SafetyinNumbers

I think you make great points which contributes to the moat. Another feature of Fairfax is that you know your optionality on the stock doesn’t get impaired by an opportunistic take-private bid from management. Arguably, the market gives Fairfax a discount for this feature as its participants are more interested in short term gratification.

At the time the hedges were put on there was real concern about negative interest rates. What’s float worth if interest rates are hugely negative? I think that’s what they were hedging so they could keep growing premiums.

Q. So you would pay a premium for any leverage or is this leverage more valuable because of its characteristics? A. Yes, in principle. Leverage from taking out a big loan would be worth a lot less than safe uncallable leverage from a steady self-renewing source of float like Fairfax's insurance business. Given the fact that float represents $28b at Fairfax, and equity is $26b (including non-controlling interests), and Fairfax is trading at only 1.1x book, you might say that Mr Market is giving very little value to that float, but I think it deserves a much more healthy premium. A huge loan that you never have to pay back is worth something. Sounds like a moat.

It makes sense in context with investor behaviour and typical institutional manager constraints. The narrative will change when price changes.

So you would pay a premium for any leverage or is this leverage more valuable because of its characteristics?

The short answer is that shareholders really liked the hedges when they were on. I didn’t own Fairfax back then but I was buying US banks in early 2016. A lot of financials were in free fall because the fears of the US and Canada going into negative rates seemed like they were at their highest point. A lot of the same PMs that now complain about the hedges owned Fairfax because of the hedges. The stock acted well when the market was down and especially when other financials were down so FFH had the effect of dampening volatility and increasing risk adjusted returns. Even now, anecdotally FFH tends underperform on big up days for the market and outperform on big down days and I think it’s partially because the historical hedges (including GFC-related hedges which worked out) still influence investor behaviour. The market wasn’t efficient back then and it isn’t now. Valuation and expected returns are just not that important to most active managers who are trying to beat the market in the short term. If they were trying to generate high risk adjusted absolute returns over long periods of time maybe it would be a different story.

I guess I misunderstood I thought it was the discussion of the moat that got us there. Using your mental model, I wouldn’t pay NAV+ for a levered bond fund. Would you? Sure insurance is a commodity business but Fairfax gets to choose how much business it writes when prices are low. Effectively that’s part of the culture/cap allocation moat, isn’t it? I’m curious for the people looking at the track record in CR, how can you tell how well the comps have been reserving vs Fairfax over time? If Fairfax, over reserves after every acquisition would that skew combined ratios higher? Do you track operating expense ratios vs comps to see if there is a delta in structural cost advantages?

Is it fair to say that unlike Buffett, you both don’t think float generating businesses are worth more than book value?

I’m just referring to liquidity. Cash is better than no cash even if there is a liability of the same amount. I appreciate your perspective.

I think it was confirmed to be a PFIC.

They would have more liquidity by adding the to the TRS vs share buybacks all else being equal.

If they bought the shares back, we would find out within the first 10 days of December.

If Fairfax added or reduced its TRS position this month what would you think? Keep in mind we wouldn’t find out until February and the news would accompany earnings so if it does happen it will be difficult to tell how the market takes it. There was a cross of ~216k shares last Tuesday at the close which is why I’m asking. That cross could be related to something entirely different but changes to the TRS are a possibility.

Glider hopefully is right that the tax losses on FDGE can be used by Fairfax and there could also the potential for lottery ticket returns based on making a further investment which probably be more difficult to do as a public stock. That’s a trade I might make too so I’m not put off by it. I think Fairfax is an expected value investor and I don’t think that will change as long as Prem is in charge. Most investors want them to use the same heuristics they do to make investments and so most investors will be constantly frustrated. Not averaging down is one of those heuristics. Investors prefer FFH get a steady 12% on their equity portfolio vs a lumpy 15% even though FFH itself is a lumpy 15% investment. Arguably the floor returns are higher for FFH now than in the past decade because of the change in the interest rate environment and the high float to book value ratio.

Quants love consistent earnings and analysts predicting growing earnings. Fairfax should have more consistent earnings the next few years given the structure of the bond portfolio.

On the face of it, it’s bigger, more liquid and has a larger dividend.

Maybe it’s because of Viking’s email or becsuse MKL was so disappointing but RBC is now calling FFH one of its preferred names taking over for MKL.

If Fairfax wasn't the 30th biggest weight in the S&P/TSX, it would be harder to disagree with your odds. The narrative will be around Buffett of the North, or India or Greece or Digit or something we don't know about yet but the mechanism is based on how active equity strategies are managed. I think those 3% odds are over 50% if Fairfax executes and given the set up, I don't think it's that big an if.

I would argue that with passive being much greater competition for active managers than ever before, the move has the potential to be even more pronounced. As long as BV is growing at a healthy rate, the multiple will keep expanding. IFC trades at ~2.5x BV based on a ~13% ROE average for the past 10 years. It’s BV hasn’t grown this year but it’s expected to resume so it’s kept it’s multiple so far. For Fairfax, expectations are relatively low for forward BV growth (10% at 1x?) despite all of the evidence to the contrary.

I did the math and it’s just under $2000/sh after accounting for the dividend unless I screwed it up. @vinod1 where would you set the odds on book value being > $2777 (current BV + 2000 - dividends) in exactly 10 years and where would you set the over/under on BV in 10 years?

I think the price will ultimately drive the narrative which will increase Social Value from a negative to a positive. The price will move as long as Fairfax executes and grows book value 10%+ which I argue is hard not to do given the float to book value ratio. As it becomes a bigger part of the index, active managers will have to buy it and they will need a rationale. The analysts will also need reasons to increase their price target. The narrative will change because the multiple expanded not the other way around. Some investors will argue float is valuable and businesses that generate float are worth more than book value. Others might appreciate how quickly dividends and associates income are growing as Viking pointed out. After some big gains in the equity portfolio some PMs will talk about the cheap exposure to Greece and India. The negatives will become positives. That’s my bet anyway, it’s still a bet as there are no sure things but the probability is high in my opinion. The beauty is at this price, it’s a free option. The more skeptical current holders are the longer it will take as extant holders determine the selling price. The institutional buyers use VWAP so they are price takers while sellers are price makers. It will be fun to see how it plays out. It’s been a good run for 3 years already as weight in the index has more than doubled from 45bps to ~100bps now. There is no reason for that to stop unless FFH book value growth stalls for a few years. It’s just hard to see how that happens in the next 5 years.

That’s great. He didn’t respond to me when I sent him the podcast. He cites a lot of of factors that have nothing to do with intrinsic value. My market model is Market Value = Intrinsic Value + Social Value. Social Value can be positive or negative. For Tesla it’s hugely positive. For Fairfax, it’s hugely negative. I only invest in things with negative SV. The big downside of that approach is that the cost of equity capital is high which means less flexibility and more risk.

I heard from a KW institutional investor in August who had heard the Business Brew podcast on Fairfax that ultimately decided to switch their position from KW to FFH. One of their reasons for selling was because they thought management compensation was too high. I’ll add, the high dividend makes it harder to grow but probably helps with valuation.

And they are at about 43% now? Does that make it less of an issue for you @This2ShallPass?

The original institutional investors (OMERS, Fidelity and Markel, I think) who negotiated this deal on behalf of minority shareholders are the ones who have let us down. In theory, they were counting on themselves to be buying to close the discount every three years to avoid this dilution. Unfortunately, the key decision makers are probably out of their jobs and there isn’t any capital for stocks outside their benchmark. This is the first performance period where it’s meaningful so let’s see what they do. FWIW, they have bought more than enough stock back at lower or similar prices to offset the dilution but I think most people think about it like you do.