oec2000

Hi Arbitragr, You can use options either for leverage or to manage risk. To use options for leverage, you need to get both the direction of the move and the timing right. Get both right and you make a great % return; get it wrong and you lose a high %. I am not competent enough to time markets so I avoid using options this way. However, I think options are a great way to manage risk. Some examples: a) When option prices are low (when implied vols are low), I do option/fixed income combos as an alternative to an outright stock purchase. E.g. Instead of investing $250 to buy FFH stock (when FFH was $250), I would buy FFH 250 2011 calls for $50 and invest the balance of $200 in ORH A pfds at $17 yielding almost 12% with good potential for capital gain. Come 2011, assuming ORH does not go under, I will still have approx $250 even if the FFH calls expire worthless. I have foregone two FFH dividends but that's a small price to pay for the comfort of taking away the downside risk of a large FFH position. Options of less volatile stocks like JNJ or PM are even cheaper (about 7.5% annualised premium to expiry) and work very well at times like these when fixed income yields are relatively high. b) When FFH experienced the short squeeze last year, I was long both FFH stock and LEAPs. I suspected that the price spike would not last but, lacking confidence in my ability to time markets, sold my stock and replaced them with FFH calls. By doing so, I retained the upside but had now locked in my stock gains. Because option volatilities and therefore premiums were high, I also sold some short term out of the money calls and puts to partially offset the cost of buying the calls. (The spike in implied vols was much greater for short dated options than for the LEAPs). c) When the market was in meltdown mode in Q4 08 and also Q1 09, and it seemed like everything was going under, my analysis suggested that Blackstone (BX) would survive. Not having 100% confidence in my analysis, I decided to buy the LEAPs instead to minimise my potential loss. d) Another possibility - say you want to take a very large position in FFH (>50% of your portfolio). A way to reduce your risk is to buy FFH calls (for the same notional amount so that you are not leveraging up). If you then sold puts to pay for the cost of these calls, you would in effect have created a synthetic long position in FFH equal to that of buying FFH stock. This exposes you to the same downside risk of buying the stock outright. However, if you instead sold puts on a basket of stocks, you can retain the full FFH upside without taking the same company specific downside risk exposure. You have achieved the same concentrated long exposure while diversifying away your downside risk. There are many different permutuations depending on what your objectives are. The one thing I would add is that I am more inclined to be a buyer rather than a seller of options for the reason that selling generally exposes you to risk for limited compensation.

While it is agreed that ECRI have a good long term track record in calling turns in the economic cycle, weren't they wrong in being very late to call the current downturn? Raises questions in my mind as to whether their models work well for garden variety cycles but not so well for 1 in 100 events like the one we are experiencing. Perhaps someone who is a subscriber could confirm that they missed this downturn?

Roughly: 33% in preferreds (mostly US financials), 20% in FFH LEAPS/FFH/ORH (notional value approx 60% of portfolio), 10% in various small caps, resource and staples stocks (mostly opening positions, aim is to increase positions as price opportunities present themselves), 5% shorts, 33% cash and arb opportunities. Longer term, aim to allocate capital as follows assuming prices cooperate: 33% in jockey stocks (FFH/BRK, etc), 33% resource (mainly energy related), 33% consumer monopolies; 30% in preferreds (using long term home equity debt as opposed to margin debt; allow cashflows from pfds to self-liquidate debt over time). Up to 20% in short term high probability arbitrage trades (using margin debt).

The ideal strategy, imo, would be for ORH to continue to take advantage of Mr Market to buy back shares at a discount to book until FFH's holding is sufficiently high (say, 80+%) that the privatisation premium would not cost a lot in absolute terms. For e.g., a $10 per share premium on 10 m shares is only $100m. Apart from the fact that $100m is less than 4% of ORH's book value, this would be offset by the annual savings in compliance and inconvenience costs of being listed. Others who were at the AGM might be able to correct me but Prem may have said that they had the capacity to double the insurance business if rates were attractive enough. So, it does not appear to me that capital is a constraint with the exception of short term fluctuations in the value of investments. In any case, there is always the option of cutting back on the insurance business if it was felt that the capital cushion was reduced because of a privatisation. This has the added advantage of improving underwriting quality and results. Disclosure: My exposure is largely in FFH but I do have a very small position in ORH.

These are what I see as the pros and cons of taking ORH private. Pros a) Having all the key subsidaries wholly-owned allows for more efficient allocation of capital. You can transfer capital in or dividend surplus capital out as required without having to worry about fluctuations. Since ORH is very well capitalised (as was NB), its surplus capital could be more easily paid out to FFH if it were 100% owned. As in the NB takeout, a significant portion of the takeout could be funded by ORH. b) Reduce costs and inconvenience of having an additional listed company. (FFH gets 100% benefit from cost reduction by buying out less than 30% of the company.) c) ORH is a good and cheap investment that FFH knows very well. When markets recover eventually, it may no longer be possible to buy it out so attractively. d) Tax planning flexibility that comes with wholly owned subsidiary. Imo, these issues factored into the decision to privatise NB at 1.3x book rather than buying back FFH stock and should continue to be the driving factors to privatise ORH. If NB continues to generate 15-20% ROEs or similar growth rates in book value, I don't see how the takeout was a strategic error. Cons a) An all-cash privatisation will reduce the overall capital available to the group. This may constrain FFH from taking advantage of a hardening of the insurance market. b) Having a listed subsidiary provides the group with some flexibility when there is a need to raise funds. The decision will be driven by mgmt's assessment of capital requirements as well as the ratings agencies'/market perception of capital adequacy. At the AGM, I believe Prem alluded to how investment performance could significantly affect their capital position. After removal of the equity hedges in Q4 08 and with the volatility of the mkts in Q408 and Q109, mgmt may have thought it prudent to conserve capital and refrain from the ORH buybacks. With the recent recovery in the markets, they may feel more comfortable to resume the buybacks. Personally, I do not agree with StubbleJumper's suggested route of buying ORH with cheap FFH shares especially as you will have to pay a premium for the ORH shares for the privatisation to succeed. It makes more sense to use their investment gains to fund any ORH purchases. The Q2 earnings report should provide interesting clues as to where they are heading.

He still has that convertible preferred. The thing about buffett is he's like a liar. He didn't even purchase that much WFC or USB at under 10. That was a BIG red flag for me. There continues to be much misperception of Buffett's GS and GE preferred purchases. You often see commentary that suggest that BRK lost money in the pfds just because GS and GE common dropped substantially from when BRK bought the preferreds. Firstly, they are not convertibles (and definitely not mandatory convertibles); they are straight perpetual preferreds. As such, these pfds should trade more like the "fixed-income" instruments that they are. Unless the issuers are perceived as being likely to go bankrupt, there is no reason for them to trade in line with the common. There is a reason why Buffett opted for preferreds instead of common stock - it's not because he's stupid. Secondly, Buffett also got "free" warrants in GS and GE. You can either consider these to be free (in which case he has not lost anything from the decline in common stock prices) or inpute a value to them (in which case this value should be deducted from the cost of the preferreds, in effect giving BRK a higher yield on them). So, there is nothing illogical about buying GE pfds when GE is at $20+ and not buying GE common at lower prices. Saying Buffett is like a liar because he didn't buy more WFC or USB is simplistic. There could be many reasons why he didn't buy more - other opportunities, position limits, liquidity constraints (which is the reason Buffett gave for selling some holdings recently). You mentioned USB as your favourite. If the price fell after you first bought in, will you keep on buying it until it became 100% of your holdings? Do you call yourself a liar if you stop buying?

Interesting - Tokyo and Osaka - and this is after almost 30 years of recessionary/deflationary conditions!

I thought this would be an opportune time to revisit the C.PR.G arb trade that had been raised when they were trading around $20. I felt then that the 20% potential upside was inadequate unless a short C position could be put on to lock in the spread. We have since seen C pull back from $3.70 to 2.60 and the G's from $20 to $16.5. Beginning to look more interesting here. The arb spread has narrowed but we are now only about 2 weeks away from closure so still a decent annualised return of you can short the common. Even if you are not able to short the common, the G's are now yielding 12% and in line with the other C pfds that are unlikely to get converted, i.e. you are getting the conversion option for free, effectively. The G's pay dividends without withholding tax. The 12% yield is not bad for Cdn registered accounts with potential for capital gain.

A distinction should be made between hedge funds and private equity funds. Although Cerberus is better known as a PE manager, the article refers specifically to their hedge fund. With PE funds, investors cannot ask for their money back - they get their money back only when underlying investments are realised or when the agreed term of the fund ends. The only way for investors to get out is to sell their position as secondaries to other investors. (Some PE funds specialise solely on investing in secondaries.) We shouldn't have sympathy for funds like CALPERS who are now suffering from "the denominator" problem. They are big boys who knew the rules when they invested in PE. The problem is that many of them overcommitted to PE when times were good on the assumption that their commitments would never get fully called before distributions came back from earlier investments. They are crying foul now because there are very punitive terms for not funding their commitments. By putting pressure on PE managers not to make investments, they are putting other investors who may want to see the managers putting capital to work in these distressed markets at a disadvantage. Unfortunately, because of their clout, the PE managers are likely to defer to them to some extent.

Kyle, It depends on what her yield expectations are. A few months back, Cdn fixed/reset preferred shares (issued by the banks and lifecos) would have done the job very nicely. Many of them were issued at an initial fixed 5-year yield of 6.5% (which with the dividend tax credit advantage translates into a interest equivalent yield of about 9%). The nice thing about these pfds, unlike the straight perpetuals, is that the dividend rates reset at 5 year intervals at historically high spreads to Govt bond yields which alleviates the interest rate risk to the holder (important if you are concerned about inflation going out). I should point out that even these sold-off by about 20% during the market meltdown earlier this year so there is no guarantee of low volatility - but that was a highly unusual time when everything was being thrown out indiscriminately. These fixed resets have rallied with the markets since then and I am not sure what they are yielding now (probably around 6% still). I think the biggest risk with them is that they get called by the issuers once the credit markets normalise and spreads tighten in 5 years time - then you will may have a reinvestment problem.

To those of you who are unhappy about the ads, I recommend you take a step back and do an objective cost-benefit analysis. This is a no brainer imo - the annoyance of the ads is so minor compared to the benefits of this board. Think about all the other investing websites that you use daily - how many of them are ad-free, even the ones that are subscription based? If you are not bothered by ads on those sites, why are you bothered by the ads here? Where is the spirit of give and take? Many of us here would gladly spend way more than $500 and endure many hours of travel to attend BRK and FFH AGMs. Yet here we are complaining about a few inconsequential ads. Considering how much we can gain intellectually and financially from this board, this is a really petty issue to get all hot and bothered about. As for Jack's comments on the issue of control, I believe most of us here do not begrudge Sanjeev having control considering the effort that he has put in. You may not agree with him on everything (and not everyone is ever going to) but he has been quite even-handed from my experience. Your offer to pay him $500 in return for control is not only arrogant but presumptuous too - what makes you think that other board members would want you to be in control? So what if he should make $1 or $1m from this site? So what if his efforts are driven purely by his own self-interest? Let's be brutally honest - we are all here out of self-interest. Don't tell me your posts are solely driven by an altruistic need to benefit others. Your only calculus of whether to stay a member should be based purely on your own cost-benefit analysis - how much he makes or loses is irrelevant. If control matters to you and you can do a better and fairer job, start a competing board and I'm sure members will flock to you. I'm not against criticism of Sanjeev but I am against criticism that is unconstructive and unfair; I am against remarks that are ad hominem or laced with innuendo. Some posters have already said that the ads can be blocked; Sanjeev has said that this is the only extent to which he will add ads; some of us will simply ignore the ads in the same way we ignore them in the New York Times or the Wall Street Journal. If you are still unhappy about the ads, you might want, with others, to offer to pay Sanjeev $500 to do away with them. This is a minor problem with simple solutions - nothing that justifies the levels to which the personal attacks have reached.

Not sure why the BML-J would move like that, but possibly some confused BAC-J with BML-J Another short candidate, imo. I would like to hear the efficient market theory academics explaining this one! To your question of whether the offer will be fully subscribed, there is no reason to think it will not - unless BAC's price collapses before the offer closes. (The offer is subject to BAC price averaging at least $10 during the reference period.)

This is how I would approach the diversification decision: 1) I would make a distinction between business ownership and portfolio investing. Firstly, most business owners do not have the option of diversification when they start out. Secondly, if the business is successful, they are able to compound the growth of their business at very high rates. Thirdly, if the business does not do that well, they do not have much resources to diversify outside the business. Under any of these circumstances, the business owner likely ends up with a very high proportion of his net worth in his business. It is only in the second situation where the business owner has an option of diversifying away from his business. At this point, the prudent ones may already have built significant wealth outside the business (e.g. Buffett and Watsa) that they can afford to take the risk of the business going under - in which case, they can safely continue to have the concentration in that one business. The portfolio investor has a choice from day one to diversify. If he chooses not to, he must either be very sure of what he is doing or he should be able afford the risk of severe loss. In the case of a business owner, the default option is to be very concentrated; for the portfolio investor, the default option is to be diversified. The business owner also has an important edge - he knows everything about his business; the portfolio investor does not. 2) Use the Kelly Formula (2p-1) to set the absolute upper limit of exposure for each investment. 3) Decide where I am in the spectrum of objectives, one extreme being to maximise wealth the other extreme being to preserve wealth. A twenty year old with $10,000 will be at one end of the spectrum while a 70 year old retiree with $5m will be at the other end. 4) All things being equal, being diversified (within limits) is better than not - diversification is a free lunch. Therefore, if I can find 5 stocks that meet my risk and return criteria, I should buy 5 rather than just 1 or 2 stocks. 5) Diversification is not just about managing risk; it can also be about managing returns. If you choose to buy only two stocks in your portfolio, you may not lose everything but if they do not perform as well as you expected, you returns could be lousy. The odds of getting 2 out of 2 wrong is quite high, much higher than 5 out of 5. 6) Given that stocks tend to move in tandem, the chances are high if FFH were to sell off to $200 that there would be plenty of other attractive opportunities in which case it would make sense to have more stocks. Of course, it is possible that FFH could sell off for company specific reasons - but if that were the case, you probably would not feel comfortable having such a concentrated position in one stock. In conclusion, I really cannot see myself having either the need or the desire to put 50% in any one stock. Even if I felt compelled to, I would try to use risk management tools (like options) to achieve the same exposure without the same risk. One last point. Buffett's and Watsa's very high concentration of their net worth in BRK and FFH must be viewed in the context that BRK and FFH are themselves very well diversified. It is more instructive to study how BRK's and FFH's portfolios are invested to understand their approach towards concentration/diversification. In FFH's case, the implication is that their max holding in a stock is about $500m, i.e. 2.5% of their $20b portfolio or 10% of their $5b equity portfolio.

Partner, something else that occurred to me that might help you put things in perspective. I'm thinking of Edward Liddy who was brought in to deal with AIG's problems, gets paid virtually nothing, and then gets hit from all sides - Congress, AIG employees, etc. It it still irritates me to think of how the politicians grilled him in the various hearings.

Partner, Unfortunately, these things do happen quite often and the "good guys" are usually the ones that get the short end of the stick. I know you only from your posts on this board but it is obvious that you are one of the most thoughtful, helpful and considerate posters here - many will agree with me on this. No one can take away your pain but the good news is that it will pass with time. It will be pass faster if you can dispel any resentment you have - anger and grudge-bearing only make victims miserable and prolong their disappointment; it rarely makes the target of the anger feel bad. While you are clearly disappointed, you do not sound bitter so I sense you will get over this quickly. You made your contributions because of your intention to serve your community, not to get the approval of the principal officer, so you should take pride in that you have achieved your objective. Finally, I can't help but bring in an investment analogy given the nature of this forum. ;) Try to think of your service contributions in portfolio terms. Just as some of your investments will work out and some won't, as long as you are doing the right thing, over time, your portfolio should work out fine. In the same way, if you keep on doing what you have been doing, your contributions will eventually be recognised by the people that truly matter - the ones who benefit from your efforts. Meanwhile, I recommend you focus on the fact that the value of FFH continues to compound while you sleep. ;D

Intriguing - is there more to it than meets the eye? It would be a shame if he were truly retiring because he is really good and will be a loss to the investment community. It had struck me as odd at the time of the Sprott IPO that JF was not appointed to the board when Peter Hodson and Allen Jacobs, who joined Sprott later, were. I had actually asked Eric Sprott at their AGM earlier this month whether there were any potential issues with managers leaving Sprott (but I was thinking more of their recent hires, Allen Jacobs and Charles Oliver who have not had too much success in ramping up their fund sizes partly because of performance issues). He gave an answer which I thought was kind of evasive initially but he did end up saying that it was not something that kept him awake at night. Digressing a bit, does anyone here know what happened to Jeff Vinik (of Fidelity Magellan fame, or should I say, infamy) who decided to (really) retire after a few highly successful years of running the Vinik Fund (after being ousted from Fidelity) during which he returned something like 35-40% p.a.?

Therefore, I believe that the solution is some kind of pegged currency at a level which will ensure that our purchasing power is close to parity. Stability is key to economic growth and I see no reason why tying up the CDN$ to the USD would be any different. Cardboard, be careful what you wish for. Adopting a USD peg means surrendering control of monetary policy to the US and accepting all unintended consequences. Hong Kong provides an interesting case study because of its long held peg to the USD. There have been times when the peg meant that monetary policy in HK had to be kept unduly loose even when local conditions did not justify it – during the early 1990s recession, the US eased aggressively. HK had no choice but to follow and as a result had to endure rampant asset price inflation. Then in the late 1990s during the Asian currency crisis, to defend the peg, HK was forced to raise interest rates to crippling levels at huge cost to the economy and asset prices fell by around 70%! To your own point about the potential massive inflation in the US, won’t we be in a worse situation if we pegged ourselves to the USD? Remaining unpegged may not prevent us from feeling some of the fallout; pegging will ensure that we feel the full effect. A strong currency keeps inflation in check. Although it has taken time for the effects to filter through, Canadian consumers have definitely benefited. Books, cars and electronics are definitely cheaper than they would have been without the C$ strength – it is no longer that attractive to go cross border shopping these days. In an open and competitive economy, there is no reason to think (and no evidence to show) that the middle men are scooping up bigger margins at the expense of others. It is true that many Cdn companies are disadvantaged by a stronger C$ - but this is largely a function of our resource and exported oriented economy. But, if you stop to think about it, C$ strength is often associated with strong commodity prices which must be good for these companies! Didn’t investors in Suncor, Potash, Teck make boatloads of money when the C$ was going from $0.60 to parity (and lose similar boatloads when the C$ weakened back to $0.80)? Then, there are the Cdn companies that sell domestically but may have some USD costs – Tim’s, Canadian Tire, Loblaws, Reitmans, Rogers, Shaw, etc. Surely they are net beneficiaries of a stronger C$. Then, you have the financials – banks, insurers, asset management companies – that are probably neutral to C$ movements. Even if you consider US companies, you can, if you take Buffett’s advice, alleviate the weak USD problem by investing in companies that have significant international earnings or have the ability to increase selling prices because of pricing power. You also have the option, as discussed by others here, of hedging your USD exposure. So, while I agree that a strengthening C$ creates some difficulties for Cdn investors, I do not accept your premise that we are screwed every which way. From a broader economic perspective, while C$ strength can cause problems for exporters of manufactured goods in the short term, provided these companies are flexible enough to respond accordingly, such currency strength should not pose long term problems –consider Japan, which maintained trade surpluses throughout the time its currency strengthened from 260 all the way to 90. Manufacturers found ways to increase productivity to offset the currency appreciation. In an ideal world, strong currency countries should experience very low wage inflation, perhaps even deflation, which will help improve competitiveness in the long run. In the final analysis, we only have to ask ourselves whether we would prefer to live in strong currency economy or a weak one. Would you rather be in China, Japan and Canada or Turkey, Zimbabwe and the US? The answer is obvious. Our goal, as investors, should be to increase our purchasing power over time. If our base currency is a strong one that is appreciating at 5% p.a., then a 5% real return in that currency is not too shabby. On the other hand, if our base currency is one that is depreciating 15% p.a., even a 20% real return in that currency is inadequate.

Thanks OCE, you are correct - only Cap XIX (F), Cap XX (G) and Cap XXI (?) will not be pro-rated. And Cap XIV is ahead of XV... Imo, the most logical arb trade right now is to short the C-O and buy the C-S. If only my broker would let me do the short....... :'(

anyone buying bac preferreds in anticipation of conversion offer? BML PRJ still trades @ 10 on 25 par. The problem with trying to do this is that the risk/reward ratio is not so attractive now that potential conversion is somewhat built into the pfd prices. The other problem is trying to figure out which issues will be given priority in the event that only a partial conversion is done (as for the C trust pfds). Logically, the highest coupon pfds can be expected to be given priority. Unfortunately, you will see that these high coupon pfds already trade in the high teens. My guess is that the BML J's will be low on priority because of the low coupon. You should only buy if you are happy owning it even if there is no conversion. Conversion will then just be icing. (I do hold the BML H's which are even lower coupon but I bought them when they were below $3.)

I wanted to come back to Citi and highlight an opportunity that I still think exists in the series "g" Citi pfd. I discussed this arb trade on this thread when the exchange offer was first announced in early March and the spread was >50%. Bought the I's around 14-15 and sold Citi calls (because I was not able to short the common) which resulted in an effective cost per C share of $0.65. Buying the pfds now would give you a much higher effective cost per C share of $3. Unless you can short the common to lock in the spread, I would advise caution in trying to do the arb today for a 20% return. A huge amount of Citi common (>>20b shares) will be issued through the exchange offers and it is difficult to tell what will happen to the price of C when all the "arbs" try to close out their positions. To the extent that many arbs are "naked" arbs who did not actually short the common (this is likely because of the difficulty in borrowing stock to short), you can expect a rush to to sell when the exchange is completed. 20% does not provide an adequate margin of safety, imo.

Besides the risk of the stock trading down, am I missing something here? Eric, I haven't read the S-4 but from Citi's earlier releases about the Pfd exchanges, only $5.5b of trust pfds will be converted. C.PR.U ranks too low in the list of trust pfds to be converted. Even C.PR.O, which ranks ahead of the U's, will only be partially exchanged so I don't understand why the mkt is pricing it so high. I have sold my U's because I think they are mispriced - they should be priced more in line with the E's and W's.

GDP is a straightforward function of total economic spending, its kind of like comparing debt to revenue, not profit. The numbers are scary but irrelevant[/i How can you say that the Debt/GDP ratio is irrelevant? You may not have noticed but we are going through a 1 in a 100 year financial storm right now - most people would attribute excessive leverage as one of the root causes of this crisis. The reason Debt/GDP is important is because there is a critical level beyond which further increases in the ratio is untenable - this is the point at which debt servicing eats up a significant portion of GDP. I think debt vs the value of all U.S assets both foreign and domestic is a more useful ratio. If you were a lender, would you be more interested in a borrower's income (i.e. ability to service/repay his debt) or his assets (which may be non-income producing or illiquid)? We only have to look to the mortgage crisis today to understand that it is caused primarily by the inability of borrowers to service their debt. If you were China and lending trillions to the US, would you consider the servicing ability or the assets of the US as a nation? In the event of a default, do you think you can take possession of Manhattan or California and foreclose on it? It is conventional wisdom to assume that no country will default on sovereign debt denominated in its own currency - this was until Russia defaulted on its Rouble debt in 1998. You are correct to imply that the US can simply keep on printing money to pay interest on its debt. But, this does not mean that such actions have no consequences - as Buffett has said, there will be a price to pay later. You can choose to control the supply or the price of a currency but you cannot control both at the same time.

This may not answer Woodstove's question but the numbers and charts in the following link, if accurate, are quite sobering to contemplate. http://mwhodges.home.att.net/nat-debt/debt-nat-a.htm#ratios I have no idea how reliable the statistics on this site are but they do seem plausible. The total debt to GDP ratio for the US economy is pretty close to the 480% Brian Bradstreet (of FFH) mentioned so appears right. We may only be in the first inning of deleveraging.

This disclosure is not that exceptional. With the CDS, they usually disclosed what happened subsequent to quarter end at the time of the results announcements. I believe the disclosure is because of the materiality and volatility of the numbers.

You must be a true Buffett cult member to do the opposite: write "buffett" when you meant "buffet"! Haha! Call it a freudian slip. I am not in Omaha for nothing. ;D