of you don’t believe macro is really useful, but, please, read the following passage from “The Era of Uncertainty”, written by Mr. Trahan and Mrs. Krantz: David Einhorn of Greenlight Capital – arguably most famous for shorting Lehman Brothers in 2007 – told his personal tale of learning this lesson at the Value Investing Congress in October 2009. He referred to a speech he delivered in May 2005 at the Ira Sohn Investment Research Conference when he recommended MDC Holdings, a homebuilder, at $67 per share. The stock reached $89 within two months, but anyone who held on to the position rode it down with the rest of the sector in 2007. H said, “Some of my MDC analysis was correct: it was less risky than its peers and would hold up better in a down cycle because it had less leverage and held less land. But this just meant that almost half a decade later, anyone who listened to me would have lost about 40 percent of his investment, instead of the 70 percent that the homebuilding sector lost.” The reason he gave for revisiting this story was that it was not bad luck, but bad analysis. He contrasted what he said that day with what he heard from legendary hedge fund manager Stan Druckenmiller a bit later in the conference. Stan’s chosen topic was the grim story of the problems we faced from an expanding housing bubble inflated by a growing debt bubble. David wondered, even if Stan were correct, how would one translate such big picture macro view into a successful investment strategy? He soon had the answer to his own question: “I ignored Stan, rationalizing that even if ha were right, there was no way to know when he would be right. This was an expensive error. The lesson that I learned is that it isn’t reasonable to be agnostic about the big picture. For years I had believed that I didn’t need to take a view on the market or the economy because I considered myself to be a “bottom up” investor. Having my eyes open to the big picture doesn’t mean abandoning stock picking, but it does mean managing the long-short exposure ratio more actively, worrying about what may be brewing in certain industries, and when appropriate, buying some just-in-case insurance for foreseeable macro risks even if they are hard to time.” David then proceeded to discuss the macro risks he believed were facing the markets at that point in late 2009. We couldn’t have said it better ourselves. I remember in 2010, at the Value Investing Congress held in Trani (Italy), Mr. Parames of Bestinver Asset Management, after exposing how crazy things were in Spain, made the following joke: “Well, I guess at least we are good soccer players!” (Spain had just won The World Championship). And I remember that I asked him: “If you saw it coming, why didn’t you short Spain?”. He answered: “Because of the timing. I couldn’t predict the timing.” Now, I have read that many of you are long BAC and AIG, and… are you sure of the timing? Can you really predict when your investment in BAC or in AIG will pay off? “buying some just-in-case insurance for foreseeable macro risks even if they are hard to time.” Things hard to time are the bread and butter of value investors, of the cool, the patient, of people who are able to sit still in a room doing nothing (paraphrasing Mr. Pascal). Does it really matter if those things are on a micro or on a macro level? Imho, this is exactly what Mr. Watsa is so unbelievably able to do: 2007: he did not ignored Mr. Druckenmiller advice and bought some just-in-case protection, 2009: with the S&P500 at almost half of its former high, and with Wells Fargo at $8 (I still can ear Mr. Buffett saying back then: “If I had to put all my wealth in just one stock, right now it would be WFC!”), he became greedy, 2011: with the S&P500 up almost 100% from its 2009 low, he managed FFH long-short exposure ratio accordingly. So, strange as it might seem, I probably recommend “The Era of Uncertainty” more to “bottom up” investors, than to “top down” analysts: I think they could find something very useful! giofranchi

Thank you for posting! Interesting indeed! Just curious: what about hedge funds? I ask, because it seems that US equity mutual funds have suffered redemptions in any kind of market (rising or falling). Maybe, that is not a sign of disinterest in equities by the public, but it might just mean that the mutual fund business model is suffering. Many more nimble investment vehicles (hedge funds, for instance) have been created and have come to prominence recently. That could put pressure on the mutual fund industry, irrespective of how much the general public is actually interested in equities. Otherwise, how do you explain the outflow of funds from US equity mutual funds both in a declining market and in a rising one? giofranchi

Or, this time paraphrasing Mr. Dalio, a 10% allocation to gold is a very good way to diversify the remaining 90%. giofranchi

That was my key takeaway... That was also my key takeaway! But that is not to say I judge it unimportant or useless… Imho, it means that right now there is no margin of safety: high equity prices + uncharted territories = no margin of safety. So, I stay defensive here. … And right now it feels completely wrong!! My hedges are costing me money and the companies I invested in are lagging the markets … I am surely in a far worse position than any of you! Therefore, I am almost certainly totally wrong, but today I need a HUGE margin of safety to be aggressive… And I really don’t see it: on a micro level, the companies I invested in are very good value, but no extreme bargains; on a market level, equity prices in general appear to be fairly valued at best (actually, they look overvalued to me); and, on a macro level, it is uncharted territories. That being said, I am here to let my views be challenged and to change my mind accordingly. So, if any of you think that right now there is a good margin of safety in the stock market, I would be really glad to know! ERICOPOLY, I am really no trader! I ran an engineering firm daily and I just try to allocate its free cash the best way I can. My firm has a very concentrated portfolio of just 9 companies. I do not have the time nor the resources to scan every stock of every market to uncover the “ultimate bargain”. And I do not have the time nor the resources to do some serious research on complicated businesses like BAC or AIG. I do not even believe that it is really indispensable to uncover the “ultimate bargain”, or to study complicated businesses. Those 9 companies are good businesses, easy to understand, and managed by great people. Believe me: I did some research on those 9 businesses. And I am constantly using the free cash generated by my firm, to buy greater stakes in those companies at good prices. That, I believe, is what in the long run will create wealth. giofranchi

WOW!! Really amazing!! Congratulations!! I really hope I will be able to say: once I talked about the stock market with the man who discovered what Dark Energy is!! Keep on doing your wonderful job! giofranchi

Very good paper on the evolution of Central Banks. FFH with its CPI-linked derivative contracts is a great hedge against deflation. Gold might be as good an hedge against inflation. Until we don’t know with certainty, if the deflationary forces caused by the winding down of too much debt will prevail on the Central Banks printing presses, or vice versa, owning some gold doesn’t look like a bad idea to me. giofranchi guggenheim_82212.pdf

Always a very good read! Find it in attachment. giofranchi fpa_82712.pdf

I think your point is irrelevant. There's actually more than one study (I read one by the guy who helped Einhorn start up his reinsurer), which points to the fact that a significant amount of Buffett's good investment results came from the "structural alpha" generated from the insurance operations. E.g.: low/0 cost leverage without the ability to be pulled during market declines. He still outperforms, even without it, but you can definitely see that a big chunk of the results came from being able to lever up returns. TariqAli, of course you are right! But rimm_never_sleeps has a point too! If you let your investments grow many times your capital, and you put to risk all your funds, without holding much cash, even Mr. Buffett could get killed. I think he knows and never let that happen. I agree with rimm_never_sleeps, when he writes that BRK has always been underleveraged... if compared to other insurance/reinsurance companies. I have already posted the chart in attachment, but you mentioned GreenlightRe, so I will do it again: please, notice how underleveraged GLRE looks to be, if compared to other similar companies. giofranchi Insurer-Reinsurer_Leverage.pdf

I surely agree with Uccmal and cwericb on RIM and FFH. giofranch

I know that almost nobody on this board believes in "macro calls". Anyway, I believe that the monthly market analysis by IceCap Asset Management is a good and useful read. In attachment you find the most recent one. I believe what they write is true and actionable: "If the World's best sell side economists and the US Federal Reserve rarely predict US economic growth with any accuracy, why then do the media and markets place so much importance on these groups? The point we make is that all to often the investment industry gets lost while focusing on the proverbial trees. Consiering the precarious state of the global financial system and global economy, it is much wiser to step back and let your eyes focus on the forests, and not blindly follow what the big boys are saying." To get every "tree" (or every turn of the economy) right might be really impossible, and to attempt doing so surley is delusional, but the get the "forest" right could be accomplished and, therefore, might be useful and should be attempted. I think that's what Mr. Watsa tries to do. giofranchi IceCapAssetManagementLimitedGlobalMarketsJuly2012.pdf

I agree with all of you: "The Most Important Thing" is a terrific reading! What's even better is that now we can partner with Howard Marks, investing in OAK. OAK looks significantly undervalued right now: at the link below you can find a good analysis and evaluation of the company. http://brooklyninvestor.blogspot.it/2012/04/oak-oaktree-capital-management-ipo.html giofranchi