2013 results are out

[Parsad]

There must be something I dont understand about those hedges.

 

So the stock market goes up, FFH make money on their stock but lose that money because hedges lost value. So we are even.

 

In 2 years, the stock market goes down as the stocks FFH own, but they make money on their hedges. We are even again.

 

How do they expect to make money with that strategy? What is the trick I dont understand?

 

They've been selling the stocks and reaping the gains as the market went up.  Those gains won't disappear if markets correct.  Cheers!

 

Based on my understanding, they had to realize hedge losses to keep that ~100% hedge stance. Those gains instantly disappeared.

 

Your assumption is that markets won't turn the other way.  If they don't, then Fairfax was very wrong.  If they do, then they won't look so stupid. 

 

I don't see the same possibility of a massive correction like they do, but at the same time, do any of us really think that Europe has finished restructuring?  The U.S. has yet to tackle it's debt problem...which is up to $17T now!  Things could go sideways for a long-time as Europe restructures...those deflation hedges could be huge. 

 

Only time will tell if they were right or wrong.  So far...very wrong!  Cheers! 

[obtuse_investor]

Just to be clear, my biggest issue with the approach has been the "equity hedges".

 

I am quite ok with the CPI derivatives because they don't cost much and is reasonable insurance against an economic catastrophe. In fact, it was encouraging to see them consistently increase their strike price for Europe and France. If and when there is deflation expectation in the market, I bet it will show up in Europe first.

 

Europeans (read: Deutschland) have historical reasons to be very averse to money printing, unlike the US. Europe is so terrified of the inflation monster that they are ignoring the deflationary one lurking right behind them.

 

[Aberhound]

The reason why the large bond losses and massive equity hedge losses are so unsettling is that the logic of the positions are so unlike Prem. In 2009 he spoke how undervalued the stocks he held the the banks and J&J were. He believes in Austrian economics. He quotes Menger "the bigger the boom the bigger the bust". He reads all the Fed papers. He knows Bernanke is going to print like crazy because that is what Bernanke said he would do in his 2002 speech.

 

Yet he buys hedges which lose money and force you to pay cash if the market rises?

 

He is the master at finding asymetric risks. Yet instead of buying hedges like an Austrian thinker during the boom he buys them in the bust when the asymetric risk is against you? Now is when you take the risk, not 2009, yet he now reduces the bet by about 1/4 locking in much of the losses? Prem is almost always right long term so he normally increases the bet as Mr. Market gets more irrational.

 

The $400M reserve release when the average combined ratio averages about 100 during the one light year is also unsettling. We are at solar maximum at the start of a Maunder or dalton like minimum. The winter storms are going to get much worse. Earthquakes are getting worse. Releasing reserves now is like banks releasing reserves in 2008 after the mortgage crisis has already started.

 

It is so unlike the Prem I have studied since 2002 that it is like someone has a gun to his head. I can't explain it. It is weird. He continues to display incredible talent in stock selection and most of his bond trades. Look how he sold hundreds of millions of Canadian bonds but kept the Us bonds seemingly in anticipation of the strong USD. It is like he has isolated brain fog only when it comes to total return swaps.

 

 

[giofranchi]

Prem is almost always right long term

 

This is the part I agree with... ;D ;D ;D

 

Gio

[SharperDingaan]

We must be on some other planet ...

 

FFH LOST $31.15/share in the year, in spite of a very benign casualty year, and an $400M reserve release. One of the best possible outcomes and they still lose money?

As Eric points out, 2-3% growth over 3 years - & even less if compounded. Apparently this is a good thing?

 

No denying this is a well run company, & they know how to invest - but come on ...

 

SD

[Partner24]

2009-2013:

 

Berkshire, Markel and Bidvest: mostly no directional bet (big macro things), build the company with an ark that will do fine if we get some rain and fine if we get some drought (reach for the silver medal)

 

Fairfax: directional bet, build the company with an ark that will do great if we get some rain and bad if we get some drought (reach for the gold medal). Fairfax positioned themselves as being very prudent and conservatives, but in fact it was not 100% the case. They had a pessimic view of the macro things, an optimistic view on on their own ability to predict them and they made a bet accordingly. I can't blame their own self-efficacy to do these things (they have a terrific track record on these things), but let's call a horse a horse. The sun shined over the last few years, we did get some drought and FFH performance over that period have been very so so. They didn't get the gold medal and are far from being on the podium 5 years later. Berkshire and the likes are having a good fundamental return (the silver medal).

 

That being said, I was all aware of their respective strategies 5 years ago, the possible outcomes of them and I tell you it would very easy to look at the rearview mirror and position yourselves as victims, but all of you that were shareholders 5 years ago should have been aware of these scenarios and the possible outcomes related to them. That being said, Prem could have been more candid and call their directional strategy as a pessimistic bet instead of positioning themselves as the very prudent and conservative people. I'm happy to have a very significant part of my portfolio in other great companies like Markel and others that reach more prudently for silver medals and regarding FFH, I still keep my shares. I say that if things don't change over the next 2 years or so, FFH were not only far too early in their predictions and bets, but were also fundamentaly wrong. It's clear that they were too early and it did cost us a lot of money so far, not still 100% clear about being wrong.

 

Cheers!

 

 

 

 

 

 

 

 

 

 

[Partner24]

And you can say thanks to Mother nature for the underwriting profit this year. If we had some major underwriting losses, it may have been a horrible year instead of a bad one.

 

Cheers!

[Parsad]

2009-2013:

 

Berkshire, Markel and Bidvest: mostly no directional bet (big macro things), build the company with an ark that will do fine if we get some rain and fine if we get some drought (reach for the silver medal)

 

Fairfax: directional bet, build the company with an ark that will do great if we get some rain and bad if we get some drought (reach for the gold medal). Fairfax positioned themselves as being very prudent and conservatives, but in fact it was not 100% the case. They had a pessimic view of the macro things, an optimistic view on on their own ability to predict them and they made a bet accordingly. I can't blame their own self-efficacy to do these things (they have a terrific track record on these things), but let's call a horse a horse. The sun shined over the last few years, we did get some drought and FFH performance over that period have been very so so. They didn't get the gold medal and are far from being on the podium 5 years later. Berkshire and the likes are having a good fundamental return (the silver medal).

 

That being said, I was all aware of their respective strategies 5 years ago, the possible outcomes of them and I tell you it would very easy to look at the rearview mirror and position yourselves as victims, but all of you that were shareholders 5 years ago should have been aware of these scenarios and the possible outcomes related to them. That being said, Prem could have been more candid and call their directional strategy as a pessimistic bet instead of positioning themselves as the very prudent and conservative people. I'm happy to have a very significant part of my portfolio in other great companies like Markel and others that reach more prudently for silver medals and regarding FFH, I still keep my shares. I say that if things don't change over the next 2 years or so, FFH were not only far too early in their predictions and bets, but were also fundamentaly wrong. It's clear that they were too early and it did cost us a lot of money so far, not still 100% clear about being wrong.

 

Cheers!

 

Nice Olympics analogy Partner!  C'mon Prem...own the podium!  Cheers!

[Uccmal]

We must be on some other planet ...

 

FFH LOST $31.15/share in the year, in spite of a very benign casualty year, and an $400M reserve release. One of the best possible outcomes and they still lose money?

As Eric points out, 2-3% growth over 3 years - & even less if compounded. Apparently this is a good thing?

 

No denying this is a well run company, & they know how to invest - but come on ...

 

SD

 

Sd, I agree wholeheartedly.  Enough excuses already.  I hope some of these shareholders will ask some hard questions this year, and not accept fluff for answers. 

 

Years are being lost here. 

 

 

[Yours Truly]

Anyone have any idea as to why FFH is paying out a dividend? Could they not find better use? or did they want to attract a different type of investor and be more similar to their peers?

[ourkid8]

Sorry to sound like an ass but please do a basic search.  That topic has been discussed to death and it will never change.  Fairfax will always be paying out a dividend.

 

Tks,

S

 

Anyone have any idea as to why FFH is paying out a dividend? Could they not find better use? or did they want to attract a different type of investor and be more similar to their peers?

[SharperDingaan]

Couple of quick observations ...

 

We have not invested in FFH, other than dividend related purchases & sales in Dec/Jan, for at least the last 3 years.

 

FFH has to realize that they make their money by taking on net risk, & getting it right. Great investing offset with opposing hedges nullifies one of the biggest competitive advantages they have, & is akin to having a Ferrari that you never take out of first gear. If I just want to get from A to B, I'll use a beat-up VW, & at maybe 1/20th of the cost. Yes the Ferrari could very easily crash & burn ... but that's why you put it in the hands of a F1 driver (preferably not Italian!), & not a mere mortal.

 

It is highly likely that FFH has a systemic management reporting problem; as how else can very smart folks consistently forget what their business is? The best analogy is a sales force taking market share - & positive they are doing great; then discovering that every sale was putting them further in the hole - as they were selling for less than it cost to make the product. And all because nobody realized that the weekly management report they were basing decisions on - was missing some costs.

 

Judging from the boards year-end investor returns, over the last 3 years - most people on this board probably had better returns than FFH did. OK, it is not scientific, but suddenly everybody is investing better than HW? Either HW has been drinking a lot of cool aid, there is something very wrong in the shop, or we're all brilliant!

 

We hope they do very well, but we just want to go from A to B with no fuss.

 

SD

 

 

 

[bluedevil]

Couldn't the same argument that you all are making now have not also been made seven years ago -- in early 2007?

 

The reason I keep most of my invested money with Fairfax is because their investment managers have demonstrated long-term success, the right theoretical foundation as long-term value investors, and they have the organizational and business structure, patience and courage to stand apart from the herd.  They are doing that right now, and as shareholders I believe we will reap the rewards in the not too distant future.

 

Yes, I wish with the benefit of hindsight they had ridden up with the stock market and put their hedges on now.  I also wish they had ridden the last three or four bubbles up to the top, then got out at exactly the right time.  But as Prem said today, better to be wrong, wrong, wrong, right, than to be right, right, right, wrong.

 

Stocks are overvalued.  (Does anyone disagree with that?)  Risk premiums are too narrow.  (Does anyone disagree with that?)  That will change, eventually.  And Fairfax will be positioned well.

 

In the meantime, they will also keep building an insurance platform that has steadily improved for years now.

 

It is simple in my mind.  When you pair great investors with good underwriting, the results will be very good, especially when you buy in at a reasonable valuation.  I think Fairfax has still got each of those ingredients.

[SharperDingaan]

Bluedevil, simple example;

 

Assume we have a long US large cap equity portfolio managed by a very good PM, and a hedge on the US Russell Small Cap Index. We can all see the basis difference, but what we don't see is that a brilliant 10% return on the large cap may be only 2% after the hedge loss on the Russell Index. Per the SML maybe we need a 6% return on this portfolio.

 

The PM silo did brilliantly, he/she earned 10% versus the 6% required. The hedge silo did brilliantly, & covered the downside risk at minimal risk. But combined - they earned barely better than a T-Bill, at many times the risk, & did so because nobody was looking at their combined return (management reporting lapse). The solution would have been to reduce the hedge, so they come out at 6%; or NOT hedge - if they cant earn better than the required SML return. 

 

... and this is just one of the many obvious solutions.

 

SD

[ERICOPOLY]

It's not as simple as right, right, right, wrong, vs wrong, wrong, wrong, right.

 

They changed how they do things.  Back in the 2007 version, they had out-of-the-money index calls to hedge against the possibility of the markets shooting up.

 

This time, they chose not to do that... so, Murphy's Law -- the markets went straight up.

 

That simple change in tactics is what this fuss is mainly about.

 

In both cases, they were hedged.  So there is more to talk about than whether or not they are hedging for collapse of equities.  You can achieve that without getting run over on the upside.

[Grenville]

They changed how they do things.  Back in the 2007 version, they had out-of-the-money index calls to hedge against the possibility of the markets shooting up.

 

I didn't realize (don't remember reading about it/started investing in FFH in 08/09) they had out of the money index calls to hedge on the upside in 2007! I'm surprised they didn't do the same here, it's cheap insurance just like the CPI derivatives.

[ERICOPOLY]

Straight from the 2006 Fairfax Annual Report -- copy/paste (with emphasis added in red):

 

At December 31, 2006, as protection against a decline in equity markets, the company had

short positions in Standard & Poor’s Depository Receipts (‘‘SPDRs’’) and U.S. listed common

stocks of $500.0 and $99.6, respectively (2005 – $500.0 and $60.3, respectively) and equity

index swaps with a total notional amount of $681.4 (2005 – $550.0). The company has

purchased near dated call options to limit the potential loss on the SPDR short positions and

the equity index swaps to $131.1 and $31.6, respectively, at December 31, 2006 (2005 – $112.1

and $110.0, respectively) and as general protection against the short position in common

stocks.

[Grenville]

Thank you for the detail from the AR. I read those ARs, but my memory isn't that good. That detail just didn't stick.

[bluedevil]

SD:

 

If I understand you right, I think the response is that they are betting that their stocks will outperform the hedges in the long run.  They buy cheap stocks, they short an overvalued index, and those two things offset each other to some degree but over time the index will lose more than your stocks will and it will be a net benefit.  So far they have been on the wrong side of that, but that is likely to reverse.

 

As Prem put it today:

 

So we are focused on protecting ourselves first and foremost, and not making as much. Again, we’ve -- some of you will say we are hedged and 100% hedged on the upside and 100% hedged on the downside, so Paul, how are we going to make any money? And what happens, we’ve realized a lot significant amount of gain, $1.3 billion from the common stock portfolios and we’ve reinvested it in things that we like which are significantly down from where they were.

 

And we are protecting our portfolios, equity portfolios from significant drops, not a 5% and 10% drop, but like 30% plus drops. That’s what we are worried about Paul. And that environment, the fact that we’ve sold our common shares that have done very well and but things that haven’t done as well, means that we’ll be protecting on the downside, we don’t expect to go down as much as the indices.

 

And that’s happen in the past, it happened more recently in 2008, that we came down significantly less and made a lot of money on our hedges and we think that yet to happen.

[SharperDingaan]

They have to deliver in this timeframe, all the time, & at an amount in line with the SML expectation.

You do not get to deliver some now & some later .. in the long term.

 

SD

[Rabbitisrich]

If anyone goes to the AGM, please ask how the Fairfax team has updated their macro views given performances in Australia, Canada, and now Japan. As much as Watsa and co. deserve respect, it's important to distinguish between being right on portfolio positioning vs. being right on the economics. Too tempting to confuse useful rules of thumb with sound logic. Was a "Lehman Moment" inevitable? Did it really have to be a great recession vs. a less volatile period of reset? The world has not provided us with enough information to come to a definite conclusion.

[LowIQinvestor]

Maybe Dan Loeb will be there and ask Fairfax about their BBRY thesis !?

 

http://www.ft.com/intl/cms/s/0/648ab300-95c9-11e3-9fd6-00144feab7de.html?siteedition=intl#axzz2tLrXSxpn

 

 

[giofranchi]

We must be on some other planet ...

 

FFH LOST $31.15/share in the year, in spite of a very benign casualty year, and an $400M reserve release. One of the best possible outcomes and they still lose money?

As Eric points out, 2-3% growth over 3 years - & even less if compounded. Apparently this is a good thing?

 

No denying this is a well run company, & they know how to invest - but come on ...

 

SD

 

SD,

I take the exact opposite view: from the second half of 2010 until 2013 FFH couldn’t have been more wrong, yet they still managed a 2-3% growth. To be so much wrong, and yet to be able not to loose capital is imo an impressive risk-management feat.

 

Think for a moment about the experience of Mr. Bruce Berkowitz in 2011: he was wrong for less then a year and lost almost half of his AUM… Now, compare that with FFH: 3.5 years of being totally wrong, and yet practically no damage to its capital… And you might start to see the resilience of FFH! ;)

When they are right, and sooner or later they will, FFH will post spectacular results. :)

 

This is not to say they have not made mistakes (and me too alongside with them!). They, WE, have most surely made mistakes! But that’s precisely what gives me confidence in the fact that, when they finally do things right, returns will abound and will be plentiful.

 

Gio

 

[giofranchi]

Conference Call Transcript

 

 

Gio

fairfaxs-ceo-discusses-Q42013-results.pdf

[SharperDingaan]

As already mentioned we are not long term FFH investors, but a final note, to close the subject.

 

In practice, a P&C's long run return will consist of consistent CR < 100, consistent use of COF (float) below market rate, and alpha on its investment portfolio. You get the CR through good underwriting, float through premium expansion/contraction, and alpha by exceptional investment prowess. Most would argue that global warming should be pressuring UW, global money printing should be reducing float spread, & that to do well you are really relying on alpha. Where FFH excels at.

 

We would suggest that their reporting is measuring alpha very well. However, they seem to have a problem with beta capture, net of the hedge overlay. The result is over hedging, and an investment return that is primarily alpha; not alpha + beta.

 

What bothers us is that hedge overlays are usually a top-of-house responsibility, we have seen a number of questionable bets over the last few years, & there is a marked refusal to cut losses. Mistakes are OK, but they seem to be piling up.

 

Last time something like this occurred they almost lost the company; & those shorts could not have borrowed their shares in sufficient quantity unless there was smoke. We are not suggesting we are there again, but the risks are escalating.

 

Nothing that cannot be fixed, but it shouldn't be there.

 

SD