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Reduction in Equity Hedges to 50%


valueinvesting101
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As a result of this action, equity hedges currently represent approximately 50% of the company's equity and equity-related holdings (a reduction from 112.7% at September 30, 2016). Fairfax will continue to evaluate the post-election U.S. economic indicators and may determine to reduce those equity hedges further.

 

 

http://www.fairfax.ca/news/press-releases/press-release-details/2016/Fairfax-Financial-Holdings-Limited-Reduction-in-Defensive-Equity-Hedges/default.aspx

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Agreed, Jurgis.

 

While this has clearly been an awful hedge (I wasn't prepared to make this statement until it was closed out, although I know others were), they are at least being consistent: they have been very vocal about the impact of economic reforms in India and I think they are applying the same rule book here.

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Guest wellmont

 

 

Wow! On other hand, Bruce Flatt is going diametrically opposite with cash hoard!

the PW of the US is also accumulating a massive war chest.

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Prem has been beating the drum for years on the disconnect "between the markets and the economic fundamentals". How does the election of trump warrant a 180-degree flip in strategy? Reads like a complete capitulation to me as the market hits record highs.

of course it's a capitulation. he is not going to admit that, though.

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For all of you who have been pounding the table and hating the hedges, this dramatically increases Fairfax's earnings capability which should be massively bullish - especially since it's down some 10% over the last 5 days.

 

I don't personally like the move, but I have to say - I did the same thing. I removed all my short hedges yesterday. Not because I think the markets are in any less danger, but because I think Trump's cutting the corporate tax rate and repatriating billions to the U.S. at 10% could be the "blow off top" that supports equities at a higher level for the near term before we see the drop I've been anticipating.

 

I didn't want to be short and managing the margin calls if the equity markets went higher by 10-15% so I closed everything out and am sitting on my hands watching now.

 

Surprised to see this about-face turn in Prem though. It's easier for me to be tactical with the thousands that I trade. I'm blown away by how quickly they changed their minds on how a multi-billion portfolio was positioned. I guess it's a good thing they can still turn on a dime.

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Prem has been beating the drum for years on the disconnect "between the markets and the economic fundamentals". How does the election of trump warrant a 180-degree flip in strategy? Reads like a complete capitulation to me as the market hits record highs.

 

It is a capitulation. 

 

As for why the election changes things, I'm reading across from PW's comments on Modi: he seems to be a believer in how pro-business government can spur growth (and reflation) and clearly he sees that in a Republican clean sweep (as do I, at least to a point).

 

My bigger issue is why he hedged 100% (as opposed to 50%) of his equities to start with, but that's been discussed endlessly here.

 

One thing I will say in favour of this decision: many on here have questioned whether FFH are capable of changing their minds when the facts change.  They are.

 

Whether it is the right thing to do is another matter.

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I don't personally like the move, but I have to say - I did the same thing. I removed all my short hedges yesterday. Not because I think the markets are in any less danger, but because I think Trump's cutting the corporate tax rate and repatriating billions to the U.S. at 10% could be the "blow off top" that supports equities at a higher level for the near term before we see the drop I've been anticipating.

 

I've been thinking the same: lower taxes and reflation = a blowoff top, soon to be punctured by rising rates.  I wouldn't invest on that thesis but I wouldn't bet against it either. 

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Yes, it's not unreasonable to think that the markets may go higher on a tax deal and it won't be comfortable to be short if the markets go on a tear. But at the current valuations taking the hedges is still a head scratcher given it was a high conviction position all the way up here. Plus the implication: are we market timing now?

 

The one encouragement is I have from the reduction in hedges is that Fairfax is maybe getting out of the macro game and going back to being pure value investors.

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One thing I will say in favour of this decision: many on here have questioned whether FFH are capable of changing their minds when the facts change.  They are.

 

Whether it is the right thing to do is another matter.

 

I think the reality is that they realized quite a while ago that their equity hedges were a bad decision.  They just needed some event so that they could “save face”.  Trump was simply a convenient excuse to reverse a decision and say “Yeah, we are removing the hedges because of Trump” instead of “Yeah, we are removing the hedges because we were wrong.”

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re deflation hedges - hope not.  They have a low cost basis now and are still a good hedge.

I don't see any economic scenario where it makes sense to remove your equity hedges at a lofty valuation but it doesn't make sense to remove your deflation hedges.

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One thing I will say in favour of this decision: many on here have questioned whether FFH are capable of changing their minds when the facts change.  They are.

 

Whether it is the right thing to do is another matter.

 

I think the reality is that they realized quite a while ago that their equity hedges were a bad decision.  They just needed some event so that they could “save face”.  Trump was simply a convenient excuse to reverse a decision and say “Yeah, we are removing the hedges because of Trump” instead of “Yeah, we are removing the hedges because we were wrong.”

 

Do you have any evidence for this?  I'm not disputing it, but your view (that they care about saving face) is quite important and carries much more weight if you have a reason for it than if you're sitting at home guessing (like I am).

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re deflation hedges - hope not.  They have a low cost basis now and are still a good hedge.

I don't see any economic scenario where it makes sense to remove your equity hedges at a lofty valuation but it doesn't make sense to remove your deflation hedges.

 

It's not (or at least, it shouldn't be) about predicting an economic environment.  It's about protecting yourself from a possibility that would ruin your business, at a low cost.  The key difference is that the equity hedges were very, very costly.  The deflation swaps are on the balance sheet for bugger all.  Leave them there, would be my choice.

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Wow.  Quite the week....

 

My guess too is that they have been wanting to wind down these equity hedges and this provided a convenient time.

 

In the grand scheme of things, the S&p500 is at the same level as ~24 months ago (increased by ~5% in 2 years)... I believe international has done less.  So, if measured against the broader market, one could think of it as removing the equity hedges 24 months ago.  We all know that Prem manages an active portfolio which does not always agree with the S&P.  Is there a chance over the past year or two that his equities have under performed and therefore over the short term, maybe the hedges were beneficial?

 

This recent move though boils down to two things for me; the past and the future.

 

Past - 100% equity hedges was quite a confident bet. Prem surely didnt win and he may or may not have lost depending on how you look at things.  He didn't lose money but he didnt make any.  There were times when the hedges appeared to be genius and others when they did not.  We all know what the current book value is, and this represents the past up until today (or end of Q3).  That is a fact which then brings us to trying to predict the future...

 

Future - We need to remember that FFH is still 50% hedged.  If the markets continue to rally then FFH has done well and unleashed earnings power (we can think of it as getting out of a bear market).  If the markets tank... well, they are still 50% hedged but PW will probably slam his head against the desk.  The future is simply unpredictable and I am in favor of less hedging and more buying undervalued stocks/bonds.  I personally prefer the BRK or MKL method of knowing that securities bought at a fair or cheap price will gain value in the future.  That is simply the most cost efficient and proven method to compound money trading equities.  Prem has proven he can do this very well, especially in the bond market.  Now he has $10b from his bonds sale and removed 50% of his hedging.  Many folks are raving about BRK having $100b in cash, as am I, so we should be welcoming FFH new position if we think in the long run that capitalism will prevail.  Lets get excited here about the future.

 

As many folks have said though, you invest in companies like BRK or FFH because you have faith in WEB or PW.  I have faith that PW can produce a better return than I can.  That is why I chose to invest.  I understand that buying low and selling high is very difficult, I probably would not be the best at it, but that PW has a great track record of doing just that.  My only concern is that he may have just sold low and bought high.... Only time will tell. 

 

Looking forward to following more of this journey with everyone here!

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One thing I will say in favour of this decision: many on here have questioned whether FFH are capable of changing their minds when the facts change.  They are.

 

Whether it is the right thing to do is another matter.

 

I think the reality is that they realized quite a while ago that their equity hedges were a bad decision.  They just needed some event so that they could “save face”.  Trump was simply a convenient excuse to reverse a decision and say “Yeah, we are removing the hedges because of Trump” instead of “Yeah, we are removing the hedges because we were wrong.”

 

This.  I got rid of my shares 4-5 years ago.  I could never understand why they didn't upside protect the equity hedges (and it was insanely cheap to do so at the time), and in general I didn't like how they were continuing to invest. (RIM, Resolute, Sandridge... you get the idea).  But thats fine.  I still admire the great company Prem and company built, just not as an investment, when I could do better as a small player.

 

I cant see how anyone would come to the conclusion that the situation in the US or the world is suddenly going to be more pro business than it was last week.  The TPP is going to unravel whether the US participates or not.  If/when the Us starts to get even somewhat protectionist with Asia, then prices rise, US exports drop, and business suffers. 

 

Juicing of the US economy.  Lets see, we have had non- stop economic stimulus for 8 years.  So, now were going to up the infrastructure ante, and drop corporate taxes.  Where exactly is this money going to come from?  Either it comes from income tax, or consumption taxes, which will kill the US economy.

 

Or, it comes from deficit spending.  Deficit spending of course requires issuing more bonds at higher rates, than they have been able to issue in the last few years.  I dont know if anyone noticed but demand for bonds just dropped last week. 

 

FFH places macro bets.  These were never intended as hedges.  They were macro bets on the economy.  I think it was just an opportune time to reduce them.  I wouldnt read it as a specific comment on the economic potential.  And as someone else has said, if you believe markets are going up, you believe that economies are going to get juiced why would you keep deflation hedges? 

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Guest longinvestor

I believe that the single biggest personal mistake PW made was to put out the statement about making a 15% long term return on their investments. Used to be 20%, I think. Seen in light of the fact that he has consistently taken the position of not providing quarterly or annual guidance on earnings, this was, IMO,  like a 100 pound anchor around his neck. This along with the shrill macro calling (wolf wolf) made me move away from FFH. I highly suspect that the two together perfectly explain the head scratching moves made by Prem over the past 7 or so years.  I had made a ton of money on FFH during 2002 to 2009 period, thanks again to Prem's macro bets but couldn't square with the continued macro shepherd that he is. I stopped going to Toronto mainly for this reason. Got tiring. And not a value investor, he was clearly something else.

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One thing I will say in favour of this decision: many on here have questioned whether FFH are capable of changing their minds when the facts change.  They are.

 

Whether it is the right thing to do is another matter.

 

I think the reality is that they realized quite a while ago that their equity hedges were a bad decision.  They just needed some event so that they could “save face”.  Trump was simply a convenient excuse to reverse a decision and say “Yeah, we are removing the hedges because of Trump” instead of “Yeah, we are removing the hedges because we were wrong.”

 

Do you have any evidence for this?  I'm not disputing it, but your view (that they care about saving face) is quite important and carries much more weight if you have a reason for it than if you're sitting at home guessing (like I am).

 

I don't have any hard evidence of this.  My (Watergate-style) attempts to bug Prem's office have so far been unsuccessful.

 

I am relying on soft evidence, such as:

1)  The length of time (many years) these hedges have been turned on; they can't stay on forever; why now really?

2)  The virtually indisputable reality that these hedges were a bad idea, and destroyed what could have been otherwise good results.

3)  My knowledge and experience with the consistency principle; part of my job is to negotiate successful results for my clients on an almost daily basis, and I never cease to be amazed at how difficult it is for people to change their mind without some way to save face.  I have developed an entire negotiation strategy centered on providing my counterpart a clear way to save face, thus easing his/her ability to change their mind to my client's benefit; it works wonders.

4)  The very odd timing of this reversal, after the markets have gone UP a substantial amount.

5)  The suddenness of the decision; no one really expected a Trump win, so they made this decision in a matter of a few days.  Is that really a long enough time to fully evaluate the new reality; perhaps.  But the suddenness seemed odd - like they were seizing the moment during all of the hysteria - knowing that the newsworthiness of removal of the hedges would get lost in a sea of post Trump election hysteria.

 

I guess it just strike me that there was sentiment to remove these for some time; but doing so is a clear admission that they screwed up. 

 

In reality, there is probably a bit of truth to both narratives.  The probably DID view the world as having changed, but I think in larger part also viewed it as a convenient way to save face.

 

So, yeah, I am sitting at home guessing just like you.

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Wow.  Quite the week....

 

My guess too is that they have been wanting to wind down these equity hedges and this provided a convenient time.

 

In the grand scheme of things, the S&p500 is at the same level as ~24 months ago (increased by ~5% in 2 years)... I believe international has done less.  So, if measured against the broader market, one could think of it as removing the equity hedges 24 months ago.  We all know that Prem manages an active portfolio which does not always agree with the S&P.  Is there a chance over the past year or two that his equities have under performed and therefore over the short term, maybe the hedges were beneficial?

 

This recent move though boils down to two things for me; the past and the future.

 

Past - 100% equity hedges was quite a confident bet. Prem surely didnt win and he may or may not have lost depending on how you look at things.  He didn't lose money but he didnt make any.  There were times when the hedges appeared to be genius and others when they did not.  We all know what the current book value is, and this represents the past up until today (or end of Q3).  That is a fact which then brings us to trying to predict the future...

 

Future - We need to remember that FFH is still 50% hedged.  If the markets continue to rally then FFH has done well and unleashed earnings power (we can think of it as getting out of a bear market).  If the markets tank... well, they are still 50% hedged but PW will probably slam his head against the desk.  The future is simply unpredictable and I am in favor of less hedging and more buying undervalued stocks/bonds.  I personally prefer the BRK or MKL method of knowing that securities bought at a fair or cheap price will gain value in the future.  That is simply the most cost efficient and proven method to compound money trading equities.  Prem has proven he can do this very well, especially in the bond market.  Now he has $10b from his bonds sale and removed 50% of his hedging.  Many folks are raving about BRK having $100b in cash, as am I, so we should be welcoming FFH new position if we think in the long run that capitalism will prevail.  Lets get excited here about the future.

 

As many folks have said though, you invest in companies like BRK or FFH because you have faith in WEB or PW.  I have faith that PW can produce a better return than I can.  That is why I chose to invest.  I understand that buying low and selling high is very difficult, I probably would not be the best at it, but that PW has a great track record of doing just that.  My only concern is that he may have just sold low and bought high.... Only time will tell. 

 

Looking forward to following more of this journey with everyone here!

 

Or they could be prepping for a market retraction and put the money to work elsewhere such as in India.  Bruce Flatt is betting on a market retraction by raising and building cash. 

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