twacowfca

Sanjeev, my day job is direct marketing publishing. One simple change should increase donations by one degree of magnitude if not two. Simply make it easy for board members to donate by putting a large click on button right above the general category box and another button above the info box. Be sure to use short directive language with each button such as: YES! I want to do my part to contribute to the expense of maintaining my favorite investing forum, The Corner of Berkshire and Fairfax Message Board. Please accept my donation. After you do this, I'll help you improve the options on the donation screen. Thank you for all you do, Sanjeev. :)

Yes. Welcome indeed! You should be a very informative contributor if even a small number of your subsequent posts are as good as your first. Sanjay Bakshi's writings simplify profound value investing concepts, the mark of a good teacher.

I couldn't agree more. That's why, the only leveraged companies I am interested in are insurance companies. As a rule of thumb, I look for insurance companies with management whose skills are above average, and with underwriting and investment leverage that are below average. That makes me sleep soundly at night. I am not a full time money manager. I run businesses. And I invest in companies that I like, as if their operations became my firm’s operations too. The only difference is that I don’t manage them personally. I don’t jump from one undervalued stock to the other. So, I have never thought hard enough about how good an investment in overleveraged companies at ridiculously low prices might turn out to be. I just don’t want the operations of overleveraged companies to be part of my firm’s operations. Therefore, I don’t look at them. At the portfolio level I agree with MrB. I don’t lever my firm’s portfolio. Right now I cannot remember exactly who was it, but someone once said: “A good investment is just that, leverage doesn’t make it any better or worse.” Probably, he used slightly different words, but I think the meaning is clear. Packer, thank you for the suggestion: I haven’t read that book yet, but I will buy it right away! giofranchi Mr. B put it very well. One should look through the company to the risk characteristics of the industry, the country and the economic sphere. If one added up all the leverage on the BS 's of the banks BRK owned, the conclusion would be that BRK's leverage is more than double what it appears to be. However, that leverage is non recourse to BRK, and the banks it owns are mostly the very best large banks in a country where the government is a credible backstop. We share your attraction to insurance companies. A number of US insurance companies experienced a gain of more than 100 times in their market prices from the 1930's through the early 1970's as interest rates slowly rose. Banks that survived the depression did OK, but not spectacularly. Most of our assets since 2005 have been invested in various proportions of three owner operated P&C insurance companies that have done very well through the financial turmoil with far less volatility than banks.

Write a put on something you wouldn't mind owning at the strike price of the put. :) However, you will probably have to have collateral set aside for your counterparty in the event the put is exercised. The best way to lever up with non recourse leverage is to buy a long dated call or warrant at an attractive price as measured by implied volatility in a time of low interest rates on a stock that you think is a good value. Then, you have the leverage of a margin loan that is non recourse beyond the price you paid for the LEAP or warrant. :)

There is good leverage (long term, non recourse, no covenants) and not so good leverage. The leverage on BRK's BS is about as good as it gets: float at zero cost or less. No need to pay it back for the most part. An interest free loan if their underwriting is good. Compare that to a company that had a large amount of conventional debt with interest and principal to pay and covenants whereby the lender could increase the interest rate or call the loan if something deteriorates.

That view of local conditions reminds me of a conversation with a friend of a friend that happended in 2007. He was from mainland China, and he had a Ph.D from a US Univ. He had a green card to work in the US as a permanent resident. I asked him about investing in China, and he looked at me as if I were crazy. Then he told me this story: He was five years old when The Great Proletarian Cultural Revolution was proclaimed in the 1970's. His parents were expelled from the city to the countryside because they were educated. Somehow they survived by eating garbage and doing work that was at the lowest level of society. Three years ago, he went back to China and brought back a bride he had never met. They have two lovely children, and they appreciate the security of living in the US. Every penny of their considerable savings stays in the US.

Ed Thorp was one of the first to model that type of long/short strategy in a systematic way. It produced returns of about 20% per annum during the first 10 years he used it, but only about 6% per annum when he gave it up to the increased competition about a decade ago. twacowfca, I am not saying that I will never remove my hedges! I am just saying that, in an environment that made Leucadia’s managers state “opportunities meeting our investment criteria are few and far between”, I am not comfortable being greedy, and I am satisfied to get a 6% per annum return as the spread between my long ideas and the hedges I put in place. If and when valuations improve, I will surely remove all my hedges and I will be fully invested, employing a long only value based strategy. Anyway, it is clear by now that all of you disagree with me. So, probably, it is true that there is some weakness in my temperament… just like PlanMaestro suggested at the beginning… He stated: “The only thing to conclude is that that investor doesn't have the temperament for the game and he would be better off buying an index fund and forgetting about it.” …Hey! Wait… Buy an index fund?! I would never do that!! Actually I am shorting indices right now!! Ahahahahahahah!! I am utterly hopeless… :( giofranchi I don't disagree with you. I like your posts. The point is that variations on old hedge fund strategies, even with extra bells and whistles are now producing mediocre returns. We are all subject to the "no place to hide" milieu of inflated nominal values as a result of central bank operations. You have some ideas that are the best of the bad lot available. BRK and FFH are the most defensive. BRK has decent upside if asset prices continue to rise, plus the amazing, but not absolute, protection of the Buffett Put. FFH offers the best opportunity to profit in a steep deflationary sell off. Other selective insurance companies with short duration assets will Profit greatly when monetary inflation finally breaks out into price inflation. Certain commodity cos will also benefit then. :)

Cardboard, I don’t like the fund of funds idea either. It is not that I judge unfair to pay someone who lets other people do all the hard work… I believe in paying for performance, not in paying for number of hours worked. If someone could identify the 5 fund managers, who will have the best track record for the next 10 years, I will pay gladly for his services! Instead, I don’t like the fund of funds idea, because I don’t like the mutual/hedge-fund industry. It has got a fundamental flaw that systematically leads to both unpredictability and underperformance. In the words of Mr. Ackman: “The principal weakness we share with most other money managers is the fact that our capital base is not permanent, and we therefore keep cash on hand and/or own passive liquid investments which we can sell to meet potential investor demands for capital. To address this weakness in our open end hedge fund structure, later this year, we intend to launch the private phase of Pershing Square Holdings, Ltd., which we expect to eventually list on the London Stock Exchange.” I didn’t invest in Pershing Square the hedge-fund, but I will be happy to invest in Pershing Square Holdings Ltd. at an attractive price. Paraphrasing Mr. Buffett, investing is really the best business, and I always like to quote Mr. Munger: “I don’t think General Motor should have wiped out the shareholders. That was a huge failure of management. If you think about it, Berkshire is a collection of failed businesses, that are gone. And here it is, this wonderful thriving place! As our businesses failed, our shareholders did not fail. We adapted. We took the money out of the failing businesses and bought other businesses. General Motors did not pass that test. They destroyed their shareholders…” You could show me a 100 pages report on the future of Apple, and give me all the right reasons why it won’t end up like General Motor one day, and you will anyway fail to convince me… Instead, I am convinced that a Berkshire Hathaway, led by Mr. Buffett and Mr. Munger, will never fail. Of course, you need to know and bet on the jockey… but he or she doesn’t really have to be a genius! Take, for instance, the Tisch family of Loews Corp.: arguably, they have never been as successful as the Mr. Buffett and Mr. Munger pair, but they achieved a 15% CAGR in stock price for 50 years nonetheless! That’s 1000 times their original capital: an astonishing creation of wealth! Or take Tom Gayner of Markel Corp.: he almost only invests in blue-chip stock at fair prices, anyone with a Morningstar account could do that! Well, Markel Corp. has achieved a 17% CAGR in book value per share for the last 20 years. Not bad at all! Add, on top of all this, the benefit of float, and I think it is easy to understand why I like FFH and GLRE so much! Now, to your question about my “macro worries”: while I undoubtedly could stomach a 30%-40% decline in stock prices, I’d lie, if I say that it would be easy. Certainly, it would be much easier with a lot of cash at hand to scoop up bargains! Furthermore, despite the fact that I am my firm’s largest shareholder, I am not the only shareholder. And I am not so sure that my partners would be so calm and cool headed as to think about the long run, while drowning in a storm… If I am forced to cut or even suspend the dividend, because of a 30%-40% decline in equity, I will have to answer unpleasant questions! More: we are still relatively young (got incorporated in 2004 and started doing business in 2005), and our business model is still unproven – I try to squeeze as much free cash as I can out of engineering consulting operations, that need almost no maintenance and growth capital, while redeploying all that cash in “Berkshire Hathaway kind of businesses” at fair prices – So, it is also a matter of confidence: I am willing to leave some fiches on the table now, to safeguard confidence, should something go wrong. Finally, my firm operates in Italy, and the business environment in Italy right now is dire. Even more so in the civil and infrastructure sector! Engineering operations will surely suffer and won’t generate as much cash as they did in the past… at least for a while. To put a 30%-40% decline in equity on top of that, would be really imprudent of me! giofranchi Actually, GM did take money out of their declining business and buy other businesses that were then spun off. Perot Systems lives on now as part of Dell. Hughes Aerospace is now Direct TV. Allstate and Discover Financial Services that were birthed by Sears are now worth much more than their surviving parent SHLD Kodak lives on as Eastman Chemical. These companies did not reinvent themselves as well or as extensively as BRK, however. BRK is not wedded to any legacy business going forward. Its corporate culture mainly resides with its BOD, Warren, Charlie and three managers in their home office, plus numerous shareholders tutored by Warren. :)

Ed Thorp was one of the first to model that type of long/short strategy in a systematic way. It produced returns of about 20% per annum during the first 10 years he used it, but only about 6% per annum when he gave it up to the increased competition about a decade ago.

And George Soros lost a huge chunk of all the money he had ever made by being about a year early shorting the internet bubble stocks.

You could be describing the original Ponzi Scheme with supposedly discounted international postal franks. Ponzi said he had a way to repeatedly monetize those illiquid, discounted assets. Of course, your description would also cover any number of other Ponzi schemes, whether based on currency controls or funny money or whatever. Is there a fatal flaw in your idea?

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. I seem to recall Buffet himself saying that about 7% of the 20% annual returns came from float. I've looked for the quote but can't seem to find it. It would be interesting if someone went back through his stock purchases and calculated the returns without leverage. if my recollection about the 7% is correct, then he averaged about 13% since taking over Berkshire. It's not just the float, but the opportunistic way he used it. He shifted almost all of his float into stocks in 1973 1974 when the companies he bought were priced by Mr. Market at less than one third what a private buyer would have paid for them. Two or three years later, the gains from that float, in a sense, allowed him to help recapitalize Geico, an investment that compounded more than 30%/annum.

I got a chuckle out of some of the superficial aspects of the paper. For example, the authors point out that the volatility of Warren's returns is higher than the market's volatility. However, most of BRK's vol is up vol! :). And a large part of his down volatility occurred when he sat out the Internet Bubble! BRK's low point in 2000 occurred almost exactly to the day when the Nasdaq peaked. Ziemba has modified the Sharpe ratio to eliminate its bias toward a normal distribution for volatility. With that modification, the extra vol in BRK's returns disappears! In fact, Warren has had one of the lowest volatilities of fund managers who have shown consistent alpha if vol is measured by Ziemba's modification of the Sharpe ratio to eliminate the distortion of up volatility. :)

Yup, this was the interview. Something to the effect, these women have big lungs, and so they have big chests and can dive for long periods to put a grain of sand in the oyster. Cheers! Interestingly, the women have big lungs because they dive for pearls not vice versa. In the beginning the men dove for pearls and the women helped. Then it was discovered that the women had greater capacity to tolerate the cold water because of their extra body fat, so the roles reversed. In the early days the women dove pretty much au naturel in the Japanese fashion. :)

I agree. Due to the high short interest and difficulty to borrow, the premiums on put options were through the roof. We were selling put options for huge premiums (I think we were getting more than $6 for the $60 puts, but I can't find my spreedsheet), and reinvested about half the proceeds into call options. I don't recall having a lot of confidence that the calls ($130-$160 strike) would pay off, but thought it was worth the gamble due to the huge short interest (equal to the float at 4.2 million shares) and improving situation at the company. I think we sold most of our calls for a 10-20X gain, but really didn't plan on such a windfall. (I also was proudly wearing my tinfoil hat at the time and believed that SEC enforcement of Reg SHO could cause a massive short squeeze. We had all of our shares in certificate form at the time so they couldn't be borrowed). I think there was some luck involved in these huge gains that many on this board shared in (and yes, I also have this board to thank for getting comfortable with the investment although I was just lurking on the old MSM board at the time) due to the fact that there were no hurricanes that year. At the time it seemed like there would be hurricanes, although now it seems obvious that there wouldn't be. This investment seems like a no-brainer now, but at the time there had been a lot of negative surprises in the recent past. I think selling the puts was really the great opportunity there - free money under almost any circumstance. Buying the calls was more fortuitous than anything for me and I would have never done it if I wasn't selling the puts along with buying stock. I have been looking for a similar investment opportunity ever since, as I'm sure many on this board have been. I think the basic situation is best described as: 1) a large short interest where the shorts fundamentally don't understand the company (i.e. the shorts legitamately thought FFH was cooking the books and was insolvent) 2) an actual dramatic improvement in fundamentals, but just as importantly in transparency. They stabilized run-off, cancelled the finite re-insurance contract with Swiss Re, restated past financials and got a clean bill of health from the auditors (not that they needed it), shored up the balance sheet by selling their Asian equities (in a very timely sale!), lowered re-insurance recoverable (and hedged the rest in the genesis of the huge CDS trade) I have a company in mind currently that I think satisfies both conditions, but would love to hear of other companies that board members think fit this bill. I think a company like RIMM probably satisfies the first condition, but not the second. Thank you for your account. Would appreciate info about the company that satisfies both conditions. Thank you.

Yup. We're about 140% long notionally (non recourse), but have a lot of what I think is a close to but better than cash equivalent: BRK because of the Buffett Put. Interestingly, Benjamin Graham was over 200% leveraged in 1929 when the market crashed, but lost only exactly 70% of his fund's value, less distributions, by the time the market hit bottom in 1932, thanks to all the ways he arbitraged and hedged, compared to the market's losing 87% of its value. It's a myth that he was wiped out, although a modest but very important investment by Jerry Newman's father in law at the market bottom was a huge relief. He never went to cash. By 1935, he was back up to his high water mark. :) Where can one learn how to do that ? :) Graham was the first to develop pair trades, long/short strategy, convertible bond arbitrage with rudimentary delta hedging and behind the scenes activism to release value for shareholders that had been hoarded by corporate managers for their own benefit. These strategies are still mainstays of hedge funds and the trading operations of banks, but the spreads are small, compared to what they were in Graham's day. :) I've been thinking about this for some times. With a long short strategy where you short one stock in the industry and buy another. I know the market i relative more efficient now a days but i always have the problem when thinking about this idea of long short since my bet depends on market inefficiency and this tools depends on eventual market inefficiency. what happens when the inefficiency continues or get worse ? for example What happens if the market become inefficient and the one you short increase in price materially ? (given your research is not wrong) Also are there case studies i can read ? How did you learn those tools by photosynthesis :D, from your apprenticeship with experienced investors or trial and error? Hedge Fund Market Wizards by Jack Schwager and his two earlier Wizard Books are a good overview of successful trading strategies. :) One reason Graham wasn't wiped out was that his arbitrage trades tended to converge even when the market was in a panic with a flight to safety. For example, he would typically be long a convertible bond and short the related stock. In the panic, the stock would lose most of it's value, but the bond would typically retain most of its value because Graham was usually very conservative in his selections of sound companies for investments.

Yup. We're about 140% long notionally (non recourse), but have a lot of what I think is a close to but better than cash equivalent: BRK because of the Buffett Put. Interestingly, Benjamin Graham was over 200% leveraged in 1929 when the market crashed, but lost only exactly 70% of his fund's value by the time the market hit bottom in 1932, thanks to all the ways he arbitraged and hedged, compared to the market's losing 87% of its value. He never went to cash. By 1935, he was back up to his high water mark. :) Where can one learn how to do that ? :) Graham was the first to develop pair trades, long/short strategy, convertible bond arbitrage and behind the scenes activism to release value for shareholders that had been hoarded by corporate managers for their own benefit. These strategies are still mainstays of hedge funds and the trading operations of banks, but the spreads are small, compared to what they were in Graham's day. :)

Yup. We're about 140% long notionally (non recourse), but have a lot of what I think is a close to but better than cash equivalent: BRK because of the Buffett Put. Interestingly, Benjamin Graham was over 200% leveraged in 1929 when the market crashed, but lost only exactly 70% of his fund's value by the time the market hit bottom in 1932, thanks to all the ways he arbitraged and hedged, compared to the market's losing 87% of its value. He never went to cash. By 1935, he was back up to his high water mark. :)

There have been four times when we have gone all in to a seemingly risky situation with more than 50% of our assets invested in one company. One was in a bankruptcy when a plan of reorganization had been confirmed. The other three were companies like FFH where an ethical, respected CEO or dominant shareholder had most of his personal assets invested in the company or a huge chunk of stock. These companies also had other major investors or important friends who stood with them and helped them through their difficulties. Having a group of respected investors who are willing and able to help a CEO when times are tough is a powerful predictor of success for a business with good economics and potentially solvable problems.

It was a bit like poker. Still is. I always thought the analogy to poker in terms of ability to card count. Now, I see it more like the Kenny Rogers song - The Gambler. Your reference to card counting is spot on. It's a lot more about game theory than mechanical computation of odds. I know an old time blackjack card counter who got a galley proof of Beat the Dealer before it was published,dropped out of school and started playing in casinos before 99% of pit bosses knew about card counters. This guy can count every card in a six deck shoe, not just the aces and tens, but he says counting ability is merely a small part off the success formula. It's much more important to know the opposition and what they can do to you such as cheating and to pick targets when the deck won't be stacked against you and disguise your play.

You are right. The short sellers were key to how well this worked out. The short interest was huge. They were financing their short sales of the stock by selling FFH calls. Consequently, the price of the calls had become dirt cheap, while puts were very expensive. Our strategy in buying FFH calls was the inverse of Ericopoly's. We tippytoed into the position, and then increased position size enormously as favorable developments worked out. We quadrupled the position as the hurricane season was petering out and the SEC investigation fizzled out. As the stock price rose, I sniffed a short squeeze when one of the short sellers' ''investigators' was charged with fabrication of evidence. We piled on and increased our investment in calls many times, by purchasing leaps because things very likely would continue to get even worse for the short sellers. I was reminded of a scene I had witnessed years before when a professional poker player had cleaned out an unfortunate sucker by bluffing and intimidation. But this time the pros (the short sellers) held the suckers hand. I realized their weakness, and we bought even more calls when the shorts began to cover as indicated by the increase in implied volatility of the FFH calls. The implied volatility of the calls finally went down as the price of the stock approached $200/sh. The amount we were receiving to lend our FFH shares to the short sellers dropped into the low single digit percentages. That was the first time in two years that we were getting less than a double digit percentage rate to lend our shares. This indicated that the shorts were no longer paying a big premium to short the stock or buy back the calls they had sold cheaply. It was time to take profits as the short squeeze was apparently over. We didn't take most of our profits until FFH passed $185.00 In price, holding some of the leaps for even greater gains a few months later. It was a huge coup, between 8 to 30 times what we paid for the calls, depending on our entry points. :)

The term referenced is probably float rather than flow. Float is customer premiums held by an insurance company that doesn't yet belong to the insurance company or will eventually have to be paid to the policy holder or expensed. Technically float =loss reserves + unearned premium reserves - (AR +RR +DAC) the advantage of having float is that the money can be invested by the insurance company until it has to be paid out.

The whole stock market and other financial markets are apparently becoming increasingly more efficient. Spreads are narrowing, and it is becoming hard to find bargains as information assymetry is reduced, especially through the internet. However part of this apparent increased efficiency is an illusion. In a parallel universe, so to speak, the tendency for markets to break down suddenly in a pattern called kurtosis that produces fat tails may be increasing.

FFH had massive adverse development of reserves resulting from buying insurance companies with increasingly toxic long tail liabilities plus big losses from hurricanes the year before. Plus an investigation by the SEC as part of a wider probe involving BRK and AIG. This led to the coordinated short attack much discussed on this board. What we did was look through all this negativity to the future. Here were the facts that contradicted the short thesis. 1) they were starting to see the light at the end of the tunnel with less adverse development on legacy reserves, and the current business they were writing was becoming profitable. 2) the current hurricane season was shaping up to be a zero in August Sept when we started buying the FFH calls. This indicated large profits in the near future instead of the large losses they experienced the year before. 3) the SEC investigation appeared to be an aftrethought of the BRK AIG fraud where the government felt obliged to check out the rumors planted by the short sellers of FFH. Nothing had come of it after more than a year, and nothing substantial appeared likely to impact their reputation. 4) Their Far East business was doing great. 5) Short interest was large. We had been getting 12% per annum for more than a year to lend our FHH shares. In a sense, we were getting a huge dividend on FFH shares that didn't come out of FFH's capital! 6) Most importantly, Prem's history and reputation until the lies put out by the short sellers had been exemplary. He and FFH were supported by ethical, respected value managers like Steven Markel, Peter Cundill and Mason Hawkins who demonstrated their faith in FFH by injecting new capital on fair terms when badly needed. I had had the opportunity to converse informally with Prem early one morning for two hours in 2003 as I pitched in with him and a few others from his office to unpack FFH annual reports and set up for a meeting. There was no doubt in my mind after that talk that Prem is a straight shooter without pretense. In short, the clouds were parting in the late summer of 2006, and the future looked bright. :)

Examination of shadows in the foreground vs background in one of the 'photos' suggests that it is faked.