jfan

FAH seems to be trading quite below reasonable cash and cash equivalent values with no fund level debt. At this stage, what are the risks associated with investing at this point in time? Here is a short list that I can see: a) Sudden increasing inflation in the countries they are in b) Default risk of their underlying loans and bonds especially with CIL c) Poor future capital allocation of cash and cash equivalents d) For us Canadians, US-Canadian exchange rates e) Falling interest rates causing it to not be able to cover fund expenses Anything else?

But at what point in price (given that the market price has dropped as low as $230 USD/share recently) that FFH becomes attractive despite issues with Prem, capital constraints, and a portfolio of turnaround equity choices? At $230, they wouldn't have to achieve more than a 98% CR and 3-4% Pre-tax Investment return by my estimates.

For those interested, here is a very detailed history of pandemic influenza (of which there are 4; 3 which are described here) and a comparative experience between Italy and South Korea https://www.ncbi.nlm.nih.gov/books/NBK22148/#a2000c209ddd00098 https://medium.com/@andreasbackhausab/coronavirus-why-its-so-deadly-in-italy-c4200a15a7bf Interestingly, the UK has decided on a different strategy that I thought initially to be crazy but perhaps there is an element of validity to it. https://www.theatlantic.com/health/archive/2020/03/coronavirus-pandemic-herd-immunity-uk-boris-johnson/608065/ Prior pandemics suggest the following things occur: 1) Usually more than one wave of spread 2) novel viruses have a relatively higher mortality and morbidity for the younger population relative to themselves, but relative to the older population, the elderly person risk is much higher 3) individual immunity can develop if exposed, but the duration of effectiveness can be variable from one year to many 4) viral mutation over time can be influenced by health policy behaviors (interestingly, virulence goes down over time as less virulent strains are selected if less affected people are allowed to infect others UNLESS more virulent strains are aggregated together eg in hospitals and they escape into the public) 5) social distancing and isolation have been tried in the past with variable effectiveness (modelling suggests months to one year of social distancing may be required that would cause massive socio-economic havoc) 6) there is considerable variability of mortality between geographies and time of outbreak (1st vs 2nd waves). I am not an expert in this matter but I wonder the following especially in a resource constrained environment with limited government ability to enforce social distancing and population movement in context of COVID-19: a) instead of broad social distancing, focus this intervention on the vulnerable population (elderly, immunocompromised) to allow a natural process of selecting out less virulent strains to survive by allowing the asymptomatic or mildly symptomatic to carry on as usual with the potential benefit of developing individual and population immunity to reduce the impact of future waves b) intense testing of asymptomatic health care workers and those that support the elderly to keep them protected until a vaccine can be developed which in this case to be deployed to middle-aged and young elderly first to maximize years-of-life saved c) random population testing to monitor strain variability It will be very interesting to see what happens to this pandemic over time between countries have be successful in the 1st wave containment (Singapore, China, Korea) vs those who were not (Iran, Italy).

For 1), statutory surplus is determined by state regulators who typically use a risk-based capital framework (similar to banks) to reduce the value of certain elements (and increase the margin of safety for the policyholder) of the balance sheet, as reported. The discounts vary and depend on the perceived level of risk. FWIW, I've been looking at a few insurers who carry a heavy load of BBB rated corporate bonds (not the case for FFH). An interesting feature is that, in the event of a recession, on top of the decrease in market value for the bonds, surplus capital gets a double whammy because the discount factor is higher for downgraded securities. For 2), your statistical appreciation of forward returns is interesting and is in line with the idea of reversion to the mean, which has been a significant long-term feature at Fairfax (investment strategy, seven lean years analogy etc) but I wonder if such an approach is satisfactory on a forward basis as the investing environment has changed and the Fairfax investment recipe has been changing (some aspects dramatically so) so the future may not be correlated to the past. I think I read you're an MD and the following statistical "joke" came to mind when reading your post. There's this surgeon who comes to the patient waiting to be rolled in and explains that the death risk with the procedure is 1 in 2 but that the patient should not worry because the previous patient did not make it. Thanks For the detailed response. You are absolutely right if the underlying people, processes, and investing environmental context change then the underlying distribution will change and the mean reversion effect may not happen. I love the joke, as most physicians have no or little statistical training/understanding despite three decades of evidence based medicine. I guess the meta question is “has hamblin watsa adapted to the environment and learned from its mistakes. Is their devil’S advocacy before investment commitment as a effective as they think it is?” That the distribution of investment outcomes is something other than 60-40 for 7%? With so many interacting variables involving a biological system, I guess this question may be impossible to estimate with any precision. We know their value principles but how about their learning and leadership principles. Certainly it appears there are a number of individuals that no longer think they have the adaptability moving forward to make decent investment returns. But everything has its price in the market and there is an argument that the past is a sunk cost and all that matters is future behaviour. Ps You might enjoy this randomized control trial from the British journal of medicine https://www.bmj.com/content/363/bmj.k5094

Is this the case where you practive? If so how well did the area handle H1N1 in 2008? I was still studying at the time so I was a bit sheltered from the H1N1 outbreak, so it is hard for me to comment. However, this is the current situation that I work in everyday with worsening year by year. The Canadian hospital system is stretched beyond all imagination on the best of days. Here is a twitter feed from Italy Obviously, I'm not an expert in calculating GNP, but I don't think the loss of productivity will be as dramatic as -7%. The chances are the working age group will have mild symptoms but be able to recover and return to work (if workplaces allow them). But the working age group could contribute to protecting your healthcare resources by not exposing yourself to the elderly, wear a surgical mask if mildly ill (it won't protect you, but it will protect others from you), don't go to your local hospital for very minor coughs, sore throats and runny noses, and hopefully your employers won't need a doctor's work note to explain your absent if you are away ill.

Just a simple question: 1) When determining the statutory surplus, is it almost equivalent to Common shareholder's equity + preferred shares + minority interest? Just a simple observation: Referring to their annual report's total return on investment portfolio footnote, it appears that they under-perform their 7% investment return hurdle rate 39% of the time over the past 33 years. If that is true, that means under-performing 5 years in a row, would put it at less than a 1% probability.

The problem with COVID-19 is not the absolute number of deaths but the possibility of # of visits to the hospital by elderly patients and those with comorbidities that require hospital admissions or care. If you are fortunate to live in an area with abundant hospital resources than you have the slack to absorb this potential influx. If you are unfortunate, then there will be significant stress on the system. The place I practice, on a regular basis has 30-50 patients admitted to the ER with no in-patient beds. The hallways are always littered with patients. The hospital functions at >98-110% capacity (>90% equates to severe overcrowding with exponential downstream effects). The impact will not only be taking care of these COVID ill patients, but the displacement of resources from all others in the community ill with other illness such as myocardial disease, strokes, renal dysfunction. Furthermore, as healthcare workers get ill, and are isolated from work, who will be left to manage the departments for more patients? During SARS, healthcare workers would work then be off for 2 weeks due to exposure, then to repeat the cycle. The end-goal of vigorous testing is to quarantine and delay the spread, protect the elderly, and buy time for the hospital system to not buckle under pressure. Certainly, there is no proof that this thing will die out in the summer months. We are lucky that SARS and MERS had such a high mortality rate, so the infected can not spread it very far. The problem with COVID-19 is it allows healthy individuals to spread it widely because it doesn't make them very sick.

Having connections within the healthcare industry in Ontario, hospitals will be moving to test all travelers that return outside of Canada with fever or respiratory symptoms for COVID-19 within the upcoming week. The mortality rate rises after the age of 50 years old with increasing rates with age. The recommendation is for self isolation for 2 weeks at home in a separate room from other family members. Its spread is primarily through droplet and a safe distance is about 10 feet. The acute stress will be primarily at the hospital levels to accommodate the potential influx of people that get sick and require hospitalization for support and figuring out how to test the sheer number of people in an efficient manner. There certainly will be a huge impact on work productivity especially if the number of people get sick and require isolation. There is some rumor to suggest that the virus is heat labile which will hopeful limit the effect with seasonal change.

In this low interest rate environment, their 3:1 insurance leverage, would it make sense for them to consider alternative investments with fixed income qualities (eg infrastructure plays and other real assets)? It would be amusing to see them use Brookfield's private funds to achieve better returns. But will it be too much for their egos?

What are the odds you are offering?

Thanks Omagh for your comments. Much appreciated and very helpful. I just want to paraphrase so that I truly understand. So it seems that premium/discount on book value for an insurance company is quite dependent on the current liquidation value + estimated book value growth. In turn, the book value growth is dependent on float growth from net premiums written annually and underwriting discipline as well as the return on the investment portfolio. So with the current interest environment, and ASSUMING they can mean revert back to historical 10.9% common stock return, their total return on equity/minority interest would be 8.5% (including common dividends), meaning that they would be deserving to have a valuation around 1x book. Given that their book value CAGR over the past 10 years, has only been 4.5%, this suggests that the market is already giving them the benefit of the doubt despite their recent underperformance. However, for those that are optimistic about FFH's future, they would be counting on the following optionalities to be recognized: 1) a hard insurance market with the chance to increase float size 2) continued success in FAH and FIH to help generate fees and increase in market value from revaluation and/or book value growth 3) repurchasing of common shares (which is a bit nullified by their options issuance) at a fair price 4) re-evaluating the effectiveness of their current deep value/turnaround investment philosophy and portfolio sizing To the last point, FFH is very different than BAM which also invests in turn-arounds. It seems to me that FFH has much less operational expertise to turnaround businesses unlike BAM. Given this limitation, it appears to me that strategically it makes more sense to move up the quality chain (especially given the float size) or consider much smaller position sizes with more rapid turnover to minimize the sunk cost fallacy and future opportunity costs. It also appears to me, that their aversion to technology and growth companies should also be re-examined since all investing is a probabilistic exercise (even in deep value situations) anyways. Would this be a fair assessment of their future?

There was a wonderful podcast with David Zervos on the Sherman Show (Doubleline Capital). At the 22:00 minute mark, he explains that the deflationary forces in the US are secondary to demographics. Decreasing labor force growth reduces demand for goods coupled with technological progress creates this persistent milieu. That being said, Torsten Slok (also on the Sherman Show) believes there is a bifurcated process. Goods are facing deflationary forces but local services that not fungible (eg health care) are experiencing inflation.

I've attached an updated FFH valuation model spreadsheet for everyone. I've included some historical data, estimated yield on their bond portfolio, estimated current investment portfolio yield, as well as their geometric total return portfolio (historically). I assumed a 2% GDP related growth of the float. I realize everything here is a rough approximation and most likely everyone here will have a more precise model. For what I gather, there are a few interesting points (at least to me): 1) The current investment portfolio likely will hover around the range of 4.5% given its cash, bond, stock composition. To get their investment returns to 7% will require a common stock return of >20% to achieve this level or much higher interest rates. 2) It seems they have been quite dependent on growing their share of profits/losses from their equity accounted investments over time (especially their non-insurance side, Fairfax AFrica and India fall here as well) to make up for their portfolio returns. This portion has been growing 33% yearly over the past 10 years. 3) Also getting to a 95% Combined ratio is likely a stretch as well. Their 11 year average CR is about 98.6%. FFH_Valuation_Model.xlsx

Given that Fairfax and Hamblin Watsa is quite dependent on human capital. Perhaps the perspective of share dilution could be viewed as growth/succession cap ex to allow the company to continue operating into the future. Furthermore, since Prem is the largest shareholder, any share dilution is also dilution of his proportion as well. Certainly, long-dated options can have the possibility of incentive malalignment. What long-term incentive structure could fairfax put in place to help transition to the next generation and align them with the common shareholder?

The 2/3 discount on the investment income was just a margin of safety that was imposed in order to be conservative. I recognize that it will be quite difficult to forecast their future investment returns as it will be dependent on the skill of the team, market sentiment changes to revalue their stock picks, the weighted average interest rate changes, global macroeconomic Dynamics, ever changing capital shifts in their portfolio, etc. I just reasoned that given the uncertainty and the complexity of all the variables, trying to predict a precise estimate would be fool's game and that the central tendency would be the most least error prone value.

Hey everyone, Fairfax is a pretty complex beast to value with all its moving parts but thought I would give it an amateurish attempt. Just wondering if all you nice people on this board won't be opposed to provide me with some criticism and feedback to my simple dcf model. Thanks for your time. Jerome FFH_simple_DCF_model.docx

Thanks Sanjeev for the clarification. That was helpful. I will try to pose these questions at the Annual Meeting. 1) Could you describe how HWIC currently organizes the responsibilities for making investment decisions with respect to the larger portion of the investment portfolio? 2) Could you describe the process by which the investment committee develops expected values and updates investment theses over time as new information arises? 3) Could you describe how the investment committee learns to improve its investment decision processes over time? 4) How does the investment committee ensure that a diversity of opinions about a decision is heard before committing capital? Yes, most of their investments seem to have a complex thesis (Greek banks, BlackBerry), or are just based on cheapness (Stelco, RFP), while Buffet is jumping 1 foot hurdles like US banks, Apple etc. Note that even when WEB is wrong like he was with IBM, he came out with minor scratches so to speak and didn’t really lose much money. FFH has great companies in their backdoor like Enbridge (which i own) or Canadian banks, or even well managed energy companies like Suncor or CNQ. I feel somehow, they got lost in the search for complexity when it really doesn’t seem necessary. It does seem that FFH prefers the deep value coupled with friendly activism as most of the investments detailed in the 2019 AR follow this pattern. I guess their goal really is to ensure that they get a minimum 7-8% TOTAL return on their investment portfolio, not what most typical OPMI are hoping for (15% CAGR over time in their personal portfolio). I guess this is why they feel comfortable with concentrating their investments as opposed to the conventional thought where these deep value plays by OPMI are not to make up more than 2-4% of their portfolio. So this might explain why they tend to either hit it out of the park on their investments (Quess) or suffer significant opportunity costs over time (Resolute, Blackberry - that being said, people will always need tissue and toilet paper and with autonomous vehicles in the horizon, data security will be a crucial component.) If the investment team dynamic remains the same, and the cultural preference for these investment types is consistent. Their reliance on mean reversion in their individual investments will likely play out in their overall portfolio as well (unless my mathematically understanding is flawed). Therefore, if their geometric mean is somewhere in the range of 7-8%, I guess it would be conceivable to see them also revert back to their long-term mean.

It seems that alot of what hinges on FFH economic fate is quite dependent on their investment returns from their cash, bonds, equities and investment in associates. It also seems their preferred style is concentrated bets in companies with more tangible assets that are market ugly. They approach it with hopes of mean reversion and some degree of activism at the corporate level. This style has left them with some difficult to turnaround equities eg Blackberry and Resolute Forest in a environment that has not been mean reverting. (As an aside, this is an interesting paper from GMO LLC about the market's mean reversion tendency.) https://www.gmo.com/north-america/research-library/is-the-u.s.-stock-market-bubble-bursting/ It also has left them with large short macro positions for too long a period of time. From my understanding, Hamblin Watsa carries out the majority of investment decisions. Prem eludes to a group that works together to help make these decisions. Does anybody have a sense of the process that they use to make these decisions and to learn from them subsequently? It is, for example, a group consensus decision or does everyone has a individual portfolio to run and the group is used for devil's advocacy? Do they routinely use pre-mortems, post-mortems, standardized checklisting, decision journal etc? I guess I'm just trying to dissect whether it is their investment process that has been sub-optimal explaining their recent returns or whether the outcomes were bad due to the inherent uncertainty in the investment outcomes. Thanks Jerome

These have been especially difficult years for value investors given QE. I'd be very leery of shifting to a Boglehead buy-and-hold index strategy at a time of QT. Index funds started to be available to me in 1998 when I started my 401k.if I had bought in back then, I would have just been flat in 2010 or so. Some foreign indices have even longer periods of underperformance. The enlightment of indexers comes after 10 years of pretty much straight bull markets if you take out Q4 2018 and some dips along the way. I fully expect to see another 50% down market in the next 10 years again. I agree that perhaps the majority of retail investors should be in index funds. However, with institutional money also piling into indices along with QE, I think indexation is setting people (and all those robo-advisors) up for long-term disappointment. And if Jack Bogle is correct that indexation may reach levels of 50% of the ownership of public securities, the role of active management becomes even more vital in price discoveries. I think the overall market needs to have a balance of indexers and active managers, however nature being as it is, the pendulum will swing between the 2. Here is a podcast on the history of financial theory that people may be interested in: https://www.hiddenforces.io/podcast/show/daniel-peris-financial-theory-history And here is Bogle's letter in the Wall Street Journal about his current thoughts of indexation: https://www.wsj.com/articles/bogle-sounds-a-warning-on-index-funds-1543504551?mod=searchresults&page=1&pos=9

Thank you Muscleman for your post. Like yourself, I started this value investing journey in 2010. After 8, going on 9 years, hacking away at this hobby with no formal training, I would have to also admit that I have not come close to outperforming the index. And reading the thread "CoBF members 2018 returns" were, also made me reflect on what am I doing here. Perhaps it is a bit of rationalization on my part, but I wouldn't consider all those years wasted time. It has forced me to learn a whole lot of things that should have learned two decades prior. Subjects such behavioral finance, decision-making, leadership, mental models, psychology, innovation in addition to learning a bit more about my personal biases and tendencies. These things have added significant non-monetary value to my personal and (non-finance) work life. I would consider the money that I lost or could have made indexing, the cost of this education. Not being in the finance field, does give a few advantages to the outsiders like me. I allows me to play a different game where poor performance does not lead to career risk. What I realized over the years, is that what people like me need to do, is to find companies that they really like, do enough homework (and keep doing it) to convince yourself that you can hold these businesses (and their management) for very long periods (10+ years). Maybe there were be a few duds, maybe there will be a few winners. We all hear about the cases of know nothing savers buying stocks that they only recognize because of their brands, and hold them for multi-decades, and produce extraordinary results. I figure that if I find opportunities with founders that are local to my geography, figure out their businesses, rule out why I shouldn't fall in love with them, and hold them "forever". I would expect a reasonable outcome. Don't know if this is a crazy strategy, I'll let everyone know in about 40 years. Jerome

I was wondering if someone could help me understand something I noticed with FFH's goal to hit a 7% investment return. The average investment portfolio allocation (2000-2017) with respect to cash & short term investments/bonds/stock is the following: 28%/52%/18% (2% in real estate and preferred shares). The 2017 allocation is 49%/26%/23% (2% in real estate and preferred shares). Their 10 year stock return was 4.2% as per their annual report. Assuming a 1.5% return on cash and 2.8% return on bonds. The total investment return is in the order of 2.4% currently. This is significantly far from FFH's goal of 7%. So I did a little digging into their 2017 annual report and came across pg 174 which describes their investment portfolio returns since 1986. Taking their total return on average investment, I calculated their investment return based on the business cycles. What I got was this: Time interval Geometric Return Since inception 8.02% Last 5 years 1.79% Last 10 years 5.12% Last 15 years 6.50% Business Cycle 1986-1991 10.8% 1991-2001 8.9% 2001-2009 10.4% 2009-2017? 3.9% So historically, their returns were above their target 7%. With the last cycle performing poorly (due to the hedging activity). There was a change in accounting practice whereby at least on the table, 2007 to present is IFRS and before that CGAAP. But included in the table are columns that include "Change in unrealized gains/losses on investments in associates". This is the difference between the Fair value less carrying value of T+1 and FV less carrying value of T0. I notice that over time, there has been a progressive increase in unrealized value over time which is contributing to the total return. I am a bit conflicted with respect to whether this is too aggressive (ie counting your eggs before that are actualized) or whether this would be appropriate given FFH's tendency to seemingly build value in its associates over time (eg Thomas Cook, First Capital). An investment in FFH is really a bet on their ability to improve their investment returns over time. If the inclusion of their unrealized fair value gains is kosher, than perhaps the probability of FFH achieving their average return of 7% would be slightly less far-fetched. Interested in hearing your thoughts on this manner. Jerome