twacowfca

Solvency II will dramatically increase capital requirements for European insurance companies by about Q2 of 2011. The most practical way for them to meet these new capital requirements is by buying more reinsurance, a LOT MORE reinsurance. Well capitalized reinsurers may experience a substantial hardening of rates then. This may lead to hardening in primary insurance markets, first in Europe and then worldwide. Time will tell. :)

The question is, do real returns matter? Yes. Very much, according to Ron Muhlenkamp in his book, Harvesting Profits on Wall Street. He makes a strong case that the Fed Model is deeply flawed, and that the strong correlation is between real interest rates and company profits/stock market returns.

Yes, they are, but US taxes are set to increase at the end of the year, especially the dividend tax rate. High income people will sell off assets to pay taxes for the once in a lifetime conversion Of IRA's and 401k's to Roth IRA's. The market will tank when that happens, unless there is a big change in the escalating rates, a change that now looks increasing unlikely.

Dang that's aggressive. Maybe not. The derivatives give a total equity return, not just capital appreciation. The prices were bargains, equivalent to a very low interest loan for a number of years on equity positions that don't have to be repaid and can't be called. The equity positions underlying the derivative aren't very correlated with the market. They actually went up in 2008 and 2009 when the market was generally down. In addition to TFCIX, an additional 16% to20% of the portfolio is sometimes in cash to be available for opportunistic situations that are high probability events. This opportunistic cash went into FFH last year when it sold way below its forward BV, came back into cash when they delisted from the NYSE, went into BRK before its run up prior to S&P 500 admission, came out and stayed in cash through the market correction and then back into BRK as it started its run up prior to Russell 1000 admission. Currently this cash is mostly in BRE, a very high probability take out in my opinion. In summary, it's a "barbell" portfolio, apparently aggressive on one end, but very liquid and conservative on the other. :)

In five weeks, the period of risk for the worst hurricanes will be about half over, but the geographical risk will shift from the western gulf to the Florida and atlantic coast. Cat exposed insurance companies with mostly energy exposure in the western gulf that have not experienced a big windstorm loss will become increasingly fat pitches as the period of greatest risk starts to wind down in the weeks following.

We have a chamelion allocation to near cash of 27% of the net value of our portfolio through Third Avenue Focus Credit fund ( TFCIX ). But we are also net long 140% As a consequence of using very long dated non callable derrivatives with no collateral requirements. TFCIX has been a good investment with about 14% return including distributions since inception last October, and better returns are likely in the future as many funds are beginning to transition to stretch for greater yield as the european bank crisis settles down. In the two market selloffs since their IPO TFCIX's beta was about 1/4 that of the market. Therefore, in the event of a crash, it's likely that TFCIX's value would be relatively unimpaired, and shares could be cashed out immediately at NAV and deployed to pick up bargains that would be available. This likely ability to preserve and deploy capital into equities after a crash is most unusual in any portfolio that is net long in mostly equities. Plus, TFCIX almost certainly will give us a return that's many times the return we would get by actually holding a lot of cash. :)

Sharper, I perceive that you've touched on two or three profound ideas, but I can't quite wrap my arms around them. Can you give two or three examples or illustrations of these concepts and walk me through them?

Not necessarily. In the 1970's BRK sometimes sold way below BV and for an even greater discount to IV, yet WEB didn't buy back shares even though that was the ideal time to repurchase. Why? Because other great companies were selling for even greater discounts to IV!

Thanks for serving up "the whole pizza", Bronco. You're right. WEB didn't buy back any shares then because BRK popped up in price after he made his offer. Contrary to what WEB said, my personal opinion is that the knowledge that some of his biggest fans like Andy were getting margin calls played a large role in his decision to buy back shares. When the offer was made BRK was selling below IV, but not dramatically below IV as was sometimes the case many years ago. Interestingly, WEB actually did buy back BRK shares once when his partnership was being dissolved. :) Five

Good news. Good company. :)

ya never know! or maybe he's just bearing the cross of someones cruel-fiction ;) Does he Grok those strange transactions. :o

You're right about taxes. However, in a world without taxation the benefit is that you get the dividend paid at full intrinsic value. It doesn't matter that the share price drops -- it's supposed to drop after a dividend is paid. I will provide now an example where the dividend adds value: Let's say for example that you want to withdraw 3% annually from your investment account, but everything in your account is trading as a 50 cent dollar. You have nothing trading at intrinsic value. And we're in difficult economic times and this discount exists for years on end. Your account is fully invested. Do you sell shares for 50% below what they're worth? Or let's say instead that you own dividend payers and your yield on your portfolio is at least 3% -- you can just extract the cash from your account at full intrinsic value, without needing to sell anything. So dividends allow you to regularly extract full intrinsic value from your investments like clockwork. A value investor should enjoy that aspect of it. Isn't the whole point to purchase shares below intrinsic value and then realize full intrinsic value from your investments? That's my understanding. Selling shares for intrinsic value is very lumpy and it might never happen as for some companies the fair value at where they should trade could very welll be far below intrinsic value (prices take risk into account) -- when you need cash on a more consistent basis the dividend is the answer. How long might you have been holding onto Fairfax shares waiting for full intrinsic value? I like their dividend -- every January I get full intrinsic value on a portion of my investment. An excellent rationale for paying dividends. Kudos, Eric. :)

I don't think that's his argument at all. Berkowitz, like Buffett, cares about the future earnings power of financial institutions like AIG and C. Tangible common equity and all those other book value measures are only helpful insofar as they tell you whether the bank is undercapitalized and is at risk of being seized by the regulators. The pig is going through the python, and what matters is what remains when everything is digested. I almost barffed when I saw what Bruce bought, but there is kind of a workout logic at play. All the big banks and many other financial institutions have been insolvent at one time or another, kept afloat by the government. With this support, eventually they manage to "earn" their way out of the hole.

Can you help me understand total return swaps? I have assumed that these were synthetic versions of what exists in the options and futures markets, but more bargain priced. How do these work, and why aren't they affected by volatility?

Yeah. New normal as in the mid to late 1930's or in Japan during the last two decades.

i have a few doubts too. smiths lack of detailed disclosure borders on secretiveness. that deserves higher discount factor imo. on the other hand he has a very long track record of strong shareholder returns. looking at the mfcaf long term performance charts shows this beyond a reasonable doubt, even after accounting for the last couple of years when khd got caught swimming naked in a storm, & suffered for it. the charts cut off just short of those last years if i recall, probably figuring that when they were spun out at the end of 06 they had effectively unhitched their wagon. i'm not sure i agree, especially if i were a shareholder who held on to khd in addition to the newly minted mfc. i also think mfc was spun out at a very, VERY stripped down valuation. that put a wind at their back, benefitting subsequent returns. but balancing that would be the spinoffs & other distributions made over many years that apparently arent reflected in their performance record. the story of mfcaf, ttt, khd, & that stranger from a strange land, michael smith, certainly makes for an interesting if challenging case. Oh! So he might be a "Valentine"? :)

The big Russell 2000 hedge was put on at a price that was only about one percent off the current price, well off the market peak a couple of months ago. Looks like they got scared after the big increase in volatility. They likely paid a larger premium then than they would have earlier, considering the increase in volatility at the time they increased the hedge.

You not only get five Brownie Points, but a Gold Star as well! :)

Agreed. A long record is better than a short record, but a medium length record using an A+ process may be a strong indicator of future success. :)

I read the WSJ article. It's great with important details that other accounts didn't have. I've reconsidered my reservations about Li. He is very talented, and he should be a good fit in the BRK culture because he gets along well with Sokol, WEB's likely successor as CEO. :)

You have a point it is extremely busy, and I couldnt find the market cap in very quickly. If it was a Value Line chart, the market cap may have been listed in a small box on the left if the company is large, but if not for a small cap a quick calculation may be necessary.

Exactly! Why look like a dummy if you aren't sure you understand the chart! It appears that Li Lu may be self referential rather than aware of others -- not necessarily a disadvantage for an analyst, but for WEB II ?? Also. It was a very brave thing that he did at Tianamin Square, but is it wise to have a revolutionary type in a major leadership role in a stable company?

The Achilles Heel of many value investors is making buying decisions with reference to a fixed ratio such as 60% of perceived IV. This method may work OK in normal markets and with most stock purchases, but it's not the method we have used with greatest success for buying stocks that become home runs. These big gainers were all bought at fire sale prices because we became aware of forces that might drive their prices to very low levels. We waited until it seemed that these forces were playing out before making a big buy of the stock. Occasionally, we missed a few that took off before we thought they would find the bottom, but our cautiousness has paid off amazingly well with a few big winners. Doe's anyone have examples of using this cautious method successfully?

Once upon a time, Buffett did do a Berkshire buyback. Five Brownie points to the first person who can describe the buyback. :)

The example is extreme, but the point is still valid. In the real world , I can only recall one example where a company was able to buy back the great majority of its shares for a price that was less than IV without moving the share price. This was when Jay Pritzker bought back all the minority shares in The co that owned the cocoa beans using payment in kind. WEB and BG made a nice profit on that deal, but Pritzker made out like a bandit. Simply by holding on to his shares, he wound up owning shares in that co that were worth many times the price per share that the stock traded for before that astonishing operation. If a company,like Lancashire for example, buys back 25% of its shares over three years,paying less than BV and far less than IV, this will add more value per share than if the same amount of money had been paid out in dividends. :)