Viking

I have been trying to understand the current FFH investment approach and I am having trouble reconciling Prem's apparent concerns regarding the economy/outlook and FFH shift into risk assets. Prem has repeatedy compared our current situation to that of Japan after their bubble burst in 1989/1990. Until Nov of last year they had about as conservative portfolio makeup as one could have (US Treasuries/stocks fully hedged & CDS). His most recent comments still talk to concerns regarding the economy which suggests he has not altered his view that we could be at the early stages of economic decline. I am not complaining about the investment moves since Nov; they have been good (US stock purchases) to brilliant (shift from US Treasuries to US tax free municipals & corporates) with the odd dog mixed in (CAN stock purchases - Brick, Canwest - & Abitibi bonds). When I look at the total portfolio today I see a VERY LARGE weighting to risk assets. As we saw in March when the markets sold off, FFH book value dropped (end of Q1) to US$254 from $278'ish. Yes, today it is likely in the US$300 range. However, it would not surprise me to see US stock averages tank again in October (to lower than March lows) as people come to understand what Prem is saying... the economy is not going to bounce back quickly and we could see 5 or 10 years of deflation. With the shift to risk assets in the investment portfolio and with all the hedges off FFH could quite easily see a $50 to $75 move in book value ($300-$75) back to US$225. At current prices, FFH is a solid buy. However, to go overweight with FFH, one has to feel strongly that the stock market averages lows are likely behind us; to be bullish on FFH current prospects I think one also has to be reasonably bullish on the outlook for risk assets. What do others think?

If you lived in Iceland and before their currency/economy imploded last year you invested 10% of your investable assets in GLD (or bought the metal outright) how would that investment be doing today? My guess is that investment would be outperforming bonds, stocks (local icelandic stuff). I do not plan on holding gold as a long term investment. I simply view it as a way to preserve my net worth in the short term as we work through some things the US and global economy have not seen before. Having said all that, I do not own gold today...

I have read similar comments regarding AIG from other insurance executives. AIG also appears to be losing many of its best people. I wonder if the many AIG businesses have begun the 'walk of death'... losing their good people, customers shift some business to competitors, business shrinks... more employees leave, customers pull the plug, business shrinks some more... "He attributed Travelers' lead, at least in part, to winning customers away from rivals, including AIG, which has struggled after massive derivatives losses led to a $180 billion federal bailout." "A flight to quality—there is no doubt there is one," said Mr. Fishman. He added that feedback from agents and brokers was that "many are concerned some companies won't have the capacity to service customers." www.businessinsurance.com/article/20090604/NEWS01/906049986

One thing that I am learnings is when valuing insurance companies is most analysts/large investors look for predictable earnings. That is why most analyst reports simply look at operating earnings (CR plus interest/dividend income). Investment gains and losses ARE NOT VALUED until after the fact (i.e. they are realized). FFH/ORH are anomalies in that they outperform their peers with investment gains but they still do not get any respect for this skill. I know FFH did in the 80's and 90's when it traded for crazy multiples. My guess is should FFH continue to outperform (over years, not quarters) Mr. Market will start to attach a higher multiple to its stock. I hope they continue to improve their underwriting versus their peers... this will be icing on the cake... The benefit is we continue to get great opportunities to buy stock at a good discount to book value.

I am definitely not a gold bug. However, I do buy into the 'store of value' argument. Buffett appears to be diversifying outside of US$ somewhat (buying multinatinals and companies such as Iscar). If gold was to sell off, I likely would re-establish a position (5% or 10%) in either GLD or a precious metals mutual fund (RBC?). Interest in gold continues to increase but I do not think we are at the mania/bubble phase quite yet.

Sorry, here is the promised Excel file!

Sanj, my vote says do what you feel is best. You have done a great job hosting this (and the previous) site and my bank account is much larger as a result. More importantly, I have learned alot and for this I owe a very large debt to you and other posters. Keep up the good job!

Cardboard, to provide a little clarity on the investment portfolio, I dropped the 13F numbers into an Excel spreadsheet (attached below). Please note, I did not include the GE calls; we also need to remeber that the 13F does not capture all investments (i.e. Canadian stuff etc) so I use this summary for directional purposes only. March 31 = $2,685 (million) April 24 = $3,142 or + $456 = 17% June 3 = $3,390 or + $704 = 26% Also, the $900 million communicated by FFH also included bond gains. Since April 24 stocks have done very well; bonds (muni's) have done OK. Bottom line is I don't think the gains since April 24 have added another $30 to FFH book (100% gain). I used 33% as my conservative guide of the possible additional after tax/minority interest gains after April 24. Regarding FFH versus ORH, I must admit that ORH shares do tend to trade in a sideways market (which can get quite frustrating 6 months or a year later). Check out the three year trend line and the high 30's looks to be the current trend line. FFH does seem to have much more volatility; I would like FFH to get about 10% lower before I get aggressive (given that I hold a chunk in ORH today). Mungerville, one reason I hold ORH is to play the equity markets/risk assets (via corporate bonds). If equity markets go 30% higher ORH will have even more mark to market gains (and book value will grow $3 to $4 more than I have previously stated). If equity markets go down 30% ORH will still see an increase in BV for Q2. If equity markets stay at current levels ORH will be sitting on large unrealized gains (we will see what Hamblin Watsa has sold when they report Q2).

Regarding ORH and their bond holdings, here are the numbers (in millions from p12 of Q1-10Q): - Total US Gov't = 2% of investment portfolio ($163/$7,500) - I am not including State Muni's in the above calculation because their yields have NOT run up to the same degree that US federal gov't bonds have. - bottom line is change in US Treasury yields will have no material effect on ORH investment portfolio in Q2. Fixed Income Securities Available for Sale - US government = $163 - State Muni = $2,436 - Foreign = $805 - Corporate = $433 Total = $3,846 Fixed Income Securities Held as Trading Securities - Corporate = $238 - Foreign = $82 - Mortgage Backed = $92 Total = $412 Total Bond = $4,258

alert, yes, the rapid increase in the CAN$ from the high 70's to $0.925 today certainly kills FFH in CAN$ terms. For those long term holders of FFH, the currency swings even out somewhat. Regarding calculation today, FFH is trading above stated book = US$265/$254 = 1.04xBV. - add in gains to Apr 24 (30$), add in additional investment gains ($10) and ICICI Lombard ($10) - FFH BV today is likely in the US$300 range = US$265/$300 = 0.88xBV - and yes, markets could crater tomorrow. FFH BV will be MUCH MORE volatile moving forward given their shift to risk assets. I have has a similar effect being an CAN investor and holding ORH. What has helped me is ORH has gone up in US$ terms since I purchased in separate intervals the past few months. - I am underwater by just under 4% and consider myself lucky. - ORH continues to trade under stated Q1 BV = US$42/$43.80 = 0.96xBV - add in gains to Apr 24 ($4), add in additional investment gains ($1.20), ICICI Lombard ($1.00?), currency gains ($2.00) and underwriting profit ($.80) - ORH BV today is likely in the $52.00 range = US$42/$52 = 0.81xBV Currently I prefer ORH to FFH because: 1.) it appears reinsurance pricing is firming sooner than insurnace pricing which leads me to believe ORH will outperform FFH in underwriting in the near term 2.) ORH interest and dividend income will be greater than FFH in the near term as ORH holds tax exempt municipals, dividend paying US stocks and in Q1 more corporate bonds, whereas FFH is weighed down somewhat by NB holding lower yielding (and taxable) CAN govt bonds - add 1 & 2 and ORH operating income should outperform FFH 3.) my guess is ORH investments are performing better than FFH (and my assumption is US investments - i.e. WFC and USB - are held primarily in ORH and C&F and CAN investments - i.e. Brick, Mega, Canwest etc are held primarily in NB). 4.) ORH continues to trade at a much lower multiple than FFH to Q1 end stated BV (almost 0.10) What I have been struggling with lately is should I buy more ORH? - it is cheap at current prices but not crazy cheap. - the CAN$ continues to move higher - as the first hurricane starts forming the re-insurance stocks tend to sell off (even though a big hurricance disaster would be a net prositive for ORH by hardening pricing)

Mungerville has said this before but the best thing for well capitalized insurers like FFH/ORH would be a high cost storm year. Many companies (insurers and reinsurers) have no 'wiggle room' as their balance sheets have been impaired by investment losses. Sounds a little dark though...

For the benefit of new board members, attached is the press release from FFH that communicates the IRS' final assessment of the trasaction that lead to the 80% consolidation of ORH within the FFH tax group for 2003 & 2004: - www.fairfax.ca/Assets/Downloads/Press/fpr2008-07-30.pdf I remember Prem also had some choice words on the Q2 conference call regarding the short allegations at the time on this topic...

Vinayd, thanks for pointing out the NB purchase from a currency perspective. The purchase price was US$374 million or CAN$458.4 (exchange rate = $0.816)! I wondered at the time why they took out NB versus ORH and in hindsight perhaps the level of the CAN$ was a key factor. And with the CAN$ now appreciating NB is becoming more valuable to FFH (reporting in US$). Regarding ORH, they actually discuss exchange rate risk in their 1Q results (see btoom of post). - a 10% (equal) decline in Euro/BP/CAN$ = $189 million hit to ORH - can we not assume the opposite (roughly) 10% decline in US$ = $189 million gain - $189/60 milliuon shares = $3.15 - 35% taxes = $2.00/share = 4.7% increase in BV The investments they hold with significant operations overseas will also mitigate the impact of a declining US$ (J&J, Kraft, GE, Intel, Magna, Pfizer etc). As a Canadian investor what this all tells me is that a weakening US dollar is a net negative, but the actual hit to my ORH investment is something less than 50% of the currency move. (This assumes the CAN$ appreciates a similar amount to the Euro and BP.) Foreign Currency Risk (page 60, ORH-Q1 report) "Through investment in securities denominated in foreign currencies, we are exposed to foreign (i.e., non-U.S.) currency risk. Foreign currency exchange risk exists because changes in the exchange rates of the underlying foreign currencies in which our investments are denominated affect the fair values of these investments when they are converted to the U.S. dollar. As of both March 31, 2009 and December 31, 2008, our total exposure to foreign-denominated securities in U.S. dollar terms was approximately $1.9 billion, or 25.4% and 23.8%, respectively, of our total investments and cash. The primary foreign currency exposures were from securities denominated in the Euro, which represented 10.3% and 9.7% of our total investments and cash as of March 31, 2009 and December 31, 2008, respectively, the British pound, which represented 5.8% and 6.0% of our total investments and cash as of March 31, 2009 and December 31, 2008, respectively, and the Canadian dollar, which represented 4.6% and 3.5%, of our total investments and cash as of March 31, 2009 and December 31, 2008, respectively. As of March 31, 2009, the potential impact of a 10% decline in each of the foreign exchange rates on the valuation of investment assets denominated in those respective foreign currencies would result in a $189.2 million decline in the fair value of our total investments and cash, before taxes."

watsa-is.., I just e-mailed you the PDF file...

return, I have been asking the same question... here is the math/reasoning I am using: 1.) FFH said they were sitting on $900 million pretax ($30/share after tax & minority interest) in gains from all investments as of April 24. - all ORH said was that they were sitting on material mark to market gains 2.) I estimate that ORH investments represent about 40% of total FFH investments - this leads me to extrapolate that they were sitting on about $900x.40=$360 million - after tax = $360 - 35% = 234 / 60 million shares = $3.90 after tax (very rough) 3.) thanks to margin of safety's ORH NAIC filings we know in Q1 ORH purchased: - 7.6 million WFC shares at $18.41 (46% of total new FFH purchases) - 6.86 million USB shares at $16.66 (43% of total new FFH purchases) - 478 thousand BNI shares at $63.01 (61% of total new FFH purchases) - 654 thousand LUK shares at $17.31 (65% of total new FFH purchases) - given that WFC (and USB to a lesser extent) has been the key driver of the unrealized gains since March 31, it is safe to assume that the ORH equity portfolio is ourperforming FFH since March 31 4.) regarding the bond portfolio, my guess is ORH is also outperforming FFH as FFH has Canadian govt bonds (Northbridge) which have likely performed better than US treasuries but not nearly as well as US minicipals or corporates (majority of ORH bond portfolio). 5.) since April 24, the FFH equity portfolio has appreciated roughly 5% Wrap it all up and FFH is likely up quarter to date more than the $900 million they reported (mark to market April 24). I think it is a reasonable assumption that ORH is up something more than $4.00 after tax per share. Factor in Q2 operating earnings and this gives me a current book value of $43.80 + $4.00 + $.70 = $48.50. With the stock currently trading about $38.5 then PB = 0.79 Yes, the equity portfolio could fall precipitously so one has to take all this stuff with a grain of salt. However, it is relevant and important because if ORH was sitting on $4.00 in unrealized losses (putting BV = $40.50) then I would feel differently about the margin of safety of buying at todays price ($38.50 or PB = 0.95) all things being equal.

Mark Jr, I appreciate the comments. Regarding the holding period, to clarify, should FFH sell off dramatically, I do not expect the stock to appreciate in 2 to 4 months. Rather, that has been my experience of what has actually happened the past 6 or so years that I have been closely following the company. I would not have a set holding period. Regarding understanding the company, I probably understand FFH better than any other company out there given the years spend following the stock, reading ALL quarterly filings and others opinions and observing management (and learning about competitors) etc. However, my understand would not be close to that of a small business owner of their own operation. Question: when you made the plunge, how much of your net worth was tied up in your company? And for how many years? My guess is it was well over 50% (perhaps closer to 80 or 90%). Is it really all that much different than what I am proposing? Bargainman, great post. Actually, I think a bad catastrophe year would actually work in FFH long term favour. Right now many of their (and ORH) competitors have little 'wiggle room'. Investment losses that past year have cause large write downs and eroded capital. Interest income is anemeic (given low bond yields). Underwriting is OK. Many companies have also in the past year released a disproportionate amount of prior year reserves (in what appears to me) to help underwriting results. Capital markets are still not open for insurers. FFH, on the other hand, has been building excess capital the past two years (ORH alone has $550 million), interest income is very high compared to peers (given tax free munis etc) with OK underwriting. My guess is they have also been very conservative with underwriting losses (given the investment gains they had no reason to dip into prior year reserves to pad earnings). If we have a bad catastrophe year, FFH will survive and we will have the mother of all hard markets. The only question would be how much excess capital they would still have to write new business...

Cardboard, I liked the article. Bottom line, asset values are rapidly declining but total debt outstanding is not. I also expect that FFH has been opportunistic and booked some profits given the size of the move in stocks and bond yields. Broxburnboy, perhaps inflation expectations are playing into yields moving higher. I do not think inflation is a risk and at some point later this year people will start to realize that it will take years to work through this thing and that deflation is the real issue and we will have a repeat of last Nov (lower stocks, lower treasury yields and a higher US$) although perhaps it will not be so severe. gaf63, very good point and makes sense. However, if treasury yields continue to move higher and muni yields continue to move lower (due to tax advantages) I would be surprised if FFH did not sell some muni and shift to treasury. (Although the BRK guarantee got me thinking... should armageddon happen, perhaps BRK is a better counterparty than the federal government?) I also thought about the gang at Hoisington... they may yet prove to be right (US treasury yields will trade lower for an extended period) but the volatility must be gut wrenching!

And the next question on everyones mind is what is going on with US municipals? Check out the chart comparing the 20 year Treasury to Muni yield: www.munibondadvisor.com/market.htm It looks to me that speads were about 300 basis points at their high in November/December. It now appears they are now less then 25 basis points, close to the long term average. Implications for FFH/ORH? 1.) by selling their Treasuries they missed this bloodbath 2.) they have made significant gains on their muni holdings I wonder now that spreads are back to normal if they will now sell the munis to realize the gains and move back into Treasuries? Unbelievable!

Has anyone else noticed the spike in Treasury yields that has been happening since their Dec lows? The 10 and 30 year have now moved more than 100 basis points higher since March 31st and even the 5 year is up 76 basis points. The insurers who sold their 'risky' assets in Q4 and moved to 'safe' US treasuries will be looking at some more material mark to market losses when Q2 closes! I wonder what the yield Why the sharp move? 1.) move to stocks/corp bonds (risk assets) has reduced demand for Treasuries 2.) concerns over fiscal situation in US 3.) less buying from China/other foreign governments??? Date 1 mo 3 mo 6 mo 1 yr 2 yr 3 yr 5 yr 7 yr 10 yr 20 yr 30 yr 12/18/08 0.03 0.00 0.15 0.43 0.68 0.92 1.26 1.59 2.08 2.86 2.53 03/31/09 0.17 0.21 0.43 0.57 0.81 1.15 1.67 2.28 2.71 3.61 3.56 05/26/09 0.13 0.18 0.30 0.50 0.96 1.45 2.30 3.05 3.50 4.42 4.45 05/27/09 0.18 0.17 0.29 0.49 0.96 1.50 2.43 3.22 3.71 4.58 4.59

I continue to think about diversification and what has worked for me in the past and what I want to do moving forward. Lets say that in the current environment, FFH moves to $220 Canadian (at $0.90 to US) = $198 US Given what I know of FFH I would be comfortable putting 50% of my net worth in the company. Are there any small business owners on this site? Is my proposal above any different that a business person who has most of their net worth tied up in a small business? Regarding timing, I am not suggesting a holding period of forever. Rather, may experience has been that within 2 to 4 months the stock appreciates substantially. Yes, there is a chance the company could blow up (earthquake etc)... less than 2% probability Or they deliver between 10 and 20% ROE... most likely... 60% or they underperform with <10% ROE... 25% or they outperform with >20% ... 13% What do others think? Reckless?

Perhaps with all the overleveraged companies with slowing business out there the shorts no longer need to manufacture (short and distort) the bust and therefore are in the process of moving on to easier kills... ;)

Here are some things I found interesting: Southeastern looks to be pretty bullish on outlook for P&C insurers & re-insurers: Partners Fund: added Berkshire "We bought a new position in Berkshire Hathaway. For the first time in our careers the stock fell and remained far enough below intrinsic value for us to buy. The company’s misunderstood derivative contracts created optically messy short-term results. In addition, some of Berkshire’s recent investments have been hotly debated, though it is far too soon to judge their ultimate outcome. The company’s book value (as well as our appraisal) incorporates the market price of Berkshire’s public equity stakes, which we believe are also selling for significant discounts to their intrinsic worth.We therefore are getting a double discount for a company that is financially and competitively advantaged, has a proven record of terrific insurance underwriting, owns a number of great brands in non-insurance businesses, and has two of the world’s best capital allocators at the helm." Small Cap: hold 9% in Fairfax (3 P&C companies =21% of total portfolio) - FFH, Everest Re & Markel "Fairfax, the Fund’s largest holding and best performer in 2008, pulled back 15% in the first quarter, making it the biggest detractor from results. Fairfax declined after reporting somewhat weaker than expected fourth quarter insurance and investment results. The company has never been as strongly capitalized and is well-positioned to benefit from current investment and underwriting opportunities. Volatility in quarterly results is a price worth paying for the superior long-term investment returns that Prem Watsa and his team have delivered to Fairfax shareholders." "The Small-Cap Fund sold for less than 40% of appraised value at quarter-end.We own companies that have staying power through the recession due to their financial and/or business strength. Many will gain advantage over weaker competitors. For example, the capital positions of Fairfax and Everest Re should enable each to attract more policies while other underwriters struggle with weaker balance sheets." International: hold another 9% in Fairfax (3 P&C companies = 24% of total portfolio) - FFH, Nippon Koa & Sompo "Owner-operators KS Li, Florentino Perez, Prem Watsa, Lorenzo Zambrano, and KT Lim have spent their lifetimes creating value by acting intelligently for the long-term while many around them fret over current events.We do not know when the market will turn, but we do know that most of the gains will accrue to those investors with the courage to invest when all others are fleeing."

With the 'black tar' subsidy that US pulp producers are currently getting and the CAN$ close to $0.90US the Canadian pulp producers have to be a little shell shocked. SFK is a great company (as is Canfor Pulp). Goes to show that just because you have a strong business model/good management and are well run that you can't get gorged by a partner or global events... I will be sitting this one out, but believe pulp will be a solid investment at some point in the next 12 to 24 months.

swf, my favourite currently is ORH, which is trading below 0.9 x BV (US$38.55/$43.80). We know ORH is sitting on sizable investment gains and also that their ICICI Lombard stake is undervalued. As well, reinsurance pricing is moving higher (more so than insurance pricing). Looks to me to be lots of safety and also several catalysts to drive share price moving forward. I am waiting for FFH to fall to 0.9 x Q1 BV = US$253 = US$228 = CAN$256 At this price, similar to ORH, we know there is $900 million in mark to market gains (about $30/share) and ICICI Lombard is undervalued. Regarding directly comparing ORH to FFH, yes, it is difficult. Here are a few thoughts (would appreciate others): FFH Strength (versus ORH) - size... more diversified - runoff... further large distributions to parent likely coming this year - investment leverage (I believe FFH has more than ORH) - less dependent on US market/impacted less with dollar weakness (important for CAN investor) ORH Strength - simpler business to understand - reinsurance pricing is firming faster than insurance - possibility that FFH purchases 30% it does not own (likely at 1.2 x BV or higher) A major weakness with ORH is the small float (given FFH 70% ownership). However, as the company continues to grow and the investment community comes to appreciate its business model/management this may not be the issue is was in the past. The fact that it is currently trading at a multiple to BV that is higher than most of its peers tells me it may be getting a little more respect these days...

Here is a great summary article on reinsurance from Aon Benfield (players, size, 2008 results compared)... ORH performance sure stands out. www.aon.com/attachments/ABAFY2008.pdf