Reduction in Equity Hedges to 50%

[Viking]

So recently Fairfax exits long dated US treasuries and reduces equity hedges. Then Trump is elected and long bond yields spike and stock markets go to all the highs. And Fairfax sells off. I hope it continues to sell off...i have not owned shares in many ears and would be happy to own them again.

[FFHWatcher]

So recently Fairfax exits long dated US treasuries and reduces equity hedges. Then Trump is elected and long bond yields spike and stock markets go to all the highs. And Fairfax sells off. I hope it continues to sell off...i have not owned shares in many ears and would be happy to own them again.

 

Agreed. But obviously, lots of investors were using FFH as a hedge, don't feel the same way about the election and have decided to move their money somewhere else.

 

Historically, once FFH has conviction on something, they have moved quite quickly.  Getting into and out of securities.  They aren't known to dollar cost average into a security or out of them.  So, it will be interesting to see the velocity at which they re-enter unhedged equity investments as well as what key sectors they will target. 

[kab60]

So recently Fairfax exits long dated US treasuries and reduces equity hedges. Then Trump is elected and long bond yields spike and stock markets go to all the highs. And Fairfax sells off. I hope it continues to sell off...i have not owned shares in many ears and would be happy to own them again.

My thoughts exactly. Is there a reason to believe BV has decli ned or is this trading at 1xBV?

[Viking]

Fairfax has underperformed for the past 5 years. BV per share (US$) has grown but modestly. Share price (in US dollars) is also up a small amount. 15 years ago when I first invested in Fairfax they were considered very good investors and below average underwriters. Reading RBC's most recent report it is now the opposite: good underwriters and poor investors. My guess is they will get the investing thing figured out over time. Good underwriting plus good investing will result in a much higher share price.

[plato1976]

Is 1x BV a very compelling valuation? 1/3+ BV is goodwill&intangible

 

Fairfax has underperformed for the past 5 years. BV per share (US$) has grown but modestly. Share price (in US dollars) is also up a small amount. 15 years ago when I first invested in Fairfax they were considered very good investors and below average underwriters. Reading RBC's most recent report it is now the opposite: good underwriters and poor investors. My guess is they will get the investing thing figured out over time. Good underwriting plus good investing will result in a much higher share price.

[giofranchi]

Is 1x BV a very compelling valuation? 1/3+ BV is goodwill&intangible

 

Fairfax has underperformed for the past 5 years. BV per share (US$) has grown but modestly. Share price (in US dollars) is also up a small amount. 15 years ago when I first invested in Fairfax they were considered very good investors and below average underwriters. Reading RBC's most recent report it is now the opposite: good underwriters and poor investors. My guess is they will get the investing thing figured out over time. Good underwriting plus good investing will result in a much higher share price.

 

Goodwill is high basically for two reasons:

1) In recent years FFH has bought high quality insurance companies at a premium to BV. This is imo why their underwriting performance has improved so much (together with the outstanding job done by Mr. Barnard of course!). Therefore, I am not really worried.

2) In recent years FFH has bought more non-insurance companies: for instance, last quarter goodwill went up $415 million

primarily as a result of the acquisition of St-Hubert by Cara and Privi Organics by Fairfax India, and the impact of foreign currency translation (principally the strengthening of the Canadian dollar relative to the U.S. dollar), partially offset by amortization of intangibles.

Are you worried they have paid too much for non-insurance businesses?

 

Cheers,

 

Gio

[Viking]

Fairfax over the past 30 years has a very good track record when it comes to investment results. The past 5 years or so have been poor. They have continued to increase investments per share. The quote below is from Prem's letter to shareholders in the 2015 Annual report.

 

"At the end of 2015, we had $769 per share in float. Together with our book value of $403 per share and $134 per share in net debt, you have approximately $1,306 in investments per share working for your long term benefit – about 5.6% higher than at the end of 2014."

[petec]

 

My issue was and I guess is that there is nothing asymmetric about hedges 100% or greater, and I think it simply cannot be true "protection" as has been implied--no one else requires that protection and they themselves haven't over time.  So the dishonesty to me is the label being applied--some amount is protection, but the other amount is clearly a macro call.  I just want them to say "this is a macro call and it didn't work out".  That's really it.  Just honesty about what the strategy actually was/is.

 

 

I've thought about this a lot and the distinction I draw is that for a fairly brief period of time (5-8 years) Fairfax thought that a repeat of the Great Depression 90% selloff was a distinct possibility.  They warned about this long and hard.  They never said it would happen, but they repeatedly said that it might and repeated Ben Graham's warning about "if you weren't bearish in 1925" etc.

 

Now, you're a levered company, with regulatory oversight and clients who need your balance sheet to be solid.  You've done your research about how underwriting profits did in the GD (not well - companies kept writing at low premia to keep the cash flowing in).  And you fear a really serious wipeout in the equity market.  Not a 10%, or 20% drop, but a 90% drop, which because you live in a mark-to-market world would destroy your book value and therefore your company, because your book value is more or less all in equities.  What can you do?  You can go to cash, but that involves selling the equities you like.  Or, you can pick stocks, which you're good at, and hedge out the market. 

 

In that environment, I think it's reasonable to describe a 100% hedge as protection, not a macro call.  (By call I mean prediction.  They were clearly calling that they saw a macro risk, but I never felt they were making a firm prediction on where the market would go.)  They paid a high price for the total certainty that they wouldn't lose the company at a time when they saw a moderate possibility of a total macro catastrophe. 

 

So, the hedges seem to me to be consistent with how they have always described them, and so does removing them if you think that a new political environment reduces the risk, not of a 20% selloff, but of the 90% selloff you feared.  What would NOT have been consistent is saying "we were wrong" and removing the hedges because the market had gone up, which is what many here wanted.

 

You can't understand the hedges in terms of a market call of +/- 20%.  They couldn't give a fig about that.  They paid (a lot) to ensure they'd be OK in a true catastrophe.  And I was very happy with that, as a shareholder who feared the same thing.  Was I wrong?  No.  The risk was there.  Do I regret the cost of the hedges?  Not one iota. 

 

But about that stockpicking...  Here I feel criticism is warranted.  In particular I don't understand why they didn't buy all of the JNJ, KO, PEP etc. shares they could - buying such companies at the prices available in 2009-2011 would have guaranteed reasonable absolute returns if the world muddled through (which it did) but also great relative returns if we'd revisited 1933.  Instead they bought BKIR which would have gone bankrupt in a 1933 revisit.  Does the fact that it worked make it right?  I don't think so, but no-one ever seems to mind that decision! 

 

[giofranchi]

But about that stockpicking...  Here I feel criticism is warranted.  In particular I don't understand why they didn't buy all of the JNJ, KO, PEP etc. shares they could - buying such companies at the prices available in 2009-2011 would have guaranteed reasonable absolute returns if the world muddled through (which it did) but also great relative returns if we'd revisited 1933.  Instead they bought BKIR which would have gone bankrupt in a 1933 revisit.  Does the fact that it worked make it right?  I don't think so, but no-one ever seems to mind that decision!

 

I couldn't agree more! Actually they had bought JNJ and WFC... unfortunately they also sold them... I have never really understood why. I remember Watsa commenting about JNJ in 2010: "We like JNJ very much: today it seems nobody wants to hold a company that can gradually but steadily increase EPS 10-15% annualy. JNJ is such a company and we are happy to hold it". Then, just a couple of years later FFH sold its investment in JNJ...

 

Cheers,

 

Gio

[maxthetrade]

If they really were hedging for a 90% selloff there would have been much cheaper ways to do this, e.g. cheap way out of the money options. IMO they speculated and it went wrong. The cash outflow simply became too big and they folded. The bad stock picking aggravated the situation. 

[petec]

If they really were hedging for a 90% selloff there would have been much cheaper ways to do this, e.g. cheap way out of the money options. IMO they speculated and it went wrong. The cash outflow simply became too big and they folded. The bad stock picking aggravated the situation.

 

Yes, I have wondered about that and need to ask them.  At the very least they were so focussed on the downside risk that they underestimated the upside risk.  Could have hedged that out easily I would imagine.  But, had their equity portfolio outperformed the market (i.e. had they locked in their alpha via the hedges) I doubt we'd be having this conversation.  It's the combination of protection proving so expensive and poor longs that got us here.