SharperDingaan

Gio, we're not that dissimilar in approach. We view our investments primarily as businesses as well, & buy/sell according to how we think the individual business's are likely to perform over the next 6-9 months; & whether that expected performance is going to reduce our total risk. We essentially see each investment as a sub; sell if we don't expect to achieve our minimum WACC, & buy if we expect a significant diversification (synergy) benefit. We could also keep our cheque-book closed, buy Canada's/T-Bill's, or start something entirely new - according to our business requirements. Obviously, buying/selling shares is a lot easier than divesting/acquiring entire divisions ;) Our portfolio approach just reflects our formal investment education. Were our focus not on running businesses, we would probably be in the OPM business. As we have the knowledge, & few of the restraints, we mostly get to have our cake & eat it as well. Different applications. SD

The worry is that unrealized gains to date might evaporate?, & you could get burned if you sold too early? So ... dump as soon as XYZ falls X% off its peak, or XYZ starts raising cash through a bond/equity issue. In the meantime enjoy; the most you can lose is the X%, & it is entirely an opportunity loss. SD

Gio. The .95 to 1.05 BV spread is simplification. The reality is that in most years, FFH has quite a spread between peak & trough; if you can systematically capture 1/2 of it, be happy. P&C's typically make their money in Q1 when nature is calm, lose it in Q2 and Q3 depending on how many & how severe the natural disasters, and make/break their year in Q4. We just recognize the seasonality, & invest accordingly. We are retail, we trade the shares directly, and we synthetically short via the sale and repurchase of 1/2 our existing long position. If we're right we restore our position at the lower value, & take cash off the table. If we're wrong we just restore our position at the higher value; the cost is 2 commissions less the interest earned on the sale proceeds, the unrealized gain on our long 50% offsets the realized loss on our short 50%. Were we institutional, we would be selling long dated calls when the mood is buoyant, & buying them back 6-9 months later when the mood is sour. We would capture the volatility delta, the time decay, & get to leverage the return. No activity in the shares themselves unless we absolutely had to. Different players in different markets. Our underlying message is that there is no conflict in being strategically long, and tactically short, at the same time. The rubber duckie could also be any core holding in the portfolio that is unlikely to sink; Oil/Gas, Health Care, etc. We try to play consistently within our market advantage ;) SD

Gio: If you did nothing more than annually sell at 1.05x BV, buy at .95x BV, & cross the year end; at an average $400 BV; you would increase your annual return to $50, versus $10. Zero thought involved, & you definitely did not increase your risk 400%. To initiate a short sale you have to evidence that you have the shares to sell; a share loan agreement, and a delivery of the specified shares under that agreement. As sizeable share loans are risky (potential reputation damage, & exposure to the counterparty’s ability to repay), there are a very limited number of potential candidates. Short hard and fast, & you can use the market turmoil to pull in additional on-the-day share loans for little additional cost; as market players/media will be desperate to get in on the action. Finesse a large enough quantity of initial share loans to fuel a credible initial dump, & you will snowball the price drop. Push hard enough, & you will put the target under before it can marshal any kind of effective defence. FFH was saved, because the manner of the short execution was so abusive that it created reputational damage. Had the short execution been more acceptable, FFH might well not exist today. The vehemence of the reaction was a Black Swan event, the abuse woke up a number of other good people who chose to stand up to it, & it eventually bled the predator white. The principles of ‘crowd funding’ were turned to ‘crowd defence’, & it probably could not have occurred anywhere else but in Canada. FFH is an ark designed to survive extreme adversity; essentially a business rubber duckie. Nothing wrong in that, but you put your money in the rubber duckie because you know it will not sink - & it will earn a positive compound return over an extended period. You are seeking safety, & the alternative is a long-term Canada/T-Bill. When investing in the rubber duckie you are more interested in the ocean level at which the rubber duckie is floating, versus the rubber duckie itself. A volatile roiling economic ocean with rapid changes in activity level is highly desirable; as BV multiple changes are large, and frequent. And if you are pretty sure the rubber duckie will not sink, the more violent the economic hurricanes the better. It is really just an application of Taleb’s Bar-Bell approach; the rubber duckie itself is one bell, the volatility of the ocean on which it floats is the other. The caution is that too much money, stuffed into the same sized rubber duckie, will eventually make it too heavy & cause it to sink; the rubber duckie has to either get bigger, or hatch ducklings. Hence multiple/sizeable acquisitions are not a bad thing. Very different approach. SD

HW makes mistakes, & does not walk on water. The cost of the hedges are the quarterly amortized premium + mark-to-market. Pay little for out of the money hedges & suffer more volatile marks, or pay more & experience less mark-to-market volatility. FFH got its insurance at the lowest possible price, & its investors pay for it in under performance. As already pointed out if FFH collected on the hedges tomorrow, you would not have to pay today's price for it. And if they do not collect you would not pay much above today's price, because you have no idea how big the next adverse mark-to-market will be. The hedges protect FFH, but do absolutely squat for its investors. And ... as most would argue this is not about to change, the result is pricing at no more that 1.0x BV. FFH almost lost it because they overstretched with TiG and C&F. But keep in mind - that raid could not have been initiated unless one/more of its major investors had actually lent their shares out; & the lending proposal would have not have flown, were the buy and hold cash yield on FFH not so low. To an investor, FFH is essentially a rubber duckie riding the ocean. Pretty sure it will not sink, but buy in the troughs, sell on the crests, & hope for hurricanes.

The smartest approach is to buy a utility just after a dividend cut. Media pisses all over the name, income investors panic & all dump at the same time, share supply greatly exceeds demand, & you get to lock in a nice low cost base. 5 years out the dividend will usually be close to what it was, & you'll have a 10-15% cash yield plus an unrealized gain. Buy & forget. Boilermaker: If you get exercised on, your strategy failed. You mitigated the failure through a willingness to actually buy in the position, & forfeited the possibility of being able to buy it in at a lower price. While that may be desirable if it is a lot of shares of a difficult to obtain stock, it is a rare exception.

Keep in mind: To optimize future return, you really have to assess the prospects of each existing investment every time you add a position or add/subtract from an existing position. Should that 4 bager bought 2 years ago, & working out, really be sold just because it’s a 2 bager today; and your portfolio design calls for 2.5x or better? And if that 4 bager also pays a cash yield? Point: prospects are not the same as seasoned investments, & cash yield is worth much more than potential yield. You also have to recognize the existence of house money in today’s position. That 4 bager bought 2 years ago may be funded today with 40% house money, or 100% house money inclusive of leverage; simply because of successful round trips or a partial sell down in the intervening years. And if the reimbursed funds are sitting in T-Bills, the real risk in the position is almost zero. Point: not all risks are the same. Simple fixes: Measure return as compound IRR based on (original cost – house money) + 1.5 (value factor) x cash yield The more house money invested the lower the PV, & the higher the IRR will be. With 100% house money funding - your return would be infinity, you would never sell (unless the coy is likely to decline), & 100% of your original investment would be in T-Bills. Assume at time T-2; PV is $10, FV is projected to be $30 in 4 years, & cash dividend is $0.50. A 3 (30/10) bager with a yield of 39.1% (31.60% IR%+.1.5(5.0%) cash yield. To beat this investment, you need the replacement to earn > 39.1% But after 2 years of round trips & profit taking at T=0, the PV is now $20, you have recovered $4/share of investment, & the cash dividend has risen to $0.75. This looks like a 1.50 (30/20) bager with a yield of 33.7% (22.47% IRR+1.5(7.5%) cash yield). To beat this investment, you need the replacement to earn > 33.7%, and you intend to sell because you want 35% or better….. But it should really look like a 5 (30/6) bager with a yield of 134.9% (123.61% IRR+1.5x7.5% cash yield). So you have effectively just sold your lowest risk investment, & replaced it with something else at roughly 4x (134.9/36.6) the risk, for the same return! And if you simply withdrew your remaining $6, & leveraged the $4 house investment, your return would be many times higher still. Not in the textbook. SD

Keep in mind the difference between get rich & stay rich. To get rich you must take risk; & it must work out. Small investments in many ventures where the odds on a win are maybe 2 in 3 or better; cost per venture an immediate write-off. You have nothing to lose & everything to gain - but you have to do it, before spouse & family tilt the ‘what you could lose’ against you. Something most youth just do not get. To stay rich you just need to outpace inflation; portfolio losses are your heir’s problem - barbell investments in low risk ventures with occasional high risk flyers. You have lots to lose, little to gain, & it starts right after you realize a material gain. Something most adults just do not get. You cannot stay rich unless you’re good at assessing risk. For most heirs, this will be a wealth manager earning the minimum return required. But risk assessment includes assessing yourself, & your capabilities as you get older; which most DIY investors just do not get. Serial entrepreneurship is no different to retaining your driving licence as long as possible; it is independence. The older you get the more valuable this is to you, & the more irritating it is to the public at large. The “act your age” social censure, versus fcuk ‘em! SD

Assuming liquidity: Look at the firms announcements & any industry pricing data over the last quarter. Estimate EV. If the result is a lower price expectation, sell 1/2 the holding & buy it back later. Long term, your objective should be a stable holding entirely funded with house money; but to get there you have to trade the odds, & trade patiently. On any given day, every holding is competing against cash for a weighting in your portfolio, & the bias is to cash (minimum risk). If you're wrong it's just an opportunity loss, & you still have 1/2 your original position. Assuming no liquidity: You either sell slowly well ahead, in expectation of a loss; or sell something else to raise cash for an additional purchase. The text book example is tax loss selling 60 days ahead, & repurchasing 30 days before the tax dead line. Tax loss, lower cost base, AND cash back. Also keep in mind that PM's are fired if they aren't always fully invested; you don't have the same liability. If a PM sells company X in Industry A, he/she effectively has to replace the weighting with another company in the same industry - even if the near term prospects for that industry are total Sh1te. You don't have to :) SD

Your friend is talking about Canadian Additiional Tier1 and Tier 2 regulatory capital, as defined in the OSFI 2013 CAR Guideline. FI's are permitted to issue CoCo bonds, that immediately convert into common equity based on some predefined regulatory trigger. The bonds are low cost 'engineered' equity, & exist to absorb losses &/or permanently boost regulatory capital in the event the bank gets into trouble. As in any company, when a company is near default - that business's risk transfers to its lowest ranked bond holders, as the business's equity has essentially been wiped out. If there are CoCo bonds there is an automated debt/equity swap that recapitalizes the company. http://www.osfi-bsif.gc.ca/app/DocRepository/1/eng/guidelines/capital/guidelines/CAR_chpt2_e.pdf http://lexicon.ft.com/Term?term=cocos SD

Welcome to the world of liquidity discounts. No-one is willing to sell because you're trying to buy too much, & too aggressively. If you really want the stock you'll pay up (higher demand, same supply). Either through additional commission on more buys, or via a higher price; your choice. Most bigger buys fill as a result of bidding for a large quantity at a lower, but generous, price; on the day of a significant adverse market. You are effectively acting as market maker & offering liquidity (at a price) to anyone who needs out - at a bad time in the market. Just be sure that it's worth marrying, because it could be with you for a very long time.

ubuy2wron: It is highly likely that we will see at least 1 new UK bank before year-end, with the right kind of dilution ;) It would seem that the outgoing governor is telegraphing the intent to break up RBS, & do it by moving retail depositors to new banks that have none of the Lloyds, Barclays issues, etc. Now if you can open up a new & unencumbered UK bank, with less capital, & favourable growth prospects - where do you think that incremental 'bank' investment is going to go? And do you really think the incoming governor is going to tolerate status-quo ? http://www.telegraph.co.uk/finance/newsbysector/epic/rbs/9912988/Sir-Mervyn-King-there-is-a-case-for-breaking-up-RBS.html http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/9897568/FSA-to-slash-capital-requirements-for-new-banks.html

You are short via the sold call; therefore if XYZ goes up another $1 you lose another $100. Instead of buying in the call you buy in 100 XYZ, & do it on margin; now if XYZ goes up another $1 you lose another $0, as the unrealized loss on the call is offset by the unrealized gain on the XYZ position. If you can margin XYZ at 65%, you had to put up $350 (100 x $10 x (1-. 65)) of equity to buy in the XYZ position. If that deep in the money call call costs more than $3.50 ($350 equity/100 shares), it is cheaper to buy in the shares vs the call. If you own that call you suddenly have a valuable asset that nobody wants to buy.

The signal is an actual admission letter; hair splitting between schools is just noise. Either school is a good choice, but look past the glitz. 7 years out; what you have done since graduation will overshadow where you graduated from. You are just 1 of X students, all in the same testosterone cloud, & all with same pedigree; superficial hair splits will determine your ‘ranking’ within the alumni & 75% of the benefit will flow to the top 25%. If you are not one of the 25%, you will have an intangible asset experiencing double declining depreciation at maybe 25%/year (to approx. the value of the ‘connections’); without one or two sizeable bonuses early on, you may well have a financial loss at the end of Year 7. If every graduate from school Y got what they wanted, the financial sector would be flooded with alumni from just school Y - but it is not; so where did they all go? The reality is that for most if they have not made it by year 7, they are not going to; and there is not much call for such a narrow study field outside of Wall Street, London, Hong Kong, etc. Every fund manager swears they are in the top quartile, but we all know that at least 75% of them have to be wrong. Those thousands of I-Bankers hitting the streets are telling you something. You don’t have to work in finance to practice value investing; for many it is actually a hobby that gets incorporated into their day-to-job, whatever that may be. As they move through life, they accumulate the benefits and if they are lucky, get to do something useful with it; managing OPM, venture financing, running businesses, import/export etc. The humble backgrounds of many on this board are a subtle message. If you’re young & unencumbered, grab the bull by the cohunes & squeeze. Enjoy the ride, but recognize that it doesn’t last forever, and have an exit plan. Good luck to you.

Put away the text book & think. Buy a 1 year call today of XYZ for $.50 at a $10 strike, or buy a T-Bill maturing 1 year out & use the proceeds to buy XYZ at $10 in 1 year ? If the intent is to buy, the T-Bill route is preferable (minimum risk); if the intent is to speculate the option is better. If the intent is to speculate why are you not selling the call for premium (at high volatility) and buying back under low volatility? Time decay works in your favor, & 70% of options expire worthless. Then keep in mind that you could just buy in XYZ on margin anytime you want to stop the potential loss on your short call; you do not actually have to buy the call back. That now deep-in-the-money call you sold has value, but no market, & bankers are not going to lend against it. Some things are not in the textbook for a reason ……

It is easiest to think of a straw (well) in a slurpy (oil field). When the slurpy is new it is easy to suck (primary production techniques) the drink (oil) up the straw; but as the drink drains the slurpy ices up & you have to suck harder (secondary & tertiary production techniques). Warm (frac, steam inject, etc.) the slurpy & for a time it gets easier (high flow rates), but it doesn’t last very long (rapid depletion). To get the last drop you put the slurpy in the sun (new technology) which melts it. How hard you suck (cost to produce) depends on how much you want the drink (what you can sell the oil for). If you can’t be bothered (price is low) you only suck until the drink is gone (lowest cost primary production only), then toss the slurpy (fields that require secondary & tertiary production techniques). Those secondary & tertiary production fields (shale, tight formations, etc.) get shut in until the price rises enough to warrant sucking harder. The reserve study basically says that at price X (ie: how hard you’re willing to suck at $80) you have Y of proven reserve (oil in the field), and Z of ‘other’ reserves (mystery oil if you can get it out). When X is high, proven reserve rises dramatically (as you can now afford to use secondary & tertiary production techniques, fracing, steam injection, etc), BUT ‘other’ reserves REALLY rise; however the relationship is not linear. Haircutting at today price (ie: $60) & multiplying by .9 (ie: [(60/80)*.9] x proven reserve) gives you a ballpark reserve value to work with. O&G is not much different to hotels; bankers are not going to lend at more than 50c in the $ at the bottom of the cycle. Multiplying the lower proven reserve (quantity) at today’s price ($60) gives an idea as to the maximum a banker would be willing to lend. Just as with mortgages, the bum (small O&G coy) versus the suit (large O&G coy), is the more likely to get their loan called in a downtown, especially if they are close to the loan limit (usually the case). The bum either sells assets to someone bigger (field consolidation), sells equity (dilution) to pay down debt, or sells out (merger). When prices rise again, you can not only afford to suck harder, but you also get to suck at a lower price as consolidation & technology have given you economies of scale. Reserves rise & your banker shovels money at you by now lending on the ‘bigger’ proven reserve at 60c in the $, AND giving you maybe 20c in the $ on the mystery ‘other’ reserves. You get free oil for zero cost, massive access to debt financing (to spend poorly), & minimal risk. Then keep in mind that some bums are really wolves in bums clothing; their exit is usually a sale to a bigger player in a rising market, after 1-2 cycles. Now if you are a value investor; 1) Isn’t the upward reserve adjustment really the realization of IV? Sell Signal 2) Doesn’t the non-linearity ensure that you will overshoot on the upside? Sell Signal 3) Isn’t some of the large company moat getting monetized via economy of scale? Sell Signal 4) And all while floating in a sea of available financing, looking for a place to get spent. Sell signal … And all you have to do is buy the mid-range consolidator, & wait for the price to rise.

Be careful when gas is being spun as equivalent to oil; oil you can sell ;) The quick & dirty for reserves is to look at the price the last reserve estimate was done at. Then multiply the reserve by (today's price/reserve price)*0.9. Multiple by 0.5 to get to the maximum debt that the reserve could carry. It is not precise, but more than good enough for predictive purposes. The ratio recognizes that at lower prices, some of the reserve will be uneconomic & get shut-in. The 10% haircut recognizes that shut-in's happen in clumps as collector lines are closed. The 50% collateral tells you who is going to have to sell &/or get foreclosed on. Then recognize that shut-ins are really a gift ;) A small rise in price brings back proven reserves at zero cost, & the opportunities that go with it.

It's great to see something like this, as it is testimony to the power of the internet, & indicative of how many future PM's are probably going to grow up; ie: you only manage OPM in the private partnerships you choose, & go the mutual fund/hedge fund route only if you don't have you own, or any other choice? We know the board from the early days of the FFH raid, & hopefully helped squeeze the orange so as to suck out as much juice as possible ;) Keep it up.

The reality is that to use these low prices, you have to make the energy intensive goods in the US - & then export the goods. You also have to recognize that without fracing the gas glut disappears, and pretty rapidly (shale depletion rates). So if you have 2-3 years before the glut disappears, what can you make? and how best to do it? Look at the smelters, foundries, etc. SD

We would put it to you that the overall approach wouldn't be much different to what he has already done. 1) Barbell approach (Taleb): T-Bills + calls; 2) Operations replacement (HW): Insurance float replaces the T-Bills; 3) Financial innovation: long-short calls/puts to nullify cash carry, & strip out alpha. In short ... a P&C insurance company getting paid thrice on its T-Bills (UW profit, T-Bill yield, securities lending) with zero cost options to exposure it to market volatility without any downside. Unfortunately, nobody would be able to buy into it :'( SD

How much exposure to banks can you really have? Adding that .. nth bank in currency X or Y really isn't going to add much, & the instrument has to at least offer the leverage of a long term option (warrant, etc). A Barclay's without BarCap will not generate the media sound bites - but it will be a lot smaller, easier to run, cheaper (lower earnings), backed by better quality earnings, & more likely to avoid nationalization. What isn't recognized is that whatever you buy; you are going to have to marry, as you are locking in today's low price in expectation of a rising dividend yield & a future higher share price. Today 3% dividend yield becoming 10-15% 5 yrs out .... & then because it is so high - leveraging against today's purchase to buy the next security. ie: Buy & hold ... forever. For this kind of an investment she had better be worth it! SD

You might want to look around you a bit .... The string of month-over-month US employment gains would suggest that the US economy has probably turned. Similar shoots elsewhere ... & every month we get further from green poop. A bump up this year is really a bet on post traumatic growth (Taleb). Probably reasonable, as survivor B/E's are far lower than they were, & most still have a fair bit of remaining capacity. Small revenue improvements are more than likely going to flow straight through to the bottom line, & generate upward earnings bias. Then the bond world ... duration reduction, & a modest re-allocation (<10%) to long term warrants, convertibles, options, etc ? (Taleb barbell). The BAC, AIG, & the TARP warrants that everybody loves? And when everyone starts moving in one direction ... the rest of the herd follows, and amplifies the move. HF algorithmic trading then amplifies it even more .... & the more gaming of the system the more reliable the outcome (antiifragility?) High cash AND some option positions. SD

40%. High as we did very well on the RIM hype ;)

Think a little longer term .... When WEB &/or Munger retire where do think the NA value community is going to go? And aren't the growing size of the FFH dinners, & the growing number/quality of folks on this board, an indirect indication of the future probabilities? You pay an annual premium & buy life insurance to get a tax free payout upon expiry. OR ... you can pay an annual premium & buy a long call/leap on FFH to get a tax free payout (tax free accounts) on WEB &/or Munger's retirement? ... and you pay for it by either annually reinvesting some BRK gain/divs in FFH calls/leaps, or periodically selling down BRK & buying FFH. The FFH discount to BV disappears re the long term arbitrage, & tends toward a premium the more it looks like WEB &/or Munger is getting ready to retire. It IS a pair trade ... just not the way that most would think of it. SD

You might find it useful to think out of the box a little: The only major way you get a large, long-term, loan book is to lend to bums. The good corporate credits are going to issue their own lower cost paper (LIBOR+, CP, BA, bonds, etc) to pay you off, as soon as they can. Good individual credits are either paying down monthly (P & I), or have the ability & intent to pay down at some future date of their choice. You have a book of bums and a book of 'churn'. When there hasn't been much economic activity for an extended period, the churn book is smaller than normal, you do what you can to frustrate the good credit's ability to leave, & the bums wag the dog. A good chunk of the bum book is often money-laundering related; there was never intent to repay, & the launderer did it to indirectly control the bank. The bank will lend additional funds to service the loan interest, or watch the loans default & the write-off wipe out the banks capital. And if the bank lends ... its shareholders will receive 'earnings' on those loans, the market will grant a higher share price, & everybody walks away with bonus. That 'new' money ultimately comes from the spread on the churn book. Repaying a loan lets a bank 'play the game' a little longer; it is effectively an insurance premium against the bank collapsing in the near-term. Investing the savings increases the bank's churn book (recipient borrows against your equity investment to expand the business) to produce additional margin. Both essentially produce the same result. Notable is that whether the bum is the underworld, or a sovereign, you get the same result. If Greece fails to service its debt, prominent German & French banks collapse. If XYZ fails to service, prominent Arab banks collapse ... but the Emir still gets to keep those nice buildings in the desert ;) The capitalist solution is to periodically deliberately collapse banks, & start fresh. Unfortunately, that is waaay too anti-fragile!