Comments and Observations about A/R

[Cigarbutt]

Just a simple question:

1) When determining the statutory surplus, is it almost equivalent to Common shareholder's equity + preferred shares + minority interest?

2) Just a simple observation:

Referring to their annual report's total return on investment portfolio footnote, it appears that they under-perform their 7% investment return hurdle rate 39% of the time over the past 33 years.

If that is true, that means under-performing 5 years in a row, would put it at less than a 1% probability.

For 1), statutory surplus is determined by state regulators who typically use a risk-based capital framework (similar to banks) to reduce the value of certain elements (and increase the margin of safety for the policyholder) of the balance sheet, as reported. The discounts vary and depend on the perceived level of risk. FWIW, I've been looking at a few insurers who carry a heavy load of BBB rated corporate bonds (not the case for FFH). An interesting feature is that, in the event of a recession, on top of the decrease in market value for the bonds, surplus capital gets a double whammy because the discount factor is higher for downgraded securities.

For 2), your statistical appreciation of forward returns is interesting and is in line with the idea of reversion to the mean, which has been a significant long-term feature at Fairfax (investment strategy, seven lean years analogy etc) but I wonder if such an approach is satisfactory on a forward basis as the investing environment has changed and the Fairfax investment recipe has been changing (some aspects dramatically so) so the future may not be correlated to the past. I think I read you're an MD and the following statistical "joke" came to mind when reading your post. There's this surgeon who comes to the patient waiting to be rolled in and explains that the death risk with the procedure is 1 in 2 but that the patient should not worry because the previous patient did not make it.

Thanks For the detailed response.

You are absolutely right if the underlying people, processes,  and investing environmental context change then the underlying distribution will change and the mean reversion effect may not happen.

I love the joke, as most physicians have no or little statistical training/understanding despite three decades of evidence based medicine.

I guess the meta question is “has hamblin watsa adapted to the environment and learned from its mistakes. Is their devil’S advocacy before investment commitment as a effective as they think it is?” That the distribution of investment outcomes is something other than 60-40 for 7%? With so many interacting variables involving a biological system, I guess this question may be impossible to estimate with any precision. We know their value principles but how about their learning and leadership principles. Certainly it appears there are a number of individuals that no longer think they have the adaptability moving forward to make decent investment returns.

But everything has its price in the market and there is an argument that the past is a sunk cost and all that matters is future behaviour.

Ps

You might enjoy this randomized control trial from the British journal of medicine

https://www.bmj.com/content/363/bmj.k5094

I don't think they have and whether it's a good thing or a bar thing is up to you to decide. They have decades of making macro calls and decades where it served them well.

To expect that they'll stop just because 2011-2016 didn't work out for them seems naive. I also made the point in 2016 that them dumping all duration following Trump's presidency was just another macro call.

I believe macro calls will continue to be made in the future and shareholder results dependent largely on the success of those calls.

My opinion (FWIW) is that, somehow, they have decided to try to move away from "macro calls" and it's ironic to note that, in the event that they could have built and maintained the ark, today's rain would look like pouring gold.

@jfan

I enjoyed immensely the research that you shared. However, I reject the validity of the conclusion because they did not control the two groups for fasting curcuma blood concentration levels.  :)

[Xerxes]

Even for the bet against the housing market 10 years back, I believe he was, in his word wrong, wrong, wrong and then right. But it was only a few years wait.

 

This time he had to wait 10 years. And it must have been very hard to maintain the steady course whilst everyone telling you to join the party.

 

In retrospect if you are a natural bear, perhaps you should have rolled your deflation hedges every five years starting fresh.

[StubbleJumper]

Even for the bet against the housing market 10 years back, I believe he was, in his word wrong, wrong, wrong and then right. But it was only a few years wait.

 

This time he had to wait 10 years. And it must have been very hard to maintain the steady course whilst everyone telling you to join the party.

 

In retrospect if you are a natural bear, perhaps you should have rolled your deflation hedges every five years starting fresh.

 

 

The problem was position sizing for both the equity hedges and the deflation hedges.  When you "hedge" more than 100% of your equity position, it's hard to continuously roll it when the market goes against you for a prolonged period.  When you buy deflation "hedges" that amount to more than 150% of the value of your assets, it's also pretty hard to continuously roll them over.  If Prem had dropped his equity hedge ratio to half of the size of the equity portfolio had the deflation hedge ratio to half of FFH's assets, it might have been sustainable.  There still would have been bitching from shareholders, but it probably would have been much more muted.

 

 

SJ

[Xerxes]

My only hope is that as a natural bear, he smelled it few weeks before it hit the fan. And somehow increased his bearish stand.

 

I vividly recall in the Q4 results from 2017, the number showed that he lost a certain amount because he shorted to early in Dec where the mini crash happened few months later in Feb 2018, when Trump went first against China on trade.

 

 

[petec]

My only hope is that as a natural bear, he smelled it few weeks before it hit the fan. And somehow increased his bearish stand.

 

I vividly recall in the Q4 results from 2017, the number showed that he lost a certain amount because he shorted to early in Dec where the mini crash happened few months later in Feb 2018, when Trump went first against China on trade.

 

I wouldn’t get your hopes up. He was in big and/or illiquid cyclicals and won’t have been able to reduce much. The best that happens now is they do a great job picking up corporate bonds and don’t have to raise equity in the meantime.

[StubbleJumper]

My only hope is that as a natural bear, he smelled it few weeks before it hit the fan. And somehow increased his bearish stand.

 

I vividly recall in the Q4 results from 2017, the number showed that he lost a certain amount because he shorted to early in Dec where the mini crash happened few months later in Feb 2018, when Trump went first against China on trade.

 

I wouldn’t get your hopes up. He was in big and/or illiquid cyclicals and won’t have been able to reduce much. The best that happens now is they do a great job picking up corporate bonds and don’t have to raise equity in the meantime.

 

 

With this market disruption, let's just hope that they don't find themselves in violation of some covenant in that goddamned revolver.

 

 

SJ

[Cigarbutt]

My only hope is that as a natural bear, he smelled it few weeks before it hit the fan. And somehow increased his bearish stand.

I vividly recall in the Q4 results from 2017, the number showed that he lost a certain amount because he shorted to early in Dec where the mini crash happened few months later in Feb 2018, when Trump went first against China on trade.

I wouldn’t get your hopes up. He was in big and/or illiquid cyclicals and won’t have been able to reduce much. The best that happens now is they do a great job picking up corporate bonds and don’t have to raise equity in the meantime.

With this market disruption, let's just hope that they don't find themselves in violation of some covenant in that goddamned revolver.

SJ

Isn't "now" a bit early in the game for corporate bonds?

https://fred.stlouisfed.org/series/BAA10Y

 

Related to SJ's concern, last February (before the R2000 went down by 37.5%), Moody's made some comments and listed the following risks: high common stock investments, general investment strategy, earnings volatility and added: "A material expansion of the group's investments in stressed or turnaround assets as a proportion of shareholder's equity could also lead to downward pressure on the rating".

https://www.moodys.com/research/Moodys-assigns-provisional-ratings-to-Fairfax-Financial-shelf--PR_1000002128

I just want to politely mention that, even if nobody knows the future, the posture comparison, at this point in time, between BRK and FFH, is simply mind boggling..

[TwoCitiesCapital]

My only hope is that as a natural bear, he smelled it few weeks before it hit the fan. And somehow increased his bearish stand.

I vividly recall in the Q4 results from 2017, the number showed that he lost a certain amount because he shorted to early in Dec where the mini crash happened few months later in Feb 2018, when Trump went first against China on trade.

I wouldn’t get your hopes up. He was in big and/or illiquid cyclicals and won’t have been able to reduce much. The best that happens now is they do a great job picking up corporate bonds and don’t have to raise equity in the meantime.

With this market disruption, let's just hope that they don't find themselves in violation of some covenant in that goddamned revolver.

SJ

Isn't "now" a bit early in the game for corporate bonds?

https://fred.stlouisfed.org/series/BAA10Y

 

Related to SJ's concern, last February (before the R2000 went down by 37.5%), Moody's made some comments and listed the following risks: high common stock investments, general investment strategy, earnings volatility and added: "A material expansion of the group's investments in stressed or turnaround assets as a proportion of shareholder's equity could also lead to downward pressure on the rating".

https://www.moodys.com/research/Moodys-assigns-provisional-ratings-to-Fairfax-Financial-shelf--PR_1000002128

I just want to politely mention that, even if nobody knows the future, the posture comparison, at this point in time, between BRK and FFH, is simply mind boggling..

 

Too early to go all in? Absolutely.

 

Too early to begin accumulating selectively? Probably a good time to get started.

 

Spreads are at roughly prior peaks outside of 2008/2009. You don't wanna blow the whole load in the event things get worse, but picking IG selectively @ 3-3.5% pick up or HY @ and an 8% pickup isn't a terrible place to start. Certainly a better outcome 3-4 years from now than waiting in 2-year Treasuries for the Fed to hike rates.

[Cigarbutt]

My only hope is that as a natural bear, he smelled it few weeks before it hit the fan. And somehow increased his bearish stand.

I vividly recall in the Q4 results from 2017, the number showed that he lost a certain amount because he shorted to early in Dec where the mini crash happened few months later in Feb 2018, when Trump went first against China on trade.

I wouldn’t get your hopes up. He was in big and/or illiquid cyclicals and won’t have been able to reduce much. The best that happens now is they do a great job picking up corporate bonds and don’t have to raise equity in the meantime.

With this market disruption, let's just hope that they don't find themselves in violation of some covenant in that goddamned revolver.

SJ

Isn't "now" a bit early in the game for corporate bonds?

https://fred.stlouisfed.org/series/BAA10Y

 

Related to SJ's concern, last February (before the R2000 went down by 37.5%), Moody's made some comments and listed the following risks: high common stock investments, general investment strategy, earnings volatility and added: "A material expansion of the group's investments in stressed or turnaround assets as a proportion of shareholder's equity could also lead to downward pressure on the rating".

https://www.moodys.com/research/Moodys-assigns-provisional-ratings-to-Fairfax-Financial-shelf--PR_1000002128

I just want to politely mention that, even if nobody knows the future, the posture comparison, at this point in time, between BRK and FFH, is simply mind boggling..

Too early to go all in? Absolutely.

Too early to begin accumulating selectively? Probably a good time to get started.

Spreads are at roughly prior peaks outside of 2008/2009. You don't wanna blow the whole load in the event things get worse, but picking IG selectively @ 3-3.5% pick up or HY @ and an 8% pickup isn't a terrible place to start. Certainly a better outcome 3-4 years from now than waiting in 2-year Treasuries for the Fed to hike rates.

I agree with you on the concept but...

For FFH, fixed income portfolio management has a been a large driver of returns over the years. Given that a significant amount of float has to be invested in fixed income, only small relative outperformance can result in a huge difference because of the embedded leverage.

It's interesting to think of their fixed income float management from the perspective of an individual investor whose objective is to remain always fully invested. Dynamic (fellow Board member) explains this very well for equities and the following quote from Keynes is complementary:

"In the main, therefore, slumps are experiences to be lived through and survived with as much equanimity and patience as possible. Advantage can be taken of them more because individual securities fall out of their reasonable parity with other securities on such occasions, than by attempts at wholesale shifts into and out of equities as a whole. One must not allow one’s attitude to securities which have a daily market quotation to be disturbed by this fact."

Quoting others doesn't result in good returns but, from a humble perspective, this juncture appears to be one of the trickiest, by far, and I would tread very carefully along the fixed income parity curves. The wild card remains what public agents will do (or come up with).

[TwoCitiesCapital]

My only hope is that as a natural bear, he smelled it few weeks before it hit the fan. And somehow increased his bearish stand.

I vividly recall in the Q4 results from 2017, the number showed that he lost a certain amount because he shorted to early in Dec where the mini crash happened few months later in Feb 2018, when Trump went first against China on trade.

I wouldn’t get your hopes up. He was in big and/or illiquid cyclicals and won’t have been able to reduce much. The best that happens now is they do a great job picking up corporate bonds and don’t have to raise equity in the meantime.

With this market disruption, let's just hope that they don't find themselves in violation of some covenant in that goddamned revolver.

SJ

Isn't "now" a bit early in the game for corporate bonds?

https://fred.stlouisfed.org/series/BAA10Y

 

Related to SJ's concern, last February (before the R2000 went down by 37.5%), Moody's made some comments and listed the following risks: high common stock investments, general investment strategy, earnings volatility and added: "A material expansion of the group's investments in stressed or turnaround assets as a proportion of shareholder's equity could also lead to downward pressure on the rating".

https://www.moodys.com/research/Moodys-assigns-provisional-ratings-to-Fairfax-Financial-shelf--PR_1000002128

I just want to politely mention that, even if nobody knows the future, the posture comparison, at this point in time, between BRK and FFH, is simply mind boggling..

Too early to go all in? Absolutely.

Too early to begin accumulating selectively? Probably a good time to get started.

Spreads are at roughly prior peaks outside of 2008/2009. You don't wanna blow the whole load in the event things get worse, but picking IG selectively @ 3-3.5% pick up or HY @ and an 8% pickup isn't a terrible place to start. Certainly a better outcome 3-4 years from now than waiting in 2-year Treasuries for the Fed to hike rates.

I agree with you on the concept but...

For FFH, fixed income portfolio management has a been a large driver of returns over the years. Given that a significant amount of float has to be invested in fixed income, only small relative outperformance can result in a huge difference because of the embedded leverage.

It's interesting to think of their fixed income float management from the perspective of an individual investor whose objective is to remain always fully invested. Dynamic (fellow Board member) explains this very well for equities and the following quote from Keynes is complementary:

"In the main, therefore, slumps are experiences to be lived through and survived with as much equanimity and patience as possible. Advantage can be taken of them more because individual securities fall out of their reasonable parity with other securities on such occasions, than by attempts at wholesale shifts into and out of equities as a whole. One must not allow one’s attitude to securities which have a daily market quotation to be disturbed by this fact."

Quoting others doesn't result in good returns but, from a humble perspective, this juncture appears to be one of the trickiest, by far, and I would tread very carefully along the fixed income parity curves. The wild card remains what public agents will do (or come up with).

 

Honestly this fall out is the best thing to happen to Fairfax. The 15% goal was laughable as recent as January 2020.

 

Interest rates were too low and equity multiples too high to have any reasonably foreseeable and sustainable path to it. Sure, insurance may be hardening but it's not going to pick up the slack and is also unstable and unpredictable.

 

Just two months later and interest rates are still trash, but there are some reasonably good alternatives to invest for a reasonable long-term rate of return.

 

Not to mention that Fairfax's stock price was falling @ the same time. It's 1000x easier for me to make a case for 15% annualized going forward from here.

[StubbleJumper]

Honestly this fall out is the best thing to happen to Fairfax. The 15% goal was laughable as recent as January 2020.

 

 

Oh, I take more nuanced view of that.  Ignoring all of the commotion of the past two months with tumbling interest rates and plunging equities, FFH had set itself up for some considerable accounting income during 2020.  The Riverstone transaction will trigger US$280m of accounting gains, and then the BIAL airport transaction will result in Fairfax India marking the airport to market quite substantially, resulting in yet more accounting gains when FFH marks its investment in Fairfax India.  But, wait that's not all!  The BIAL airport transaction could possible trigger a large performance fee, probably in early 2021, so it's the gift that keeps on giving!

 

If you can create $750m or $1B of paper gains over the course of a year, hitting that 15% target is not such a distant prospect.  But, as a FFH shareholder, should you celebrate that when the quality of earnings are what they are?

 

 

SJ

[petec]

My only hope is that as a natural bear, he smelled it few weeks before it hit the fan. And somehow increased his bearish stand.

I vividly recall in the Q4 results from 2017, the number showed that he lost a certain amount because he shorted to early in Dec where the mini crash happened few months later in Feb 2018, when Trump went first against China on trade.

I wouldn’t get your hopes up. He was in big and/or illiquid cyclicals and won’t have been able to reduce much. The best that happens now is they do a great job picking up corporate bonds and don’t have to raise equity in the meantime.

With this market disruption, let's just hope that they don't find themselves in violation of some covenant in that goddamned revolver.

SJ

Isn't "now" a bit early in the game for corporate bonds?

https://fred.stlouisfed.org/series/BAA10Y

 

Related to SJ's concern, last February (before the R2000 went down by 37.5%), Moody's made some comments and listed the following risks: high common stock investments, general investment strategy, earnings volatility and added: "A material expansion of the group's investments in stressed or turnaround assets as a proportion of shareholder's equity could also lead to downward pressure on the rating".

https://www.moodys.com/research/Moodys-assigns-provisional-ratings-to-Fairfax-Financial-shelf--PR_1000002128

I just want to politely mention that, even if nobody knows the future, the posture comparison, at this point in time, between BRK and FFH, is simply mind boggling..

Too early to go all in? Absolutely.

Too early to begin accumulating selectively? Probably a good time to get started.

Spreads are at roughly prior peaks outside of 2008/2009. You don't wanna blow the whole load in the event things get worse, but picking IG selectively @ 3-3.5% pick up or HY @ and an 8% pickup isn't a terrible place to start. Certainly a better outcome 3-4 years from now than waiting in 2-year Treasuries for the Fed to hike rates.

I agree with you on the concept but...

For FFH, fixed income portfolio management has a been a large driver of returns over the years. Given that a significant amount of float has to be invested in fixed income, only small relative outperformance can result in a huge difference because of the embedded leverage.

It's interesting to think of their fixed income float management from the perspective of an individual investor whose objective is to remain always fully invested. Dynamic (fellow Board member) explains this very well for equities and the following quote from Keynes is complementary:

"In the main, therefore, slumps are experiences to be lived through and survived with as much equanimity and patience as possible. Advantage can be taken of them more because individual securities fall out of their reasonable parity with other securities on such occasions, than by attempts at wholesale shifts into and out of equities as a whole. One must not allow one’s attitude to securities which have a daily market quotation to be disturbed by this fact."

Quoting others doesn't result in good returns but, from a humble perspective, this juncture appears to be one of the trickiest, by far, and I would tread very carefully along the fixed income parity curves. The wild card remains what public agents will do (or come up with).

 

Agreed. But I think there is probably an opportunity to increase yields over those available in ST treasuries without taking real credit risk. If Fairfax’s interest income doesn’t rise over the next few weeks I’ll be disappointed. If spreads then compress and you get a levered impact on equity, great.