Fairfax 2022

[Viking]

The Q1 report for Fairfax will be very interesting but for different reasons than in the past (at least for me). My focus the past 15 months has been primarily on the equity portfolio (given how much it fell in value in 2020). Because recovery in the valuation of the equity portfolio was the primary driver of earnings and growth in BV in 2021 (i include Digit, which was an unexpected surprise, in the equity ‘bucket’). Moving forward i am really looking forward to seeing:

1.) how the insurance business is performing

- can written premium growth continue at close to 20% year over year?

- can CR of 95 be maintained or even go lower?

2.) changes to the bond portfolio

- will interest and dividend income increase from Q4? Short term rates have been increasing since Jan 1. Was Q4 the bottom?

- how aggressively is Fairfax buying longer duration and higher yielding fixed income instruments? We already have the Kennedy Wilson announcement. 
- how will these changes impact interest and dividend income moving forward?

We have all seen interest rates across the curve move dramatic dramatically higher so far this year with another pop higher this week after the Fed meeting. I am also reading that credit spreads are also widening. Both are VERY positive developments for Fairfax given how its bond portfolio was positioned at the end of Q4. 

 

Looking ahead, i think it is possible that Fairfax could earn $2 billion in 2023 from underwriting income + interest and dividend income. Q1 results will provide a pretty good early indicator of how likely this is. If this happens then the investment thesis for Fairfax will change dramatically. In a good way. If Fairfax starts kicking out predictable operating earnings of about $500 million each and every quarter it will have an unprecedented amount of free cash flow rolling in. We will see  What we do know is that outcome is not remotely priced into the share price today (trading at US$478). 
—————

We already received one update from Fairfax regarding my second question - changes to the bond portfolio:

 

Fairfax boosts target for debt investment platform to $5 billion

- https://ir.kennedywilson.com/news-events-and-presentations/press-releases/2022/02-23-2022-211613501

 

Fairfax has increased its first mortgage target within Kennedy Wilson’s debt investment platform by $3 billion to $5 billion.

—————

From page 12 of Prem’s letter in the 2021AR: At the end of 2021, our fixed income portfolio, inclusive of cash and short term treasuries, which effectively comprised 72% of our investment portfolio, had a very short duration of approximately 1.2 years and an average rating of AA-. Rising rates in 2021 resulted in a small unrealized bond loss of $261 million. During the last two years, we were able to invest $1.6 billion in first mortgages with Kennedy Wilson at an average rate of 4.5%, with an average term of three years.

—————

Homebuyers and owners scramble to secure low mortgage rates before more hikes come
- https://finance.yahoo.com/news/homebuyers-scramble-to-secure-low-mortgage-rates-160123047.html

 

“This week's more than quarter-point jump in mortgage rates is sending a dire message to homebuyers and owners: Time is running out.

 

Weary buyers already facing the worst affordability conditions are now clambering to snag a low rate before any future increases price them out altogether, according to interviews with real estate pros, while the number of refi candidates coming through the door have dwindled as rates soared past 4% for the first time in almost three years.

 

Mortgage rates have marched up by a full percentage point since the beginning of 2022, hitting 4.16% this week, according to Freddie Mac, and further increases may come as the Federal Reserve is set to raise a key benchmark rate up to six more times this year to combat inflation.”

Edited March 19, 2022 by Viking

[Viking]

On 3/16/2022 at 4:27 PM, glider3834 said:

I have just updated my fixed income portfolio duration chart for Fairfax vs peers

 

 

 

@glider3834 thanks for posting this. What your chart clearly highlights is the significant macro bet on interest rates that Fairfax has been making the past few years (culminating at YE 2021). And how well Fairfax is positioned versus all peers in a rising interest rate environment - which is where we are today. 
 

It is actually nuts how Fairfax’s fixed income portfolio is positioned (average duration of 1.2 years) compared to ALL OTHER P&C INSURERS. When insurance companies report Q1 earnings it will be VERY INTERESTING to see how higher interest rates will impact earnings:

1.) how big are the mark to market losses in their bond portfolios

2.) what is the size of the hit to BV

 

From an investing perspective, i also expect Fairfax to get ZERO CREDIT from investors (for now) for how it is positioned today - to actually benefit from rising rates via a material increase in interest and dividend income. But Fairfax will get credit for this positioning over time - eventually analysts and investors do ‘figure it out’ and the share price responds accordingly. Perhaps this macro bet will be the next big catalyst driving Fairfax’s share price higher.

—————

It is quite interesting… WRB discussed this exact topic on its Q4 earnings call… funny, after Fairfax, they are next shortest duration at 2.4 years.

 

“But again, as we see it, the growth will continue and the rate increases. There is nothing that leads us to believe that we will not continue to be able to get rate increases that outpaced trend by something that would be measured in the hundreds of basis points. So again, very promising on that front. Pivoting over to – for a moment to the investment side of the business. Again, we have, in my opinion, taken a very disciplined approach for an extended period of time in keeping not just the quality high, but the duration short.

 

As we've discussed in the past, this has come at a price. But we think that we are going to be rewarded for that discipline going forward as you see interest rates moving up. You are going to see an opportunity for us to invest at higher rates, and you are going to see an opportunity for us to, under those circumstances, take the duration back out or extended. Both of these circumstances on the underwriting side and how we are poised there as well as how we are positioned on the investment side are going to have a very meaningful impact on the company's economic model.

 

And as this unfolds, I think it's going to be quite consequential of what it's going to mean for the earnings power of the business. So let me pause there, and I will hand it over to Rich.”

Edited March 19, 2022 by Viking

[Viking]

Rising interest rates will impact P&C insurers in two important ways:

1.) short term: immediate impact to earnings as existing fixed income portfolios are re-valued. If hit is large it could also impact BV.

2.) long term: increase to interest income in future quarters / years as bonds and cash is re-invested at higher rates

—————

It looks like Fairfax has done two important things in recent years to protect itself from the possibility of rising interest rates:

1.) aggressively sold down its bond portfolio and left proceeds parked in cash and short term investments

- this has greatly reduced the total amount of bonds held. This can be seen by looking at the average duration of the fixed income portfolio = 1.2 years at Dec 30 2021.

2.) it has also entered into forward contracts to sell long dated U.S. treasury bonds (notional value $1.7 billion Dec 31, up from $300 million Dec 31, 2020).

—————

It is possible to get a ballpark estimate of the possible losses from the recent spike in interest rates. Each P&C insurer publishes sensitivity estimates of the impact of changes in interest rates on its fixed income portfolio. So what has Fairfax published?
 

If interest rates increase 100 basis points (from Dec 31, 2021) Fairfax would likely see mark to market losses on its bond portfolio of about $220 million (down from $335 A year ago). A 200 basis point increase would result in about a $420 million hit (down from $625 a year ago). Both of these amounts are VERY manageable for Fairfax. Given the spike we are seeing in interest rates so far in 2022 full credit to Fairfax for what they have done here.
 

It would be VERY INTERESTING to see sensitivities for other P&C insurers, especially those with larger and longer duration portfolios. Could some P&C insurers see mark to market losses approaching $1 billion from their bond portfolios in 2022? Maybe… it will be very interesting to see how rising interest rates are impacting individual P&C insurers when they report Q1 earnings. (The life insurers are a whole other kettle of fish.)
—————

Fairfax- From page 111 of 2021AR: “The table below displays the potential impact of changes in interest rates on the company’s fixed income portfolio based on parallel 200 basis points shifts up and down, in 100 basis points increments.” Base portfolio is $14.5 billion

                                          Dec 31 2021.        2020

200 basis point move up           ($418)       ($625)

100 basis point move up           ($224).      ($335)

100 basis point move down      +$281.       +$410

200 basis point move down      +$608.      +$872

 

Includes the impact of forward contracts to sell long dated U.S. treasury bonds with a notional amount at December 31, 2021 of $1,691.3 (December 31, 2020 – $330.8).

 

Fairfax market cap is $11.9 billion. 

Edited March 20, 2022 by Viking

[Viking]

How will rising interest rates impact WRB, Markel and Chubb? Well Chubb better pray interest rates don’t increase by 200 basis points over the next year…

—————

WRB - page 60 of 2021 annual report.
- Average duration of bond portfolio is 2.4 years.

- size is $18.3 billion.
- 100 basis point increase in interest rates = decline in value of bond portfolio of $449 million.

- 200 basis point increase = decline of $894 million.
- 300 basis point increase = decline of $1.32 billion.
- WRB’s market cap is about $17 billion.

—————

Markel - page 65 of 10Q.
- avg duration of fixed income portfolio is 3.1 years

- size is $12.6 billion.

- 100 basis point increase = decline in value of bond portfolio of $565 million.
- 200 basis point increase = decline of $1.097 billion. 
- Markel’s market cap is about $19.5 billion.
—————

Chubb - page 69 10Q:

- avg duration of fixed income portfolio is 4.1 years

- size is $106 billion.
- 100 basis point (bps) increase in interest rates would reduce the valuation of our fixed income portfolio by approximately $4.4 billion

- Chubb’s market cap is about $90 billion.

Edited March 20, 2022 by Viking

[Thrifty3000]

19 hours ago, Viking said:

Looking ahead, i think it is possible that Fairfax could earn $2 billion in 2023 from underwriting income + interest and dividend income.

@Viking to bring this down to a per share level, you’re suggesting over $80 per share of income from the insurers alone is possible next year.

 

Wow, sounds like I’m going to have to update my look through earnings model. Sounds like look through earnings could comfortably exceed $100 per share in 2023.

[Viking]

1 hour ago, Thrifty3000 said:

@Viking to bring this down to a per share level, you’re suggesting over $80 per share of income from the insurers alone is possible next year.

 

Wow, sounds like I’m going to have to update my look through earnings model. Sounds like look through earnings could comfortably exceed $100 per share in 2023.

@Thrifty3000 yes, i think Fairfax is positioned to deliver +$80 per share from underwriting + interest/dividends in 2023 (perhaps more). This does not include share of profit of associates which was $324 million in 2021 (and could be +$400 million in 2022 and +$500 million in 2023).

Assumptions:

1.) combined ratio = 94 in 2022 and 2023. 2021 was 95 so forecasting a 94 while we are still in a hard market is not being overly aggressive. For Fairfax to achieve a 94 in 2022 they will likely need to deliver a sub 94 CR when they report Q1 (low catastrophe quarter) so we will get better visibility into this in about 5 weeks. The 88CR they delivered in Q4 (and 95 for 2021) got me thinking we could see a sub 95 CR in future years.

2.) how much will net premiums written grow in 2022 and 2023? I have pencilled in 12% growth in 2022 and 5% growth in 2023. Growth in net premiums earned should be a little better (given 20% growth seen in 2021).
3.) interest and dividend income should be much higher in 2022 and again in 2023 given the big move in interest rates since Jan 1; especially in short term rates which is where Fairfax has most of its fixed income parked. The $3 billion invested with Kennedy Wilson could bump interest income by an incremental $100 million all by itself once it is fully deployed. So it is not a big stretch to pencil in a $250 million increase in interest and dividend income in 2023 (from 2021). We will need to see this bucket move higher when they report Q1 results to get a $100 million increase in 2022; and also an indication from Fairfax that they are starting to re-invest some of their cash/short term investments at higher rates.
4.) share count: i think a conservative estimate is for the share count to fall 3% in 2022 and another 3% in 2023. My guess is Fairfax will reduce share count by more than this if shares continue to trade in the US$500 range into Q2 and Q3.

 

Here is what i am thinking:

               UW.       I+D.    Runoff.    Total.   /share.   shares (year end)

2023.   $1,200 + $900 - $100 = $2,000   $90.        22.5

2022.   $1,000 + $750 - $150 = $1,600.    $70.        23.2

2021.       $801 + $641 - $200 = $1,250    $50        23.9.    

Edited March 20, 2022 by Viking

[Thrifty3000]

48 minutes ago, Viking said:

@Thrifty3000 yes, i think Fairfax is positioned to deliver +$80 per share from underwriting + interest/dividends in 2023 (perhaps more). This does not include share of profit of associates which was $324 million in 2021 (and could be +$400 million in 2022 and +$500 million in 2023).

Assumptions:

1.) combined ratio = 94 in 2022 and 2023. 2021 was 95 so forecasting a 94 while we are still in a hard market is not being overly aggressive. For Fairfax to achieve a 94 in 2022 they will likely need to deliver a sub 94 CR when they report Q1 (low catastrophe quarter) so we will get better visibility into this in about 5 weeks. The 88CR they delivered in Q4 (and 95 for 2021) got me thinking we could see a sub 95 CR in future years.

2.) how much will net premiums written grow in 2022 and 2023? I have pencilled in 12% growth in 2022 and 5% growth in 2023. Growth in net premiums earned should be a little better (given 20% growth seen in 2021).
3.) interest and dividend income should be much higher in 2022 and again in 2023 given the big move in interest rates since Jan 1; especially in short term rates which is where Fairfax has most of its fixed income parked. The $3 billion invested with Kennedy Wilson could bump interest income by an incremental $100 million all by itself once it is fully deployed. So it is not a big stretch to pencil in a $250 million increase in interest and dividend income in 2023 (from 2021). We will need to see this bucket move higher when they report Q1 results to get a $100 million increase in 2022; and also an indication from Fairfax that they are starting to re-invest some of their cash/short term investments at higher rates.
4.) share count: i think a conservative estimate is for the share count to fall 3% in 2022 and another 3% in 2023. My guess is Fairfax will reduce share count by more than this if shares continue to trade in the US$500 range into Q2 and Q3.

 

Here is what i am thinking:

               UW.       I+D.    Runoff.    Total.   /share.   shares (year end)

2023.   $1,200 + $900 - $100 = $2,000   $90.        22.5

2022.   $1,000 + $750 - $150 = $1,600.    $70.        23.2

2021.       $801 + $641 - $200 = $1,250    $50        23.9.    

Holy crow. I’m going to have to invest even more in this thing aren’t I?

 

Thanks for the additional detail!

 

Just came up with a new investment mantra:

Be greedy when others are clueless.

[Viking]

2 hours ago, Thrifty3000 said:

Holy crow. I’m going to have to invest even more in this thing aren’t I?

 

Thanks for the additional detail!

 

Just came up with a new investment mantra:

Be greedy when others are clueless.

@Thrifty3000 what i laid out above is the bullish case for Fairfax.
 

Here is the bearish case: We could have higher than normal catastrophes in 2022 driving the CR back over 95. The hard market could slow dramatically in the coming months.  Fairfax may keep cash/short term investments at same/very high levels which would slow increase in interest dividend income bucket. Geopolitical situation could blow up and extreme risk off could hammer equities. 
 

My guess is Fairfax at U$480 is pricing in lots of bad news already. If actual performance at Fairfax trends closer to my bullish case then i see lots of upside in the share price. We will see  

Edited March 20, 2022 by Viking

[glider3834]

8 hours ago, Viking said:

4.) share count: i think a conservative estimate is for the share count to fall 3% in 2022 and another 3% in 2023.

I was just thinking about the max dividend capacity of the insurance subs - its currently sitting at $2 bil. In 2021, they paid a dividend equal to around 27% of their 2020 dividend capacity. I just wonder given their approx 20% net premium growth rate , if that 25-30% area is what we should expect in 2022 or whether they could go for a higher dividend payment because this looks to be the primary avenue (short of FFH selling whole or part of a sub) that FFH will use to fund their share buybacks. If the hard market slows down & net premium growth rate turns into single digits, they could potentially get more aggressive on share buybacks.

Edited March 21, 2022 by glider3834

[MMM20]

“it has also entered into forward contracts to sell long dated U.S. treasury bonds (notional value $1.7 billion Dec 31, up from $300 million Dec 31, 2020”

 

I’d missed this before. Thanks for sharing. So instead of shorting stocks they are shorting long term treasuries.

 

I like that risk/reward much better but we prob gotta stop saying they “stopped shorting”

Edited March 21, 2022 by MMM20

[bluedevil]

Agree - this was a point I made earlier that I think is important to understand about Fairfax.

 

Markel, for example, doesn’t speculate with its bond holdings.  It forecasts its insurance liabilities, then finds bonds that will come due when the cash is needed for customers (with a margin of safety) and keeps reinvesting the new cash - with an avg 3 year duration. The portfolio is not positioned long or short interest rates.  There is exposure to changing rates, but it’s manageable - if rates go up 100 basis points, the bond holdings get marked down (BUT cash remains same bc they hold to maturity) and they reinvest new cash at higher rates.

 

fairfax on other hand often has macro views about the future of interest rates and makes big bets on it, often amplified with options/contracts.  At times they have made boat loads of money on these trades, at others they lost boatloads.

 

personally, I don’t think it makes sense to believe that you have an “edge” over the long run betting on the future of interest rates.  
 

Fairfax has taken some important steps to reduce risks and let its strengths shine, but I would love for Fairfax to also stop with the macro interest rate calls and reduce overall leverage.  
 

that said I do think the current situation is asymmetric.  Interest rates have much more room to go up than down, so protecting against a rise is very understandable.  But I don’t think this should be how the company operates in the long run.  It doesn’t need to do these types of “trades” to make a lot of money.
 

 

 

 

 

[Viking]

Bond yields are spiking again today. Fairfax’s massive fixed income portfolio, with an average duration of 1.2 years, is looking better and better as interest rates continue to move higher.
 

Every time the Fed speaks it is a little more hawkish and the market then prices in incrementally more hawkish Fed policy. At the next meeting the Fed then simply follows though and ‘does’ what is then priced in the market. 7 rate hikes in 2022 was the example last week. Today the Fed opened the door to a 50 basis point increase at its next meeting in May. The market has now ‘priced in’ a 65% chance the Fed will move 50 basis points in May. Guess what is likely coming at the Fed meeting in May? Bottom line, the Fed appears firmly focussed on inflation and is taking every opportunity it is given to incrementally execute more hawkish interest rate policy. And they are just getting started. (They were still buying bonds a few short weeks ago. And last week was the first rate hike of 0.25%. Balance sheet run off has not started yet.)
 

The bond market has been COMPLETELY WRONG with how fast and how high yields have moved so far in 2022. The question is how high do yields (across the curve) go from here? And at what point does the equity market start to freak out.

 

Yields below are for US Treasuries. What about corporate bonds? I think spreads have been widening so far in 2022 for corporate bonds compared to Treasuries. This suggests to me that the increase in yields on corporate bonds should be more than what is listed below for Treasuries. Most insurance companies have significant holdings of corporate bonds.
 

                 2020.    2021.     2022.                                    Change

               Dec 31.  Dec31.   Jan 31.   Feb 28.    Mch 21.     YTD

 

3 mo.       .09.         .06.        .22.         .35.         .47.          + .41

6 mo.       .09.         .19.         .49.         .69.         .88.         + .69

1 yr.          .10.         .39.         .78.        1.01.        1.25.         + .86

2 yr.          .13.         .73.        1.18.        1.44.       2.10.        + 1.37

5 yr.          .36.       1.26.       1.62.        1.71.        2.31.       + 1.05

10 yr.        .93.       1.52.       1.79.        1.83.       2.30.         + .78

30 yr.      1.65.       1.90.       2.11.         2.17.        2.52.        + .62

Edited March 21, 2022 by Viking

[glider3834]

Berkshire acquired Alleghany at 1.26x BV

 

https://www.cnbc.com/2022/03/21/warren-buffetts-berkshire-hathaway-agrees-to-buy-insurance-company-alleghany-for-11point6-billion.html

 

I haven't looked into the details but my initial thoughts were WB is bullish on insurance & reinsurance space & he is prepared to pay a reasonable premium to book value

 

 

 

 

[nwoodman]

57 minutes ago, glider3834 said:

I haven't looked into the details but my initial thoughts were WB is bullish on insurance & reinsurance space & he is prepared to pay a reasonable premium to book value

 

 

 

 

My first thoughts were it only reinforced what a discount Fairfax is still trading at.  We are all forward looking.  But man it must be quite depressing if you had sat on Fairfax for the last decade as “your best idea” waiting for it to be “understood’.  FWIW Berkshire is now at the upper end of my valuation range while Fairfax is at the lower end.  Probably irrational but I won’t be rolling one into the other

 

[glider3834]

10 hours ago, bluedevil said:

Agree - this was a point I made earlier that I think is important to understand about Fairfax.

 

Markel, for example, doesn’t speculate with its bond holdings.  It forecasts its insurance liabilities, then finds bonds that will come due when the cash is needed for customers (with a margin of safety) and keeps reinvesting the new cash - with an avg 3 year duration. The portfolio is not positioned long or short interest rates.  There is exposure to changing rates, but it’s manageable - if rates go up 100 basis points, the bond holdings get marked down (BUT cash remains same bc they hold to maturity) and they reinvest new cash at higher rates.

 

fairfax on other hand often has macro views about the future of interest rates and makes big bets on it, often amplified with options/contracts.  At times they have made boat loads of money on these trades, at others they lost boatloads.

 

personally, I don’t think it makes sense to believe that you have an “edge” over the long run betting on the future of interest rates.  
 

Fairfax has taken some important steps to reduce risks and let its strengths shine, but I would love for Fairfax to also stop with the macro interest rate calls and reduce overall leverage.  
 

that said I do think the current situation is asymmetric.  Interest rates have much more room to go up than down, so protecting against a rise is very understandable.  But I don’t think this should be how the company operates in the long run.  It doesn’t need to do these types of “trades” to make a lot of money.
 

 

 

 

 

I think Markel, Berkshire, Fairfax have all said in different words over last few years that they think interest rates were too low given risks of inflation, credit risk etc. Berkshire & Fairfax are both shorter on duration in their fixed income portfolio than Markel (I couldn't find Berkshire's duration number but just looking at their balance sheet), although Markel still looks to be below the median duration level amongst peers. Markel did reduce duration from 3.3 to 3.1 yrs in 2021.

 

Whether they are setting premium pricing, reserves or investing their portfolios, insurers have to form some type of judgement on expected levels of inflation, interest rates.

 

 

Edited March 22, 2022 by glider3834

[Viking]

1 hour ago, nwoodman said:

My first thoughts were it only reinforced what a discount Fairfax is still trading at.  We are all forward looking.  But man it must be quite depressing if you had sat on Fairfax for the last decade as “your best idea” waiting for it to be “understood’.  FWIW Berkshire is now at the upper end of my valuation range while Fairfax is at the lower end.  Probably irrational but I won’t be rolling one into the other

 

@nwoodman “But man it must be quite depressing if you had sat on Fairfax for the last decade as “your best idea” waiting for it to be “understood’.” I agree. One lesson for me is to not blindly hold any stock. And when ‘the story’ (thesis for owning) materially changes for the worse to sell and move on. The other lesson is when the story changes and materially improves to buy (and not get caught thumb sucking - stuck in the past - unable to objectively look at the current situation or properly forecast what is likely to happen in the near future). Bottom line… be a rational investor.

[Viking]

10 hours ago, bluedevil said:

Agree - this was a point I made earlier that I think is important to understand about Fairfax.

 

Markel, for example, doesn’t speculate with its bond holdings.  It forecasts its insurance liabilities, then finds bonds that will come due when the cash is needed for customers (with a margin of safety) and keeps reinvesting the new cash - with an avg 3 year duration. The portfolio is not positioned long or short interest rates.  There is exposure to changing rates, but it’s manageable - if rates go up 100 basis points, the bond holdings get marked down (BUT cash remains same bc they hold to maturity) and they reinvest new cash at higher rates.

 

fairfax on other hand often has macro views about the future of interest rates and makes big bets on it, often amplified with options/contracts.  At times they have made boat loads of money on these trades, at others they lost boatloads.

 

personally, I don’t think it makes sense to believe that you have an “edge” over the long run betting on the future of interest rates.  
 

Fairfax has taken some important steps to reduce risks and let its strengths shine, but I would love for Fairfax to also stop with the macro interest rate calls and reduce overall leverage.  
 

that said I do think the current situation is asymmetric.  Interest rates have much more room to go up than down, so protecting against a rise is very understandable.  But I don’t think this should be how the company operates in the long run.  It doesn’t need to do these types of “trades” to make a lot of money.

@bluedevil Fairfax is definitely not your plain vanilla P&C insurance company… when it comes to BOTH insurance and investing. With insurance, how many companies would do what they did with ICICI Lombard? And now Digit? Actually GROW a runoff division? How about Ki? With investing they have a massive fixed income portfolio today with an average duration of 1.2 years… that is NUTS (in a good way today). TRS position on 1.96 million Fairfax shares? $1.9 billion invested in Atlas? $1.5 billion invested in commodity companies (steel, forestry, mining, potash etc)? Significant exposure to real estate (including partnership with KW). 
 

My view is Fairfax is like a super tanker… very big and slow to change direction. Lots of big mistakes were made from 2010-2017 so results suffered. However, beginning in about 2018 something changed. Better new decisions were made. And each year a few past errors were fixed (pot holes were filled). The hard market over the past 3 years has helped. Covid just muddied the water (masked the improvements that were happening). Today Fairfax is a VERY different company from what is was in 2017. Most importantly it is positioned and poised to deliver very good results moving forward. But most investors do not understand or recognize the magnitude of the changes. And the stock is trading at US$480 - it is trading at a historic low. And that is called a wonderful opportunity. 

Edited March 22, 2022 by Viking

[Parsad]

40 minutes ago, glider3834 said:

I think Markel, Berkshire, Fairfax have all said in different words over last few years that they think interest rates were too low given risks of inflation, credit risk etc. Berkshire & Fairfax are both shorter on duration in their fixed income portfolio than Markel (I couldn't find Berkshire's duration number but just looking at their balance sheet), although Markel still looks to be below the median duration level amongst peers. Markel did reduce duration from 3.3 to 3.1 yrs in 2021.

 

Whether they are setting premium pricing, reserves or investing their portfolios, insurers have to form some type of judgement on expected levels of inflation, interest rates.

 

 

 

Markel's book of business is different than Fairfax's and Berkshire's for the most part.  While Markel writes considerable long-tail insurance, the overall duration is shorter than Fairfax and they write more specialty business.  So the duration of their bond investments have to match up with their future liabilities which are shorter than Fairfax...but that's also why Markel is less volatile than Fairfax.  Berkshire would be more volatile than Markel if it wasn't for their massive cash flows from non-insurance operations that stabilize the volatility in insurance losses.  Cheers! 

[Parsad]

10 minutes ago, Viking said:

@bluedevil Fairfax is definitely not your plain vanilla P&C insurance company… when it comes to BOTH insurance and investing. With insurance, how many companies would do what they did with ICICI Lombard? And now Digit? Actually GROW a runoff division? How about Ki? With investing they have a massive fixed income portfolio today with an average duration of 1.2 years… that is NUTS (in a good way today). TRS position on 1.96 million Fairfax shares? $1.9 billion invested in Atlas? $1.5 billion invested in commodity companies (steel, forestry, mining, potash etc)? Significant exposure to real estate (including partnership with KW). 
 

My view is Fairfax is like a super tanker… very big and slow to change direction. Lots of big mistakes were made from 2010-2017 so results suffered. However, beginning in about 2018 something changed. Better new decisions were made. And each year a few past errors were fixed (pot holes were filled). The hard market over the past 3 years has helped. Covid just muddied the water (masked the improvements that were happening). Today Fairfax is a VERY different company from what is was in 2017. Most importantly it is positioned and poised to deliver very good results moving forward. But most investors do not understand or recognize the magnitude of the changes. And the stock is trading at US$480 - it is trading at a historic low. And that is called a wonderful opportunity. 

 

I think investors just have to realize that Fairfax is not Berkshire or Markel, and never will be.  Fairfax's greatest investment successes usually comes during bear markets.  Because bear markets are few and far between, there are huge periods where their out of favour style struggles.  It is what it is. 

 

They aren't going to pay up, and they aren't like Munger who looks for growth at a good price.  The legacy Fairfax team likes distressed equities...period!  They want to buy cheap stuff...cigar butts is what they know better than anyone else.  That doesn't appeal to the modern Berkshire investors or Markel investors, but that's why you get these dramatic periods where Fairfax swings from 1.1 times book to 0.7 times book and back to 1.1 times book. 

 

It's hard for the average investor to stomach, and they don't like timing the purchases.  But you look at every thing Fairfax's investment team touches and it is all about timing their purchases...bonds, equities, insurance businesses, non-insurance businesses.  They buy soooo out of favor stuff that no one wants to touch it, and then somehow it becomes gold a few years later...forget alchemy and turning lead into gold...Prem Watsa turns shit into gold! 

 

In the mean time, they will stagnate, suffer the slings and arrows of trolls, and then suddenly with the next insurance hard market/bear market become well respected again for a few years as they outperform everyone else.  Then it's the same cycle all over again, where patience truly is a virtue and many Fairfax shareholders once again wish they had bought Berkshire!  Maybe that's why I love stocks like Fairfax...I love the changing seasons in Canada, and Fairfax always has its spring, summer, fall and winter.  Even Hawaii (Berkshire) gets boring after a while!  Cheers!

[ValueMaven]

How about the timing of their hedges and massive macro calls @Parsad ??  The valuation difference you correctly note is the difference between Quality and Deep Value.  It is what it is - and doesnt tend to revert imho!!!

[TwoCitiesCapital]

30 minutes ago, ValueMaven said:

How about the timing of their hedges and massive macro calls @Parsad ??  The valuation difference you correctly note is the difference between Quality and Deep Value.  It is what it is - and doesnt tend to revert imho!!!

 

Always reverted before despite the macro calls and hedges - and the equity hedges are gone now. 

 

Just a matter of sentiment changing. The catalyst for that? I thought the improvement to it's profitability outlook and massive repurchases would've done it. I guess not - more time to accumulate (and for Fairfax to repurchase shares at low prices) while waiting for whatever the trigger ends up being. 

[ValueMaven]

fair point!

[Viking]

3 hours ago, TwoCitiesCapital said:

 

Always reverted before despite the macro calls and hedges - and the equity hedges are gone now. 

 

Just a matter of sentiment changing. The catalyst for that? I thought the improvement to it's profitability outlook and massive repurchases would've done it. I guess not - more time to accumulate (and for Fairfax to repurchase shares at low prices) while waiting for whatever the trigger ends up being. 

My belief is Fairfax is a constantly morphing entity. It is not some ‘constant’ - monolithic type organization - (the past 36 years) that falls in and out of favour. Rather, Fairfax is an organization that goes through 5-7 year stretches where it makes very good decisions and its stock does well (eventually) and other 5-7 year stretches where it makes bad decisions and the stock gets crushed. And the stock price often lags or overshoots (often by years) what is really going on under the hood.
 

Its almost like Fairfax makes some exceptionally good decisions (over a few years), makes an incredible amount of money for shareholders and then it goes to their head. Then they then get stupid, and then make some incredibly stupid decisions (over a couple of years), and they lose a shitload of money for shareholders. And then (eventually) they recognize their errors, fix the mistakes, and get humble. And then they get smart again and start making exceptionally good decisions again…

 

As an investor, you want to own Fairfax right when they flip from ‘incredibly stupid’ to ‘exceptionally good’ phase. My read is this change actually started in late 2016 (beginning of recognition of what a train wreck their shorting strategy had become). And every year since we have seen Fairfax make more important big strategic changes. No more new large insurance acquisitions. No more insurance acquisitions in emerging markets (spending $300 or $400 million per purchase). Recognition Fairfax is NOT a turn-around private equity shop (they tried that - with numerous equity purchases - and it failed miserably - spending years and hundreds of millions every year to fix all of the mistakes). Their success rate since 2018 with new equity investments (Seaspan, Stelco, Dexterra) suggests to me they are using different criteria than in the past.

 

What does all this mean for the 2022 version of Fairfax? It is completely misunderstood. Investors do not recognize the changes Fairfax has been making (for years now). The changes are just starting to show in earnings and BV growth.

1.) all the many acquisitions have now been digested by Fairfax. Underwriting results are poised to do well with hard market being a big catalyst.

2.) equity investment portfolio is poised to perform well (in aggregate). Problem children have mostly been fixed. New investments made since 2018 are growing in value nicely. 
3.) bond portfolio looks exceptionally well positioned for a higher interest rate environment.

 

This all means Fairfax is poised to deliver very good results in the coming years. My guess is we are only about a year into another of the ‘makes a shitload of money for shareholders’ phases.
 

Edited March 22, 2022 by Viking

[Xerxes]

^^^
If the shorts had done well or really well (for whatever reasons), would we have considered them still as a “stupid move” “gone over their heads” etc.  

 

does the outcome has a say if the move was stupid or is the binary nature of thinking that is considered stupid, regardless of the outcome  

Edited March 22, 2022 by Xerxes

[TwoCitiesCapital]

1 hour ago, Xerxes said:

^^^
If the shorts had done well or really well (for whatever reasons), would we have considered them still as a “stupid move” “gone over their heads” etc.  

 

does the outcome has a say if the move was stupid or is the binary nature of thinking that is considered stupid, regardless of the outcome  

 

I think it was the structure and the duration it was held.

 

I've been concerned/anxious/bearish about markets for about as long as Fairfax - but still generally have positive returns because I chose my spots, had periods of time where I closed shorts (like shortly after Trump was elected) when it became clear there were threats to the downside thesis like tax reform. 

 

The way they structured the shorts, and picked their longs, the shorts lost more money than the longs made and because they were TRS it was a regular drain on holdco liquidity. At any point they could've closed the swaps and bought put options, or purchased CDX protection, or swaptions instead of swaps, etc. 

 

It was the sizing, the stubbornness, and the vehicle that were problematic - not so much the concern on valuations and deflationary concerns IMO.