Fairfax 2022

[Viking]

Is ‘macro call’ (with attached probability) and ‘risk mitigation’ not largely different sides of the same coin? 
—————

In terms of re-deploying the cash and short term holdings… it appears Fairfax is redeploying to max 1 to 2 year duration for now. Why not longer duration? Prem talked about ‘70’s inflation and long interest rates that went to 16%… so Fairfax is going to be ‘very careful’… ‘protection’ is the priority.

 

i do wonder what happens to other insurers and capital levels if interest rates do the unthinkable and keep moving higher (like even 4 to 5% across the curve). I can’t see how rates could go much higher due to international capital flows… If rates in the US spike another leg higher then would we not see historic devaluation of Yen and Euro versus US$?

—————

From Q1 Conference Call

Tom MacKinnon: Okay, that’s great. And then, in terms of deploying some more cash into bonds, are you kind of finished with that now or would you look at putting more of your substantial cash position in the bonds going forward?

 

Prem Watsa: Yeah, so, Tom, we think the big risk today is the fact that people have not -- for 40 years, interest rates have gone down and you have to be in the business for a long time, like in the ‘70s, to have seen how interest rates went up, inflation went up, interest rates went up. So the big risk today, as I said, is interest rates going up, and we don’t know how high it is going to go. So what we’ve done is just one or two year bonds -- we are limiting our investments to one and two years, which by the way significant increase in interest rates have taken place in that term one to two years. And Brian Bradstreet, that’s what he’s limiting it to, two years max, and just rolling it over, as Peter told you in his presentation.

 

Tom MacKinnon: If rates continued to rise, would you look at deploying more or what would be your thinking in terms of what you would want to see before? 
 

Prem Watsa: Tom. Yeah, if you were in the ‘70s, you’d have thought the rates were much higher than of course, what 5%, 6%, 7%, would have been good rates, 8% would have been good rates. 10%, 11%, 12% would have been good. It went to 21%. Long Canadas, that’s 30 year Canadas went to an unbelievable 16%. On the other side, in the pandemic treasury bonds went – 10-year treasuries went to 0.5%, never in the history of -- at least the modern history, including depression of the ‘30s, 10-year treasuries go to 0.5%, they did and they stayed for some time. So, you have to be just very, very careful. You can’t have preconceived ideas as to what can happen and we’re just being very, very careful. We’ve protected our company for 36 years, we want to last 100 years, we’re going to be very careful.

Edited April 30, 2022 by Viking

[glider3834]

On 4/30/2022 at 4:47 PM, petec said:

Interesting point on the accounting. Do you know which applies to capital for solvency purposes? I’m half hoping that Fairfax can continue to outgrow peers because they’ve taken less of a capital hit. Is that possible?

 

 

I think your question is around how industry capital could be impacted from rate rises - Oct-21 article from Fitch on US market might help

The commercial insurance market is currently benefiting from profit improvement tied to higher commercial lines pricing, lower pandemic-related losses and outsized investment gains, but questions remain whether pricing and reserving can keep pace in an extended inflationary period. However, information system and financial reporting advances since past inflationary periods provide insurers with faster and more comprehensive information on loss costs that enhances capability to recognize and respond to shifting adverse trends. The industry balance sheet and capital position are also significantly stronger relative to past history.

Investment risks are less prominent for P/C insurers versus life insurers as the industry has lower asset leverage (2.2x for p/c industry at YE20 vs. 9.0x for life industry), with less interest rate risk given a lower portfolio duration (estimated at 4.2 years versus over 7 years for the life industry).

We estimate that a 300-bp parallel increase in interest rates would lead to a nearly 13% pre-tax decline in p/c bond portfolio market values. However, unrealized gains/losses from interest rate changes are amortized over time and eliminated to the extent that insurers hold bonds to maturity. At YE20, the market value of p/c industry fixed income portfolio was 107% of statutory carrying value tied to the previous extended period of declining interest rates.

https://www.fitchratings.com/research/insurance/inflation-rising-rates-fuel-downside-risk-for-us-p-c-insurers-28-10-2021

 

 

Edited May 4, 2022 by glider3834

[gary17]

On 4/30/2022 at 1:11 PM, Viking said:

Is ‘macro call’ (with attached probability) and ‘risk mitigation’ not largely different sides of the same coin? 
—————

In terms of re-deploying the cash and short term holdings… it appears Fairfax is redeploying to max 1 to 2 year duration for now. Why not longer duration? Prem talked about ‘70’s inflation and long interest rates that went to 16%… so Fairfax is going to be ‘very careful’… ‘protection’ is the priority.

 

i do wonder what happens to other insurers and capital levels if interest rates do the unthinkable and keep moving higher (like even 4 to 5% across the curve). I can’t see how rates could go much higher due to international capital flows… If rates in the US spike another leg higher then would we not see historic devaluation of Yen and Euro versus US$?

—————

From Q1 Conference Call

Tom MacKinnon: Okay, that’s great. And then, in terms of deploying some more cash into bonds, are you kind of finished with that now or would you look at putting more of your substantial cash position in the bonds going forward?

 

Prem Watsa: Yeah, so, Tom, we think the big risk today is the fact that people have not -- for 40 years, interest rates have gone down and you have to be in the business for a long time, like in the ‘70s, to have seen how interest rates went up, inflation went up, interest rates went up. So the big risk today, as I said, is interest rates going up, and we don’t know how high it is going to go. So what we’ve done is just one or two year bonds -- we are limiting our investments to one and two years, which by the way significant increase in interest rates have taken place in that term one to two years. And Brian Bradstreet, that’s what he’s limiting it to, two years max, and just rolling it over, as Peter told you in his presentation.

 

Tom MacKinnon: If rates continued to rise, would you look at deploying more or what would be your thinking in terms of what you would want to see before? 
 

Prem Watsa: Tom. Yeah, if you were in the ‘70s, you’d have thought the rates were much higher than of course, what 5%, 6%, 7%, would have been good rates, 8% would have been good rates. 10%, 11%, 12% would have been good. It went to 21%. Long Canadas, that’s 30 year Canadas went to an unbelievable 16%. On the other side, in the pandemic treasury bonds went – 10-year treasuries went to 0.5%, never in the history of -- at least the modern history, including depression of the ‘30s, 10-year treasuries go to 0.5%, they did and they stayed for some time. So, you have to be just very, very careful. You can’t have preconceived ideas as to what can happen and we’re just being very, very careful. We’ve protected our company for 36 years, we want to last 100 years, we’re going to be very careful.

this reads like a macro bat to me

[Crip1]

18 hours ago, gary17 said:

this reads like a macro bat to me

I respectfully disagree. This looks/feels to me like risk-reward analysis. The yield spread between the 2 and 10 year treasuries is 27 bps. The spread between 2 and 30 year is 35 bps. The question is whether or not it is worth the risk of capital loss to extend past 2 years in bond duration. Looking through the prism of 2010 through 2021, the answer is "maybe". Looking at it through the prism of 1960 through 2022, IMHO the answer is a resounding "no". It's less of a "bet" that rates are going to rise and more of "it's quite possible, and I don't want to lose my a** if it happens". 

 

-Crip

[petec]

18 hours ago, Crip1 said:

The yield spread between the 2 and 10 year treasuries is 27 bps.

 

This.

 

I think there are only two ways you can prefer the 10y here:

1) you think rates will fall. This is a macro bet.

2) your liability is a perfect hedge for a treasury bond, and therefore the extra 27bps comes free. Insurance liabilities are far from a perfect hedge.

 

Absent one of these factors, the prudent thing to do is to buy the 2y. That's risk-reward analysis, not a macro bet.

[petec]

On 5/4/2022 at 4:56 AM, glider3834 said:

I think your question is around how industry capital could be impacted from rate rises - Oct-21 article from Fitch on US market might help

The commercial insurance market is currently benefiting from profit improvement tied to higher commercial lines pricing, lower pandemic-related losses and outsized investment gains, but questions remain whether pricing and reserving can keep pace in an extended inflationary period. However, information system and financial reporting advances since past inflationary periods provide insurers with faster and more comprehensive information on loss costs that enhances capability to recognize and respond to shifting adverse trends. The industry balance sheet and capital position are also significantly stronger relative to past history.

Investment risks are less prominent for P/C insurers versus life insurers as the industry has lower asset leverage (2.2x for p/c industry at YE20 vs. 9.0x for life industry), with less interest rate risk given a lower portfolio duration (estimated at 4.2 years versus over 7 years for the life industry).

We estimate that a 300-bp parallel increase in interest rates would lead to a nearly 13% pre-tax decline in p/c bond portfolio market values. However, unrealized gains/losses from interest rate changes are amortized over time and eliminated to the extent that insurers hold bonds to maturity. At YE20, the market value of p/c industry fixed income portfolio was 107% of statutory carrying value tied to the previous extended period of declining interest rates.

https://www.fitchratings.com/research/insurance/inflation-rising-rates-fuel-downside-risk-for-us-p-c-insurers-28-10-2021

 

 

 

Thanks!

[glider3834]

On 5/1/2022 at 6:11 AM, Viking said:

In terms of re-deploying the cash and short term holdings… it appears Fairfax is redeploying to max 1 to 2 year duration for now. Why not longer duration? Prem talked about ‘70’s inflation and long interest rates that went to 16%… so Fairfax is going to be ‘very careful’… ‘protection’ is the priority.

viking I just listened to a twitter space from 24/4 which is a good one - hosted by George Noble  who used to work with Peter Lynch.

 

Guest speaker Michael Howell (Cross Border Capital) gave an overview of global liquidity flows which he said are pointing to a less liquid environment - he suggested staying long US dollar, sticking to front end of yield curve. That is similar to Fairfax's recent fixed income moves - focusing on US treasuries, liquid & low risk & duration 1-2 yrs. He also said that corporate bond market is at risk as conditions tighten that spreads could push out & again that could be the reason Fairfax are not really pushing harder as yet into corporate bond space.

 

 

 

 

 

 

 

 

Edited May 6, 2022 by glider3834

[ander]

Re: comments on how Fairfax is allocating to bonds and thinking of duration risk, I pulled the excerpts below from the 2021 Annual Report. They have about $13 B in investments (Associates, Common and Preferred) and have $36 B between cash and bonds ($14 B in bonds). The way I interpret is that Fairfax 1) thinks of the $13 B as their "excess" capital bucket that they can invest and 2) is likely to keep the $36 B in cash / bonds and will likely keep duration on the shorter side since they don't know how high rates may go (e.g., if rates at 8% on long end) -- and if there was an increase in the duration they would probably be thinking of that as part of the $13 B "excess" capital bucket they have.

As float grows so does the $36 B bucket which eventually leads to more excess capital to the $13 B bucket.

That's how I think about it.

 

2021 Annual Report:

"Inflation and higher interest rates are the big risks the markets face today. The CPI index was up 7.5% in January 2022, the highest in 40 years and the ninth consecutive monthly reading above 5%. The Fed is behind the curve as it was in the 1970s and we fear interest rates will increase significantly over time. We should benefit as our total fixed income portfolio, inclusive of cash and short term treasuries, has a duration of only 1.2 years (an average term of 2.2), but significantly higher long rates will have an impact on the economy. This may still be a few years away and, as I said earlier, we have companies with great management that should be able to navigate these “rocks” profitably! Higher interest rates will destroy the speculation we have seen in high tech and other growth stocks with high valuations, SPACS, crypto currencies, etc. Another risk we continue to see is China and its real estate bubble – which is being tested."

 

"Interest rate risk Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. Typically, as interest rates rise, the fair value of fixed income investments decline and, conversely, as interest rates decline, the fair value of fixed income investments rise. In each case, the longer the maturity of the financial instrument, the greater the consequence of a change in interest rates. The company’s interest rate risk management strategy is to position its fixed income portfolio based on its view of future interest rates and the yield curve, balanced with liquidity requirements."

[Xerxes]

For the life of me I don’t understand why Prem is not short the market. It seems so easy to do. 
 

when rates goes up, that is when the shorts go on.  not when rates go down 

[Gregmal]

7 hours ago, Xerxes said:

For the life of me I don’t understand why Prem is not short the market. It seems so easy to do. 
 

when rates goes up, that is when the shorts go on.  not when rates go down 

Prem, among others, giving up shorting was one of the markers we were nearing the top. 

[ander]

Any thoughts on Fairfax exposure to tech (e.g., Digit, etc.) -- especially as lofty valuation multiples compress.

[Thrifty3000]

19 hours ago, Xerxes said:

For the life of me I don’t understand why Prem is not short the market. It seems so easy to do. 
 

when rates goes up, that is when the shorts go on.  not when rates go down 

 

[Cevian]

I'm a long time Fairfax shareholder and I have to say it has always been one of the most frustrating positions. Always unloved, perennially undervalued, down when the market is down, down when the market is up. This week is no different.

[Xerxes]

Cevian

 

i disagree. I think given how illiquid & complex it is, it tend to be less correlated to indices. And it’s day to day movement are largely irrelevant. 
 

quarterly updates and the state of the insurance market are the real driver behind the stock and it happens in step change. And not the indices. 
 

when I see FFH I see a stock that hasn’t lost 40-70% of its value. This what we should look at.
 

It is good to have as a diversifier of opinion (i.e. a capital allocator at the helm that sticks to a certain framework (something works and sometimes it doesn’t). 

[Viking]

34 minutes ago, Cevian said:

I'm a long time Fairfax shareholder and I have to say it has always been one of the most frustrating positions. Always unloved, perennially undervalued, down when the market is down, down when the market is up. This week is no different.

YTD Fairfax has been a massive out performer. Fairfax is up 2% and the S&P500 is down 17%. I am quite impressed with the performance of Fairfax stock so far this year. 
 

importantly, the outlook for Fairfax is quite good.
1.) Rising interest rates are a confirmed tailwind.

2.) We know we are still in a hard market (+20% top line growth)

3.) Fairfax’s equity portfolio looks reasonably well positioned (so far) - but this could change in a hurry

 

Personally, i am hoping the stock gets killed (i appologize in advance to board members who have a full position). I am down to a low weighting (a little under 10%). I have been waiting for sub US$500 pricing and we are almost there. At $450 i would be a very aggressive buyer. We are in a bear market (middle innings?) and this will punish everything.

Edited May 10, 2022 by Viking

[ander]

7 hours ago, Viking said:

YTD Fairfax has been a massive out performer. Fairfax is up 2% and the S&P500 is down 17%. I am quite impressed with the performance of Fairfax stock so far this year. 
 

importantly, the outlook for Fairfax is quite good.
1.) Rising interest rates are a confirmed tailwind.

2.) We know we are still in a hard market (+20% top line growth)

3.) Fairfax’s equity portfolio looks reasonably well positioned (so far) - but this could change in a hurry

 

Personally, i am hoping the stock gets killed (i appologize in advance to board members who have a full position). I am down to a low weighting (a little under 10%). I have been waiting for sub US$500 pricing and we are almost there. At $450 i would be a very aggressive buyer. We are in a bear market (middle innings?) and this will punish everything.

 

"Fairfax’s equity portfolio looks reasonably well positioned (so far) - but this could change in a hurry"

--any stand out to you as potentially vulnerable?

 

[Viking]

On 5/10/2022 at 5:31 PM, ander said:

 

"Fairfax’s equity portfolio looks reasonably well positioned (so far) - but this could change in a hurry"

--any stand out to you as potentially vulnerable?

 

@ander to March 31, Fairfax’s equity portfolio was holding up remarkably well. As the sell off in the stock market has intensified in recent weeks lots of Fairfax’s equity holdings have been taken out behind the woodshed. ATCO, their largest holding, being the most recent example. Dexterra is another holding that was crushed the past month.

 

However, unlike the steep sell off in 2020, most of Fairfax’s equity holdings are in pretty good shape - most of the businesses are humming along and are not impaired. So the sell of in shares today is less of a concern (from my opinion). Also, it is only the mark to market holdings that impact quarterly earnings so this will mute the reported impact quite a bit.

 

Importantly, Fairfax also has two very big cash generators today: underwriting profit and growing interest income. Earnings from these two sources will more than offset the quarterly hit to the equity portfolio moving forward.

Edited May 13, 2022 by Viking

[Parsad]

1 hour ago, Viking said:

@ander to March 31, Fairfax’s equity portfolio was holding up remarkably well. As the sell off in the stock market has intensified in recent weeks lots of Fairfax’s equity holdings have been taken out behind the woodshed. ATCO, their largest holding, being the most recent example. Dexterra is another holding that was crushed the past month.

 

However, unlike the steep sell off in 2020, most of Fairfax’s equity holdings are in pretty good shape - most of the businesses are humming along and are not impaired. So the sell of in shares today is less of a concern (from my opinion). Also, it is only the mark to market holdings that impact quarterly earnings so this will mute the reported impact quite a bit.

 

Importantly, Fairfax also has two very big cash generators today: underwriting profit and growing interest income. Earnings from these two sources will more than offset the quarterly hit to the equity portfolio moving forward.

 

I bought a bunch of ATCO today.  First time in a few years!  Cheers!

[Viking]

47 minutes ago, Parsad said:

 

I bought a bunch of ATCO today.  First time in a few years!  Cheers!

I bought a bunch of Recipe the past couple of days at average cost of $13. And i might add to my very small holding of Dexterra. I’ll be reviewing ATCO this weekend. On the other hand, i have been reducing my position in Fairfax India (on concerns over US$ strength and its impact on emerging markets). 

Edited May 13, 2022 by Viking

[Parsad]

1 hour ago, Viking said:

I bought a bunch of Recipe the past couple of days at average cost of $13. And i might add to my very small holding of Dexterra. I’ll be reviewing ATCO this weekend. On the other hand, i have been reducing my position in Fairfax India (on concerns over US$ strength and its impact on emerging markets). 

 

Haven't bought any Recipe or Fairfax India.  I don't like Recipe and I'd rather have exposure to Fairfax India through my Fairfax holdings, where it benefits from its ownership in FI and performance bonuses from FI.  Cheers!

[petec]

18 hours ago, Parsad said:

 

I bought a bunch of ATCO today.  First time in a few years!  Cheers!

 

Out of interest, why? I have slightly cooled on it, although I haven't sold a share. $2 of earnings puts it on 6x 2024. I suspect EPS might be understated and I think the right PE is probably 8-10x, so it's certainly cheap - but then a lot of things have got a lot cheaper recently, including things that have far better pricing power in an inflationary environment than Atlas does give its long term contracts. I'm not sure Atlas looks better relative to other things than it did at $16. What are your thoughts and how do you value it? (Sorry if this should be on the ATCO thread.)

[Parsad]

36 minutes ago, petec said:

 

Out of interest, why? I have slightly cooled on it, although I haven't sold a share. $2 of earnings puts it on 6x 2024. I suspect EPS might be understated and I think the right PE is probably 8-10x, so it's certainly cheap - but then a lot of things have got a lot cheaper recently, including things that have far better pricing power in an inflationary environment than Atlas does give its long term contracts. I'm not sure Atlas looks better relative to other things than it did at $16. What are your thoughts and how do you value it? (Sorry if this should be on the ATCO thread.)

 

ATCO is not a shipping company.  It's a leasing company.  Investors and analysts don't fully realize that yet.

 

6 times earnings is low.  10-12 times earnings is more reasonable.  In 2024 it should be at $20-22 a share.  It fell closer to half of intrinsic value, so I bought. 

 

Cheers!

[ourkid8]

Interview with Prem and Kamesh.

 

-India has 100 unicorns this year 
-looking to double marketshare in the next 10 years to get their insurance penetration to 5 percent 

-insurance industry in India is growing 12-15% over the next 2-3 years

-Prem thinks the sell-off in the market could have a lot more to go

 

 

 

Edited May 15, 2022 by ourkid8

[backtothebeach]

15 minutes ago, ourkid8 said:

Interview with Prem and Kamesh.

 

-India has 100 unicorns this year 
-looking to double marketshare in the next 10 years to get their insurance penetration to 5 percent 

-insurance industry in India is growing 12-15% over the next 2-3 years

-Prem thinks the sell-off in the market could have a lot more to go

 

 

Thanks for posting a quick summary and not just the link!

[petec]

On 5/13/2022 at 10:58 PM, Parsad said:

 

ATCO is not a shipping company.  It's a leasing company.  Investors and analysts don't fully realize that yet.

 

6 times earnings is low.  10-12 times earnings is more reasonable.  In 2024 it should be at $20-22 a share.  It fell closer to half of intrinsic value, so I bought. 

 

Cheers!

 

 

I'm sceptical that the market doesn't understand that Atlas is a lessor. Atlas trades at a huge premium to other lessors. So it should: it is a better operator, it has longer contracts, it is not over-earning in the short term markets the way the others are, and it has Sokol. But Sokol has attracted a hell of a lot of attention and I think the market knows what this business is.

 

I am also sceptical that a lessor should trade at 12x. I wouldn't capitalise long term contracted cash flows at 8% unless they were inflation-linked. BAM-style assets are infinitely more attractive than ATCO style assets, given they are largely inflation-linked cash flows that can be financed fixed. 

 

I do think the market is disappointed that they failed to grow earnings much in the best market in history. Short term rates are set by the marginal buyer, and can therefore spike to incredible levels in an unbalanced market; long term rates are set by the cost of new ships, so they stay much more stable. Normally, high short term rates don't last, so Atlas' strategy of locking in long term cash flows is normally smart, and they may yet look smart if the market normalises soon. But this spike in short rates has lasted 18 months now. Companies at the short end have earned vast percentages of their enterprise values in a few months. If that continues for another year or two, Atlas will look dumb, and worse, their competitors will be exceptionally well-capitalised.

 

I also think there is confusion about the diversification strategy is and whether it will succeed. The market won't assume that's a success before it is one. The only way I think this gets to 12x is if Atlas successfully develops 2-3 other earnings streams at good returns, and that'll take a decade.

 

Anyway, I agree it is cheap, and I would have been adding at $12 6 months ago. I just think the market might be offering better opportunities now.