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HWIC Investment Returns?


txlaw
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I'm curious.  When you guys are trying to determine the intrinsic value of Fairfax, what types of investment returns do you use for HWIC going forward?

 

For the equity portfolio, I use a pre-tax return of 12%.  For the fixed income portfolio, I use a pre-tax return of 9%.

 

Do you think I'm being too optimistic here?  I'm particularly interested in hearing what people think about the fixed income returns going forward, as I don't know much at all about fixed income investing.

 

Also, how has HWIC been able to generate such a high return on its fixed income portfolio?  Based on their AGM presentation, they appear to have blown out many well regarded funds such as Pimco's various total return funds.  Is it because they have significant fixed income investments outside of the U.S.?

 

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I'm curious.  When you guys are trying to determine the intrinsic value of Fairfax, what types of investment returns do you use for HWIC going forward?

 

For the equity portfolio, I use a pre-tax return of 12%.  For the fixed income portfolio, I use a pre-tax return of 9%.

 

Do you think I'm being too optimistic here?  I'm particularly interested in hearing what people think about the fixed income returns going forward, as I don't know much at all about fixed income investing.

 

Also, how has HWIC been able to generate such a high return on its fixed income portfolio?  Based on their AGM presentation, they appear to have blown out many well regarded funds such as Pimco's various total return funds.  Is it because they have significant fixed income investments outside of the U.S.?

 

 

Any reason you are discounting their returns on equities and not the returns on bonds?  I mean if you're going to be conservative why not assume something less than 9 on fixed income :).  If you work with 10% on assets you'll have an idea of what the best likely scenario would look like, 6-7% far more conservative. 

 

I'd be quite satisfied if the stock portfolio doubled from current levels every 5 years, Without adding to it they'd have 16 billion dollars in stock 10 years from now  Its scary to consider what it would look like if they maintain their historic rate of return.

 

Cheers. 

 

 

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Also, how has HWIC been able to generate such a high return on its fixed income portfolio?  Based on their AGM presentation, they appear to have blown out many well regarded funds such as Pimco's various total return funds.  Is it because they have significant fixed income investments outside of the U.S.?

 

Could it be that they have the best bond guy around? Period.

 

i.e) Last fall and winter when everyone was piling into US treasuries what was FFH doing?  They did the same thing in 2002, 2003. and undoubtably before that.

 

 

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Einstein said something along the lines of "things should be made as simple as possible, but no more so"

 

I believe the corollary applies here - things should be made as precise as possible but no more so.

 

With that in mind, I would suggest that you assume FFH grows book value at 15% per year for the next 5 years or so- if you want to do some sort of intrinsic value calculation.  I don't think more precise calculations of float, stocks and bonds will get you a more accurate answer.

 

Also, I think it is important to note that while HWIC has a VERY VERY good track record in bonds, a lot of that track record took place during a period of higher interest rates. I think doing 300 basis points better than ten years treasuries is a pretty darn good result. That would be about 6.5% in this environment.

 

I know the muni bonds are already getting them most of the way there, and they have done better in bonds (as well as BV growth) in the last few years. I think my estimates above are conservative (even though they suggest massive outperformance of the industry over time). I think they will do better, but I wouldn't want to count on it. It will just be a nice bonus if it happens.

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My analysis is pretty bare bones. I am comfortable owning FFH at below 1.3 - 1.5 BV. If its above BV then I would want decent and consistent underwriting profits and a decent basket of undervalued securities / or an overall undervalued market. A hard market also would be desirable above BV. At much more then that then I will look to sell and buy back around or under BV.

 

Under Book seems like a no brainier especially if you can see what they are investing in and review their FI yield.

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Any reason you are discounting their returns on equities and not the returns on bonds?  I mean if you're going to be conservative why not assume something less than 9 on fixed income :).  If you work with 10% on assets you'll have an idea of what the best likely scenario would look like, 6-7% far more conservative.   

 

I use 12% for the equity return because, according to the AGM presentation, that's how they've performed over 15 years when not considering equity hedges.  I use 9% for the fixed income return because they've consistently earned over 9% on the portfolio over 5, 10, and 15-year periods. 

 

However, you're probably right about using between 6% and 7% for the bond return in order to have a margin of safety built into the model, given the lower interest rate environment.

 

Note that it's unclear to me whether the AGM presentation is talking about returns on the portfolios before or after tax. 

 

 

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BTW - Dont do intrinsic value calculations... Cant imagine they are ever accurate.

 

I agree that intrinsic value calculations are not accurate in terms of precision, but I completely disagree with you in abandoning the exercise of trying to calculate intrinsic value.  I tend to have an appraisal range for a potential equity investment a la Seth Klarman in Margin of Safety. 

 

Note that even Longleaf uses a metric they call price to value (P/V) to serve as a reference point for judging the value of their portfolio.  From the 2008 Partners fund annual:

 

The price-to-value ratio (“P/V”) is a calculation that compares the prices of the stocks in a portfolio to Southeastern’s appraisal of their intrinsic values. P/V represents a single data point about a Fund, and should not be construed as something more.We caution our shareholders not to give this calculation undue weight. P/V alone tells nothing about:

 

• The quality of the businesses we own or the managements that run them;

• The cash held in the portfolio and when that cash will be invested;

• The range or distribution of individual P/V’s that comprise the average; and

• The sources of and changes in the P/V.

 

When all of the above information is considered, the P/V is a useful tool to gauge the attractiveness of a Fund’s potential opportunity. It does not, however, tell when that opportunity will be realized, nor does it guarantee that any particular company’s price will ever reach its value. We remind our shareholders who want to find a single silver bullet of information that investments are rarely that simple. To the extent an investor considers P/V in assessing a Fund’s return opportunity, the limits of this tool should be considered along with other factors relevant to each investor.

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Some questions I've been turning over in my head regarding investment results going forward:

 

How will the diversification of FFH into insurance companies located abroad affect investment returns going forward?  Polish Re and Advent, for example, may have substantial investments in European bonds and equities.  Hard for me to tell what sort of affects this will have going forward.  Also, while some of the diversification is from minority investments (e.g., ICICI Lombard and Arab Orient), perhaps HWIC is learning about how to optimally invest in these countries from the homegrown managements of these companies. 

 

 

What sort of returns can we expect for FFH's distressed company investments such as Abitibi, the Brick, etc.?  I have to admit that I haven't done any analysis of these positions.  Is FFH going to try to compete with the likes of GE Capital, Brookfield Asset Management, and other distressed investment shops?  If so, do they have the chops to do this?

 

 

Does size matter at this point?  Are we at a sweet spot in terms of size in that we can use financial muscle to obtain opportunities we've never had before (e.g., DIP financing investments)?  Does diversification abroad mitigate any size issues if there any?

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8% on the overall Fairfax portfolio is what I like to use. I understand it is below the 9.8% that they have achieved historically, but based on how much they hold in cash and bonds it is seems about right to me. Then JNJ, WFC, USB, GE and KFT is almost like holding the Dow. Together, they are unlikely to deliver 20% a year even at current level.

 

To go beyond 8%, they will either need to increase their equity exposure or to find some low capital/high return tool like the credit default swaps. The latter are very unique opportunities and don't come very often (once a decade?). So I prefer to be on the conservative side, but I also think that 8% is realistic based on their asset mix, HWIC skill, portfolio size, typical holding period, etc.

 

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