oec2000

Stop losses are the most misused risk management tool imo. They do not help manage risk - they just give you the illusion and false comfort of risk control. While they do limit your losses on individual stocks, they don't limit losses at the portfolio level. Say you keep 10% stops and you get stopped out because of a market drop. What do you do next? If you don't reenter, you risk missing out on a market recovery. If you reenter the market, you expose yourself to another 10% loss. In a prolonged and trending bear market or a choppy whipsawing market, you will run out of portfolio before you run out of stops. There is also an unintended consequence of using stops. People who use stops often give themselves the excuse of not thoroughly analysing their "investments" because their "risk is limited." [btw, "stop profits (taking profits based on a fixed % profit)" are equally illogical.] The best risk management tool is to be realistic about what you do and do not know and to do only things that you understand. It is not always easy but I don't think there is any other way to go.

I understand you are not questioning the wisdom of TARP. Nevertheless, your question is unanswerable. It is now impossible for us to evaluate what the impact on JPM would have been if TARP had not happened. Who can tell what losses JPM would have suffered if AIG had failed and brought more banks or insurers that JPM had large exposures to down with them? Who knows how JPM would have been affected if interest rates had shot up in response to credit fears? If, as you suggest, you look only at the actual losses JPM has suffered since then, it is not a true picture of a TARP-less scenario.

This is the best historical chart I could find on US home prices: http://mysite.verizon.net/vzeqrguz/housingbubble/ There are extended periods when prices lagged inflation but it does show, remarkably imo, that nominal prices rose steadily through the 70s, 80s, 90s, and 2000s until the bubble burst. I still can't get my head over why when interest rates (and presumably mortgage rates also) shot up to double-digits during the Volcker era, cap rates did not follow. Maybe they did but that would have meant that rents rose as fast as interest payments on mortgages did. It's hard to imagine that they would have done so during a severe economic crunch though. Maybe cap rates started off higher in the early 1970s - the rent/price chart at the bottom does show that even after the price collapse, prices are still significantly higher relative to rents vs. the 70s. Would appreciate insights from posters who remember that era.

I am merely throwing out the idea that the relationship between inflation and real estate may not be the simple positive correlation that most people assume when inflation is not the benign gradual type that we have experienced for the past 30 years. For example, it would be instructive to find out what happened to real estate values in the 1970s when inflation was a serious problem or in Turkey or the Latin American countries when they had their inflation problems. My concern is that all asset prices fall in response to a rise in long term interest rates (which are in turn a response to higher inflationary expectations). This is not an argument for gold; rather it is a question of whether real estate is a good inflation hedge under all conditions (I suspect it may not but until I check the numbers, it is just that - a suspicion.) Just thought you might want to take it into consideration.

I gather that most seasoned short sellers do not like to short stocks purely on the basis of valuation. They prefer to short companies that have a fundamental problem in their business. It's a slower way to lose money. ;D

Hi Sanjeev, Tried to but couldn't find the Ben Graham Exchnage link. Is it discontinued? oec

Have you considered the risk if interest rates move up sharply in response to inflation that cap rates spike and seriously hurt capital values? Not good for a leveraged asset. The bull market in real estate has been global in nature and has gone on even longer than the gold boom so it is arguably in a bubble too. (Should be interesting to find out how real estate did in the inflationary 1970s.) The other concern is that the current economic problems seem to have their roots in a debt bubble fueled by exceptionally stimulative monetary and fiscal policies over 20-30 years. If the cure requires a return to more responsible policies, could we see a prolonged period of debt restraint/compression which would not be good for debt-financed assets? Your point about gold stocks lagging gold prices begs the question of whether it's a Mr Market phenomenon that could be taken advantage of. Finally, as other posters have pointed out, gold needs to be looked at as more than an inflation hedge. When Eric Sprott started buying in gold in 2000/2001, he did it not as an inflation hedge but as an alternative to financial assets whose prices had been propped up by irresponsible economic policies. People forget that gold has quadrupled during a period of low inflation. Sprott's thesis is that gold is a short against bad economic policy - until there are signs that governments and central banks are changing course, gold will likely stay the currency of choice.

Ok, it's beginning to look like I'm flogging a dead horse here but these points are too significant to let pass: The Sprott Hedge Fund beat its benchmark by a whopping 29 percentage points per year since inception. If you combine Sprott's 1985-2000 Cdn Equity Fund returns with the Hedge Fund returns from 2000-2010, $100,000 would have compounded to $18.5 million after fees, a 185-fold return. Compare that with FFH's numbers which show BVPS increasing roughly 100-fold from 1986 to 2010 ($4.25 to $400). (Some of FFH's growth in BVPS is due to issuance of shares at significant premia to BV which is why I excluded the 1985-86 BVPS growth which showed almost a tripling due primarily to issuance of shares at a huge premium to book.) The Sprott returns are achieved without the use of material leverage except to the extent that short positions count as leverage. Gross long positions tend to be around the 100% mark or less and I believe they cannot use options for leverage. Any more naysayers?

I agree with frog's "some people just don't get it" comment. (To clarify, this comment is not aimed at you myth.) Seems like some are happy to pass judgement without looking at the evidence. As stated in my quote from the 2000 annual report, the performance was 23% from 1985-2000. The performance over the past 10 years is about the same. Proof enough that it was not a "commodities flash in the pan" result? One trick ponies do not survive for > 25 years. Mind you, these are all after fees of probably 2.5% + incentive (less than 20% for the Cdn Equity Fund). Fairholme has much lower management fees iirc. Contrary to popular belief (and misconception), he did not do badly in 2008. The Sprott Hedge Fund LP lost only 5% in 2008 beating the benchmark by 20%. This is his flagship fund by which his performance should be measured as it is the fund in which he has the most flexibility in managing. Its long positions are identical to the Sprott Cdn Equity Fund and its returns are similar except with lower volatility because of the dampening effect of the short positions in the hedge fund. Before, someone else repeats the "lucky dart throwing monkey" analogy, don't just go by the man's track record. Read and listen to the man - you will understand and appreciate him better. He is not only smart, he is comfortable surrounding himself with other smart guys who do not necessarily agree with him or share his style. Many of his managers (e.g. Allen Jacobs, JF Tardif (ex)) are from the pure value mold. Sprott himself has a strong value bias except that he overlays this with his macro views (which is not so different from HWIC's style even though the areas of focus may be different). As for Staylehp's query, the mutual fund is open and I believe the hedge fund is too.

From the 2000 Sprott Canadian Equity Fund annual report: "Although the Sprott Canadian Equity Fund (the “Fund”) was incepted in late 1997, the Fund uses the same investment philosophy and style that has been exceptionally successful for investors of Sprott Managed Assets for over 15 years. Having invested $100,000 in Sprott Managed Assets beginning January 1, 1985, would have generated an annualized compound return of 23.18% for investors, or net worth of $2,280,353 (after all fees were paid) as at December 31, 2000. Comparatively, having invested $100,000 over the same period in the TSE 300 Total Return Index would have achieved an annualized compound return of 12.29%, or net worth of $569,220 as at December 31, 2000." Can anyone tell me what gold or commodities did between 1985 and 2000?

Do you know where we can find Sprott's track record prior to his starting SAM? I remember reading about it somewhere but can't now find the performance figures before the late 1990s. I believe his success has come from a solid track record of getting many different calls right, including the tech bust and the financial crisis, neither of which had anything to do with commodities. His performance prior to the commodities boom was of very similar magnitude and simply can't be explained away by calling him a gold or commodities bug. He already had a strong reputation before the current boom in commodities began.

No. This is a specific hedge (called CPI-linked derivative contracts) in the whole Fairfax hedges instruments. You can take a look at page 12 of their last quarterly report to take a look at the basic numbers behind the hedges fhat Fairfax has: http://www.fairfax.ca/Assets/Downloads/2010Q3.pdf Cheers! The deflation hedge is structured like an option and FFH's risk is limited only to the original premium paid. This is clear from their quarterly report. As for the equity swaps, you have raised two concerns: Counterparty risk, and the mismatched nature of the equity hedge. Given FFH's cautiousness about the economic situation, it is reasonable to assume that they have taken similar steps to minimise counterparty risk as they did when they had the CDS exposure. It is also important to keep in mind that daily posting of collateral will limit credit exposure to just a few days of market movement. Imo, this is not a huge risk. As for the risk that the S&P or the Russell doubles or triples while FFH's equity portfolio stays stagnant, how likely is this scenario? For this to happen, either corporate earnings have to double/triple or PERs have to go up to tech bubble levels (50-60x?) while at the same time FFH's equities did not move in sympathy with the broader market. I think it is way more likely we have major terrorist event plus a major natural disaster in one year than for this scenario to play out.

Partner, I can understand your frustration and agree that your question about swaps could have been answered without disclosing any sensitive information as the index swaps are very generic instruments. On the other hand, I can understand FFH's reluctance to answer this question because then it can become difficult to draw the line if someone else asks about something more complicated (e.g. the deflation option or a particular type of insurance coverage). It's also possible they may have felt that the equity swaps are straightforward instruments for which information is readily obtainable from the internet or library. Not sure how they finally responded to you but at the very least they should have explained why they could not entertain individual questions or made a commitment to better explain the instruments in the next report to shareholders (although I feel that FFH does a pretty good job already compared to many other companies - try reading MFC's reports, for e.g.!) oec

Partner, this is how I believe it works. Both parties to the swap will have to pay up the difference every quarter (assuming that is the agreed settlement period). Technically, it is a settlement of the difference and not a posting of collateral (although there is posting of collateral in between the quarterly settlement dates). The quarterly settlements can therefore have significant cashflow consequences for FFH if the indices move materially. This is the reason I believe FFH switched some of their long equity positions into long swaps so that they would help generate cash settlements to offset those arising from the index swaps. (Remember the discussion on another thread about why FFH had switched some of the stock positions?) As for your question on what if the counterparty wants to close out the position, the swaps are usually written for a fixed term and it is unlikely that the counterparty can close out before the expiry. In any case, the index swaps are generic ones and should be very liquid barring any major dislocation in financial markets.

Is the $55t net worth that of the entire nation - public and private? If so, shouldn't that be compared with total debt held by both the pubic and private sector. Your $14t figure appears to be that of the Federal govt only. On the other hand, it is not clear to me whether we should just look at debt held by foreigners only since debt held by domestic investors would simply offset a large chunk of the debt.

What about Buffett, Watsa and Klarman and for that matter, Soros and Blackstone? I think they would be worth paying 2+20 for. 15% and 20% gross returns translate into net returns after 2+20 fees of roughly 11% and 15% - pretty respectable, imo. So, the question boils down to whether there are sound managers out there who can achieve greater than 15% gross returns. I think there are. You do make a valid point about the difficulty of differentiating between the real superinvestors and the others who are just "lucky monkeys." However, if you accept that we can pick winners like Watsa and Klarman (who are not pre-identified superinvestors), then you can't rule out the possibility of finding other superinvestors. I agree it is risky just to look at past performance because you can fooled by randomness. You can reduce the risk of being fooled by looking closely at the investment style and philosophy of the manager and whether he sticks to his claimed knitting.

Merkhet, For purposes of estimating SCP's NAV, I think it is fairer to take just OIP's quoted value. (The same way we would use, for e.g., WFC's quoted price and not our estimate of its fair value when computing FFH's BV.) In any case, the market values OIP at about $320m EV, or about $50,000/boepd which is not too bad considering it is 50% gas.) On this basis, SCP's unrealised gains amount to approx $230m. This is consistent with the number that management gave on the last conference call of $200m. After taxes and SCLP's carried interest, the net gain is only about $145m, which when added to the Q3 NAV and allowing for the full conversion of warrants gives a revised NAV of about $4.80. SCP is a commodity-focused private equity fund, not a fund that simply invests in commodities. As I said, it's fees are not out of line with the private equity/hedge fund industry. As to whether they can overcome the 2%/year headwind, consider these facts. Their first investment, PBS Coals, achieved a 4x return within one year (in 2008, the year of the crash!) and they have grown NAV from $1.50 at the end of 2007 to about $4.80 currently - a triple in 3 years (after fees and taxes too!). Investors would be actually be worse off if they had adopted WEB's incentive formula. The beauty in these returns is that they have been achieved by taking a lower risk approach to resource investing. It remains to be seen where they go from here but I think you would be hard pressed to find any other fund that has done as well as they have over this 3 year period. It is important to point out that they do not need commodity prices to rise from here for investors to make good returns going forward - they just need to prove up the feasibility of a couple of their projects. In my mind, there is no question they have quite fairly earned their fees (and taken care of the headwinds for the next 20 years at least). This brings me back to my original point about not understanding why people would summarily write off 2+20 funds without first investigating what they are capable of.

Where do you peg NAV to be? I have it pretty close to where the stock is trading now. The warrants, at $4.25 are not hugely dilutive. Fwiw, I have recently added because I think there is potentially a lot of latent value in their projects. Good risk reward tradeoff. Imo. Kevin Bamborough has proven to be a disciplined and astute asset allocator. Fair comments but history shows that these gurus do not completely eschew investing in commodity or macro-type ideas. Their success comes from being able to handicap odds well and to apply that skill in a disciplined way. It may be useful to try and learn how they do it and not keep our minds completely closed to it. As far as hedge or private equity funds go, their fees appear normal. I thought the problem with Biglari was that he changed the rules midstream - not sure how your comparison is valid. Care to clarify? As to hedge fund type fees, I do not quite get why there is such appears to be such dislike/disgust (it's just my impression; I might be mistaken) on this board for such performance-linked fee structures. WEB used it before and many managers that are spoken of highly here (Klarman, Chou, McElvaine, etc) charge performance fees. As long as they provide fair value in return, what is the problem? If I could go back in time and invest $100K with George Soros when he launched the Quantum Fund, why wouldn't I?

This is only part of the problem. When we do accept immigrants who are well educated (doctors, accountants, etc) we make them jump hoops before they can use their skills here. Then we complain about the shortage of healthcare workers. I know of someone who has practised medicine as a doctor in Saskatchewan for some 30 years with qualifications from the UK but he can't move to BC to practise because the rules are different here. They want him to go back to school at 60+ years of age! We also take in immigrants who dump their non-working dependents here to benefit from the cheap/free services and benefits while they return to their home country to work without paying taxes here. Compare the situation in Singapore where despite having no shortage of highly educated locals, they continue to scour the world for talent and encourage them to take up residence. I'm an immigrant myself so I am certainly not anti-immigration. I just feel, like you, that we can be so much more sensible about it. Why do not more Canadians complain about this silliness to their MPs? Btw, SJ, aren't you discouraging an intelligent (if he lurks on this board, he has to be smart) guy from moving to Canada? :)

I bought some PZA.UN when it was yielding north of 14% for my RESP account for the reason you gave. Imo, there is going to be a tug of war between: 1) Those who hold these trusts in their registered accounts (like me) who should, in theory, sell these positions. (When the distributions were fully taxable, it made sense to shelter the income in registered accounts but with the dividend tax credit now applicable to the distributions, it makes more sense now to hold them in non-registered accounts, and 2) Non-registered accounts hungry for yield who will be tempted to buy these for yield. I suspect the balance will favour group 2 especially since those in group 1 may simply switch their positions from reg to non-reg accounts (although some might not have as much funds in their non-reg accounts to do the switch). The other reason I bought the units was because they offered protection from food inflation. If restaurants raise prices in response to rising food commodity prices, these royalty trusts get a direct boost to their revenues. Of course, this could be offset by declines in sales. (This is why I bought only PZA because it sells a low price product that I thought would be more resilient to an economic downturn. As it turns out their SSSG have suffered slightly in the recession.)

Actually the portable alpha issue does not arise with the swap positions because the swaps are merely a synthetic substitute for their long stock positions. The answer to whether they are pursuing an alpha strategy lies with their original equity positions they took. To the extent that they put on the equity positions first and then put on the index shorts much later suggests that this was not what they had in mind. In any case, the question is why they converted their long equity positions into swaps since this does not alter their economic position. Was it to get leverage (I don't think so) or some other reason (my guess is cashflow matching)?

I have never understood why bankers do not adopt the practice of pricing mortgages according to risk. My understanding is that as long as borrowers meet the income servicing criteria, lower LTV loans are not priced more cheaply than high LTV loans (i.e. in the way corporate credits are priced according to risk). Apart from making theoretical sense, it also creates the right incentives for borrowers to keep their LTVs as low as possible. It also makes the risk takers pay more than the prudent borrowers.

It shouldn't really matter in the long run, i.e. the voting vs weighing machines argument. It is difficult to isolate the reasons for MSFT's recent poor stock price performance. As for FFH, I would think that the typical shareholder is less prone to being influenced by such noise. Paying excessive dividends (especially when it is accopmpanied by an issue of discounted shares) sends the wrong signal about capital allocation strategies. Given management's need for personal cashflow, I can see the rationale for special dividends occasionally when there is excess capital but it seems that expectations are growing for dividends to be maintained or even increased from this year's high level. For the sake of managing expectations, I feel it would be good to make a distinction between "base" and "special" dividends.

Sorry, didn't see this until now. I have no clue what portable alpha is. I would imagine that there are tax consequences to the switch on the long positions but they are probably offset by the losses they suffer on the short swap positions. I'm not particularly knowledgeable on US taxation so would defer to other people on the board who understand taxes better. I am convinced now that they are doing this purely for cashflow management purposes. The economic impact (in terms of P&L is, I believe, not material).

This discussion comes up every now and then but if we all agree that FFH is undervalued here, shouldn't we all also agree that the rational thing is to minimize the dividend and use the funds for buybacks? A rational investor should be agnostic as to whether he gets his returns in capital gains or income. A $10 dividend is worth only $10 to me (or less after tax for non-Canadian taxpayers). $10 used to buy back undervalued stock gives me some incremental value equal to the discount obtained through the buyback. Buying back undervalued stock is the closest thing to alchemy that I can think of. FFH should scrap the dividend and use it for buybacks.