Fairfax 2023

[Viking]

WR Berkley just reported an exceptional quarter. Will be interesting to hear their commentary on the current state of the hard market on the conference call at 2pm.

 

Fourth quarter highlights included:

- Return on equity of 23.0%.

- Book value per share grew 8.1%, before dividends and share repurchases.

- Net investment income grew 40.2% to a record $231.3 million.

- Record quarterly pre-tax underwriting income of $291.9 million.

- The current accident year combined ratio before catastrophe losses of 1.2 loss ratio points was 87.2%.

- The reported combined ratio was 88.4%, including catastrophe losses of $30.8 million.

- Average rate increases excluding workers' compensation were approximately 6.9%.

[jfan]

10 hours ago, MMM20 said:

 

I am a terrible trader but it seems more likely to me that Fairfax hits $1200 for the first time at ~1-1.2x BV in ~3-5 years and so the decision to hold is made easier by the market's fixation on valuing it as a multiple of book, which imho systematically undervalues the underlying cash flowing power of the business (and frankly management's willingness and ability to "do a teledyne") on a forward looking basis. I think it just depends how things look if/when we get there, right? But the dream of 15% compounding is certainly alive if they can continue to underwrite at 95% combined ratio which, as I think many others here understand intuitively, is functionally equivalent to borrowing about half the value of their ~$50B investment portfolio at a negative 5% interest rate - which is even more valuable now that rates are back to "normal"-ish! This is the power of float and a relatively large and truly well managed insurance operation. I personally think that largely for this reason it's actually cheaper now than it was in 2020, or at least not dissimilar given the range of outcomes from their current position of massive strength. But, again, I might still be the biggest bull here, and I am wrong all the time.

 

Wish I could go to the meeting for the first time but i'll have a newborn! Next year i hope! Love Toronto!

 

Congratulations on your new addition! Enjoy every moment.

 

I have a 4% position on FFH. I haven't yet earned the privilege to take concentrated positions yet. But a few thoughts about my ownership from this point on:

 

1) If Prem and team continue to stay in charge for the next 10 years, I think it would be reasonable to expect that they will pull interesting tricks out of their hat from time to time. They do better with value now and value not so far in the future investments. In a higher or for long interest rate environment and global reach, I feel fairly confident that they will always find something to do.

2) They don't run private non-insurance businesses or do turnaround activism very well, but they always seem to be able to attract good capital allocators to partner with. Hopefully they continue to build out this platform which might have long-term positive outcomes.

3) I'm also fairly sure that Prem and team recognize that at some point in the future, the insurance market will go soft. If they position their float now (assuming they can maintain decent retention rates) to generate a decent amount of interest, dividends, and more capital gains than losses, they will continue use those opportunities to buyback shares given that they've slowed down the expansion of their insurance geographies. 

 

If they do the above, I think I would be content to enjoy the ride and hold on to it.

 

However if the following happens, I would trim or sell out:

1) more insurance company purchases with FFH shares

2) large macro bets

3) position sizing hard on too many turnarounds or deep value plays with too many macro externalities

 

[Viking]

Lots of great information on the current state of the P&C insurance market from WR Berkley's release today (with a listen if you have time). WRB posted great Q4 results. But I wonder if the decelerating top line growth spooks markets tomorrow.

 

Of note, Fairfax has an average yield of 1.6 years on their fixed income portfolio at the end of Q3, the shortest by far of any P&C insurer. WRB is next, with a duration of 2.6 years. WRB saw the yield on their fixed income portfolio increase from 3% in Q3 to 3.6% in Q4. We know the yield on Fairfax's fixed income portfolio increased in Q4... perhaps the increase in WRB's yield of 0.6% gives us a clue.

----------

1.) top line growth: net premiums written: growth slowed to 6.6% in Q4 compared to 13% for the full year.

 

Elyse Greenspan: And then you made a lot of good market commentary on different business lines. You've in the past spoken about, right, 15-plus premium growth, that's obviously come down reflective, right, of some of the trends in the comp and in liability lines. How do you think when you put everything together, and I know that's hard, where do you think the top line growth could trend over the coming year?

 

Robert Berkley: As far as your question about growth, we'll have to see how it unfolds. I would tell you that based on the limited data I have on January so far, early returns are encouraging. But my ability to speak at a detailed level beyond that, I just wouldn't want to mislead you. But we see a lot of opportunity, and we're watching the opportunity shift from over time from one product line to another. So I think we have good balance to the shift, but we also are very nimble amongst the different parts of the business.

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Rob Berkley: As far as rate goes, as you would have seen from the release we got just shy of 7 points of rate and we think that that comfortably helps us keep up with trend and more likely than not perhaps we are exceeding trend.

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Rob Berkley: Another comment that I did want to make is on renewal retention ratio. Obviously, different product lines, different parts of the business, we target different levels of renewal retention. When we look at our portfolio overall, we look through the renewal retention to sort of float somewhere between 77 and 80, maybe 81 depending on the mix.

 

When we see that renewal retention ratio ticking up above that, from our perspective, it is an invitation to be pushing rate harder. We want to be in the market at a granular level, testing it every day to be getting as much rate as we can to ensure that we are at a minimum at rate adequacy. That's a very important thing that is a priority for us as an organization.

 

2.) investment income

 

Richard Biao EVP & CFO: Our book yield on the fixed maturity portfolio increased from 3% for the third quarter to 3.6% for the fourth quarter, which compares very favorably to 2.2% in the year ago quarter. Our new money rate exceeds the roll-off of our invested assets and we expect net investment income to continue to grow. The investment funds performed well, with a book yield of 5.6%, despite the deterioration in the broader equity markets in the third quarter. And as you may remember, we report investment funds on a one quarter lag.

 

The credit quality of the portfolio remains very strong at a double A minus with the duration on our fixed maturity portfolio, including cash and cash equivalents of 2.4 years. 

----------

 The unrealized loss position on fixed maturity securities improved in the quarter.

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Rob Berkley: And I think as Rich flagged and I will flag again, the new money rate these days is north of 4.5%, we're flirting with 5%. So I will leave it to others to fill in the blanks as to what this means for our economic model. But obviously, when you think about the spread between the book yield and the new money rate and what we're able to achieve and you extrapolate that for what it means for our economic model, I think it is very encouraging.

 

One last quick comment on the investment front. While we are not in a rush and we are going to do it in a very thoughtful way, we certainly are considering beginning to push that duration out towards to 2.6, maybe more towards 2.8 over time. But again, we are not in a rush. We're going to do that in an opportunistic way as windows open and close.

 

Edited January 27, 2023 by Viking

[Viking]

36 minutes ago, jfan said:

However if the following happens, I would trim or sell out:

1) more insurance company purchases with FFH shares

2) large macro bets

3) position sizing hard on too many turnarounds or deep value plays with too many macro externalities

 

I agree. If Fairfax wants to attract new long term shareholders they need to be very careful not to pick old scabs. My watch out is arrogance. Do they have some success with Mr Market in 2023 (shares rip higher), get cocky and then mess up with a big purchase/macro bet/empire building. Not my base case... but definitely something to monitor.

[SafetyinNumbers]

22 hours ago, Viking said:

Well i lightened up on my Fairfax position today. Why?

1.) i was way, way overweight. Especially given the recent run-up. My strategy with Fairfax is to have a core position i hold as long as the story remains intact (the Fairfax story is actually getting better). I trade around that core holding - buy more when the stock sells of (like last Sept/Oct) and lighten up when the stock pops (like now). This strategy has worked exceptionally well since Fairfax hit its pandemic lows in Oct 2020.

2.) tax reasons. My wife and i do not have day jobs. Selling Fairfax in our taxable accounts realizes some pretty big capital gains (we were up 35% on those positions) that we will pay minimal tax on (given it will be our only income for the year). In Canada capital gains receive very favourable tax treatment. 
 

Fairfax remains a little over 30% of my total portfolio - so i am still way overweight. Oil is about 30% (mostly SU). Cash is up to 35%. Misc is 5% (US financials and Fairfax India). I recently sold my big tech and dividend stocks for 6-8% gains (over 6 weeks). My total portfolio is up about 8% to start the year so i am happy to lock in gains and raise some cash (that will earn +3%) while i wait for the next fat pitch.

Market reacting today learning Viking has trimmed some of his FFH position 

[gfp]

29 minutes ago, SafetyinNumbers said:

Market reacting today learning Viking has trimmed some of his FFH position 

 

It's funny, for me today was the day the dividend actually cleared the accounts.  If you were inclined to reinvest the dividend at least there was a dip.  The "Viking" dip!

[Viking]

6 hours ago, gfp said:

 

It's funny, for me today was the day the dividend actually cleared the accounts.  If you were inclined to reinvest the dividend at least there was a dip.  The "Viking" dip!

Looks to me like Mr Market likely did not like WRB’s outlook for the hard market. A few insurers traded lower today. Chubb’s commentary when they report after market on Tuesday should provide more good insight.

—————

As others have pointed out, if we get clear signs the hard market is ending we will likely get multiple contraction across all P&C insurance stocks. Something to monitor.
—————
WRB   - 2.94%

TRV    - 1.74%

CB.     - 1.64%

FFH.   - 2.61%

 

Edited January 28, 2023 by Viking

[SafetyinNumbers]

5 hours ago, Viking said:

Looks to me like Mr Market likely did not like WRB’s outlook for the hard market. A few insurers traded lower today. Chubb’s commentary when they report after market on Tuesday should provide more good insight.

—————

As others have pointed out, if we get clear signs the hard market is ending we will likely get multiple contraction across all P&C insurance stocks. Something to monitor.
—————
WRB   - 2.94%

TRV    - 1.74%

CB.     - 1.64%

FFH.   - 2.61%

 

My understanding is that if the market softened that Fairfax would have a lot of excess capital free up for buybacks and since we are still well below 1.2x book maybe that would help us get multiple expansion faster. Growth is better but with Fairfax’s insurance business so much bigger as a percentage of its market cap than the peers, I think it’s a mistake to paint them with the same brush.

 

[Xerxes]

On 1/26/2023 at 6:42 AM, StevieV said:

 

I'm not either.  Fairfax is going to trade opposite the market?  I wouldn't think so.

 

Like last year, Fairfax may be able to break free from trading with the market, but I don't see why it would trade opposite.

 

@nwoodman @Viking

 

If the big technology firms get a bid and S&P500 bottoms out and money flows into them (ala post Dec 2018), wouldn't that take some air from FFH like names. I am not talking about the underlying business just the stock price.

 

Prem himself endlessly talks about how FFH does outperform the S&P500 coming out of a crash (not FFH book value he is talking, but FFH share price). We had that massive contrarian outperformance in 2022, which followed outperformance (though mild) in 2021 by FFH.

 

What is the likelihood of that repeating itself, if S&P500 rallies hard, third time in a row.

I think low.

 

I get all the "it is cheap" arguments. That is being for me, as a core position at 11% (not counting FIH), it is a hold, so it is not like I am missing out on anything but I will wait before adding more money in 2023. 

 

Lastly, the mountain has two sides, as I like to say.

 

At some point when FFH rallied hard in 2014 from $400 to $700. There were all kinds of reasoning that made sense at the time, why it was a buy at $700. "Don't you see the deflation coming". Hindsight is 20/20, 8 years later now we know better. That was the "left side" of the mountain. And 2020 was the "right side" of the mountain. When the share price revisited the same dollar value.

 

I could say the samething about any other stock. Say Microsoft.

$248 today in Q1 2023. And it was $248 in Q1 2021. 

In 2021, you were crazy for not owning, and in 2023, there is a "tectonic shift".

 

FFH may go (will?) to +$,1200. But there could be really good reason for it to take a dive some years down the road.

 

I guess, i am looking at this with an eye to long-term capital deployment.

I am too busy enjoying life than trade around. Of course one could trade Microsoft around that step change in outlook etc. And one can trade FFH as well.

 

 

 

Edited January 30, 2023 by Xerxes

[SafetyinNumbers]

BMO upgrades to outperform C$1050 price target.

 

 

[Crip1]

3 minutes ago, SafetyinNumbers said:

BMO upgrades to outperform C$1050 price target.

 

 

So, yeah, we had to figure this was coming. And while I agree with upgrading FFH as it is my largest holding, this is really another example of Wall Street advisors using the rear view mirror approach. The main difference between FFH now and FFH 3 months ago is the 30% increase in share price. It's the same damned company that was rated neutral at US$490 but is now rated outperform at US$638. It's back-asswards,

 

-Crip

[SafetyinNumbers]

2 hours ago, Crip1 said:

So, yeah, we had to figure this was coming. And while I agree with upgrading FFH as it is my largest holding, this is really another example of Wall Street advisors using the rear view mirror approach. The main difference between FFH now and FFH 3 months ago is the 30% increase in share price. It's the same damned company that was rated neutral at US$490 but is now rated outperform at US$638. It's back-asswards,

 

-Crip

 

They have been fairly constructive for some time and were probably waiting for a downtick to make it official. It's still really early based on their own estimates. I don't think they will regret the upgrade. 

[Viking]

7 hours ago, SafetyinNumbers said:

BMO upgrades to outperform C$1050 price target.

 

What we are seeing is more analysts looking out the front windshield. Analysts have no choice… regardless of what they think of Fairfax as a company, they have to update their models. Lots of good things were happening under the hood at Fairfax in 2022 but they were masked by market to market losses, mostly in their bond portfolio (equities as well).  Now that the losses in the bond portfolio are over (and likely reversing) we will see the earnings power of the company shine through. Who knew???

 

The BMO note also illustrates beautifully ALL ANALYSTS CARE ABOUT: ‘operating earnings’. They hate ‘investment gains’ - likely because of their volatility quarter to quarter. 
 

Analysts are awakening to the fact that operating earnings at Fairfax are exploding and the higher amounts are sustainable. Underwriting income and interest and dividend income are no brainers. I was pleased to see BMO also giving Fairfax credit for ‘share of profit of associates’. I wasn’t sure how analysts would treat that line item.
 

My guess is Fairfax could deliver about $3.5 billion in ‘operating earnings’ in 2023 = about $150/share (underwriting profit + interest & dividend income + share of profit of associates). If analysts include share of profit of associates in their estimate of operating earnings (the ‘predictable’ items) then we could be off to the races in terms of upgrades/investor interest. Analysts use operating earnings as their ‘north star’ to value P&C insurance companies. 
 

Bottom line, analysts are finally getting their analysis of Fairfax correct when it comes to underwriting income, interest and dividend income and share of profit of associates. But where are analysts still messing up? Investment gains. 
 

BMO clearly has no idea how to model investment gains. So they assume they mostly do not exist. That is easy. And safe. But way underestimates what Fairfax will likely deliver.
 

BMO is estimating Fairfax will deliver an average of US$280 million per year in investment gains in 2023 and 2024. The Ambridge sale already announced should deliver a big gain in 2023 (we should know more when Fairfax reports Q4 results). We also know a $100 move in FFH share price = US$200 million in gains (thank you TRS). Fairfax has a large mark-to-market equity portfolio. They likely will monetize more assets over the next 2 years (for sizeable gains). The $280 million estimate looks comically low to me… but we will see.
 

The good news is only very modest ‘investment gains’ are built into BMO’s updated estimates. So future investment gains should provide further upside to BMO’s estimates.

 

The bottom line is Fairfax has two engines of growth: insurance AND investments. And both engines are performing exceptionally well right now. Nice to see analysts starting to figure out at least one engine.

Edited January 30, 2023 by Viking

[cwericb]

Analysts really are a bit of a joke. In theory they look into their crystal balls and make predictions of the future when all too often the reality is that they simply react to what has already happened.

 

When it comes to Fairfax, really, is there an analyst out there who can match Vikings knowledge of the subject? I very much doubt it - and Viking (and others here) provide their knowledge and insights of Fairfax to board members without charge.  Thank you.

[Crip1]

53 minutes ago, cwericb said:

Analysts really are a bit of a joke. In theory they look into their crystal balls and make predictions of the future when all too often the reality is that they simply react to what has already happened.

 

When it comes to Fairfax, really, is there an analyst out there who can match Vikings knowledge of the subject? I very much doubt it - and Viking (and others here) provide their knowledge and insights of Fairfax to board members without charge.  Thank you.

That's damn right.

 

[MMM20]

 

Just incredible that you can cover this company professionally and literally lead off your upgrade report getting the whole point totally backwards. Lumpy does not equate "unreliable" and "lower quality" earnings. Lumpiness in intelligent value investing is the price you pay for a shot at long term outperformance. Give me the lumpy returns from Fairfax's private and illiquid public investments all day. Would you rather have "smooth" returns from keeping the cash in the bank or buying long duration treasuries all the way up to 1-2% yields like most insurance companies did over through the past few years? Looks super smooth quarter to quarter, doesn't it? So you get a premium valuation for that even if you're definitionally locking in lower returns for investors?

 

If Fairfax can underwrite to 95-98% combined ratio and invest in cash/fixed income at ~3-4% and equities at ~6-8% CAGR over the next decade, that'll be an absolute home run for shareholders from this valuation, even if it's "lower quality" and puts a cap on multiple expansion b/c of bad logic like BMO's.

 

If you insist on smooth 15% returns, well, that's how you end up invested in Madoff.

 

Edited January 31, 2023 by MMM20

[TwoCitiesCapital]

2 hours ago, MMM20 said:

 

Just incredible that you can cover this company professionally and literally lead off your upgrade report getting the whole point totally backwards. Lumpy does not equate "unreliable" and "lower quality" earnings. Lumpiness in intelligent value investing is the price you pay for a shot at long term outperformance. Give me the lumpy returns from Fairfax's private and illiquid public investments all day. Would you rather have "smooth" returns from keeping the cash in the bank or buying long duration treasuries all the way up to 1-2% yields like most insurance companies did over through the past few years? Looks super smooth quarter to quarter, doesn't it? So you get a premium valuation for that even if you're definitionally locking in lower returns for investors?

 

If Fairfax can underwrite to 95-98% combined ratio and invest in cash/fixed income at ~3-4% and equities at ~6-8% CAGR over the next decade, that'll be an absolute home run for shareholders from this valuation, even if it's "lower quality" and puts a cap on multiple expansion b/c of bad logic like BMO's.

 

If you insist on smooth 15% returns, well, that's how you end up invested in Madoff.

 

 

I don't disagree with you, but this IS how markets work. 

 

Debt gets lower returns than equities, and is considered higher quality/safer investment, precisely because of the reliability of coupon payments and maturities versus the uncertainty of earnings/dividends. This is what drives the so called equity-risk premium - it's the risk that returns vary and are unknown. 

 

Having an insurance company with more stable year-to-year earnings will typically result in it trading at a premium valuation to another insurance company that is riskier, but earning more.

 

Sure Fairfax got it right this time around and are doing very well because of it, but that ignores that they did very poorly from 2016-2019 as interest income fell dramatically and stayed low for years because they got the last pivot wrong. That's the risk. 

[cwericb]

It is not like the term "lumpy returns" just came out of nowhere. Prem used the term 8 or 10 years ago to warn about his plan for Fairfax's future and made no bones about it. It was a case of like it or not, but that was his personal prediction of how he was going to run the company. As far as the ups and downs are concerned, I sure like the direction in which we have been going lately. Like it or lump it.

[Viking]

Share buybacks, done in a responsible manner (purchased at attractive prices) and sustained over many years, can be very beneficial for shareholders.

 

Fairfax’s 'common stock effectively outstanding' peaked in 2017 at 27.75 million shares. At September 30, 2022, share count had fallen to 23.45 million shares. Over the last 5 years, Fairfax has reduced its share count by approximately 4.3 million shares or 15.5% = 3.1% per year (or 860,000 shares per year). See table at the bottom of this post for details.

 

The big share repurchase came in December 2021, when Fairfax executed a substantial issuer bid and purchased 2 million shares at US$500/share at a total cost of $1 billion. With Fairfax shares trading at US$670 today, this repurchase is already looking like a great decision for shareholders.

 

Fairfax has been doing a solid job on the buyback front the past 5 years: share count has come down nicely and shares have been repurchased at attractive prices.

 

What could we see in 2023? The good news is Fairfax’s free cash flow should be very high in 2023, driven by record underwriting income, record interest and dividend income and solid realized investment gains. The bad news is Fairfax’s share price is trading today at new all time highs (US$670) so Fairfax will have to ‘pay up’ a little.

 

It looks pretty likely that we should see Fairfax continue to buy back stock in 2023. My guess is a repurchase of 2% of shares outstanding is a pretty safe minimum amount (470,000 shares @ $670/share = cost of $315 million). A much larger repurchase is also very possible. Much will depend on how cheap Fairfax feels their shares are. My guess is Fairfax feels US$670 is dirt cheap. So it would not surprise me to see Fairfax execute another large buyback while shares are still cheap. Perhaps something in the range of 1 million shares (cost @ $670 million at todays share price). They could easily do this as part of their approved NCIB.

 

Much will depend on opportunity cost: Fairfax has lots of good options of what to do with their growing free cash flow:

1.) we are still in a hard market: supporting growth at insurance subs will likely be the top priority

2.) we are in a bear market for equities: lots of companies are cheap

3.) continue to buy out minority shareholders (Allied, Odyssey, Brit): while not technically a buyback, taking out minority shareholders does increase the amount of earnings that flows to Fairfax shareholders. Some on this board have likened this activity to a stock buyback.

 

We will know much more when Fairfax reports Q4 results. It will be interesting to see what they have been up to on the capital allocation front. And to learn how they are thinking as we begin 2023.

—————

Below is Prem’s quote from 2018 that suggests Fairfax will continue to be aggressive with share buybacks in the coming years. It is interesting that Prem discusses share buybacks and buying out minority partners  in the same paragraph (viewed as being similar activities?).

 

2018AR Prem’s letter to shareholders: “I mentioned to you last year that we are focused on buying back our shares over the next ten years as and when we get the opportunity to do so at attractive prices. Henry Singleton from Teledyne was our hero as he reduced shares outstanding from approximately 88 million to 12 million over about 15 years. We began that process by buying back 1.1 million shares since we began in the fourth quarter of 2017 up until early 2019 – about half for cancellation and half for various long term incentive plans we have across our company. This was after we increased our ownership of Brit to 89% from 73% while having the funds ready to increase our ownership of Eurolife from 50% to 80% in August 2019.”

—————

Fairfax’s total return swaps on 1.96 million Fairfax shares: some on this board consider this investment to represent a buyback of sorts. Here is an update on this holding. It is turning into one of Fairfax’s best investments ever.

 

Cost at Inception =        $733 million ($372.96) - initiated late ‘20 & early ‘21

Value Sept 30, 2022 =   $913 million ($464.80 share price)

Value Dec 31, 2022 =   $1.167 billion ($594.12 share price)

Value Jan 31, 2023 =   $1.305 billion ($665.74 share price)

 

Increase in value of position from inception = $574 million = + 79% over 26 month holding period (not including any costs  to maintain TRS position).

 

From Q3 2022 Report: Long equity total return swaps

During the first nine months of 2022 the company entered into $217.4 notional amount of long equity total return swaps for investment purposes. At September 30, 2022 the company held long equity total return swaps on individual equities for investment purposes with an original notional amount of $1,012.6 (December 31, 2021 - $866.2), which included long equity total return swaps on 1,964,155 Fairfax subordinate voting shares with an original notional amount of $732.5 (Cdn$935.0) or approximately $372.96 (Cdn $476.03) per share that produced net losses of $82.3 and net gains of $7.1 during the third quarter and first nine months of 2022 (2021 - net losses of $50.4 and net gains of $51.1).

—————

Edited February 1, 2023 by Viking

[Crip1]

From the Q4 Markel press release:

 

Development on prior years loss reserves within our general liability and professional liability product lines in 2022 was impacted by broader market conditions, including the effects of economic and social inflation, and was most pronounced on the 2016 to 2019 accident years, which was before we began achieving significant rate increases for these product lines. 

 

There's a yin and yang to this. First, one has to think that as time goes on this (economic inflation) is going to be seen throughout the industry. This has to have a negative impact on loss ratios for everyone which will negatively impact earnings for the foreseeable future. At the same time, this will either delay the end of the current hard market or mitigate the "softness" of the market. It is going to impact the whole industry and, like other macro trends, some companies will navigate it better than others. 

 

-Crip

 

[Viking]

1 hour ago, Crip1 said:

From the Q4 Markel press release:

 

Development on prior years loss reserves within our general liability and professional liability product lines in 2022 was impacted by broader market conditions, including the effects of economic and social inflation, and was most pronounced on the 2016 to 2019 accident years, which was before we began achieving significant rate increases for these product lines. 

 

There's a yin and yang to this. First, one has to think that as time goes on this (economic inflation) is going to be seen throughout the industry. This has to have a negative impact on loss ratios for everyone which will negatively impact earnings for the foreseeable future. At the same time, this will either delay the end of the current hard market or mitigate the "softness" of the market. It is going to impact the whole industry and, like other macro trends, some companies will navigate it better than others. 

 

-Crip

 

Mr Market did not like Chubb's earnings; stock was down today 6.2% in a strong market. Travellers was also down 3.1% and WRB was down 1.5%. Looks like the best days of the hard market are now behind us. Still a decent position for most companies. But discipline will be more important than ever moving forward, especially if companies see development in prior year loss reserves like Markel.

[Viking]

Net gains (losses) on investments - both bonds and stocks - was a significant headwind for Fairfax in the first three quarters of 2022. Fairfax had a great year in 2022 but the significant losses in their bond and stock portfolio made reported results look terrible, at least over the first three quarters. In Q4, stocks rebounded and the losses likely stopped in bonds.

 

My earnings estimate for Fairfax for 2023 is about US$105/share. One of the key inputs is net gains on investments = $750 million for the year. 

 

Well one month into 2023 how are we looking? I think we might be close to my $750 annual estimate after 1 month. How?

1.) Ambridge Partners sale for $400 million. We don't know the gain yet. Brit paid $100 million for Ambridge but also merged it with part of their operation. I am going to assume a gain on sale of $200 million. Note, this deal might close in Q2.

2.) Mark to market equity gains are tracking at about $370 million today (total equity portfolio is up about $810 million as of today).

3.) Investment gains on bonds. This is the hard one for me (I don't have a model for this). Given the big decline in bond yields we are seeing 3 years and further out on the yield curve, my WAG for $250 million in gains on the bond portfolio. 

 

Total: $200 + $370 + $250 = $820 million

 

Bottom line, from here it would not be a stretch for Fairfax to report +$800 in net gains on investments in Q1. Early days; but something to watch. And a big headwind in 2022 is poised to be a big tailwind in 2023.

----------

So in 2023 we could see record underwriting income, record interest and dividend income and near record share of profit of associates. And perhaps also a big bounce back year in net gains on investments. The story keeps getting better and better...

----------

Fairfax Equity Holdings Feb 1 2023.xlsx

Edited February 2, 2023 by Viking

[StubbleJumper]

9 minutes ago, Viking said:

3.) Investment gains on bonds. This is the hard one for me (I don't have a model for this). Given the big decline in bond yields we are seeing 3 years and further out on the yield curve, my WAG for $250 million in gains on the bond portfolio. 

 

People should ignore this.  Three or four years ago, I expressed caution about quality of earnings when Fairfax cobbled together some paper gains from reorganizing certain holdings.  I reassert that caution about the quality of losses for 2022 and the quality of some of the gains in 2023.  FFH has demonstrated every intention to hold the bulk of its fixed income portfolio to maturity.  Therefore, we would be well served to completely ignore the M2M losses that we saw in 2022 and the M2M gains that we will probably see from the fixed income port in 2023.  It's a nothing.

 

The one thing that we might get from the M2M losses/gains on the fixed income port is that sometimes Mr. Market responds to headline EPS numbers.  Last fall, Mr. Market hated FFH's EPS numbers and the stock traded off to US$450ish.  That was a very attractive buying opportunity.  Will we shoot the other direction in 2023?  Will the M2M gains result in Mr. Market giving us an attractive selling opportunity?

 

As a shareholder, the bond gains and losses are pretty irrelevant from an economic perspective, but maybe stupidity will reign in the opposite direction in 2023?  If it happens, I'll take it.  Just remember, M2M gains/losses on bonds for Fairfax are not real or relevant in any way.

 

 

SJ

[Viking]

3 hours ago, StubbleJumper said:

 

People should ignore this.  Three or four years ago, I expressed caution about quality of earnings when Fairfax cobbled together some paper gains from reorganizing certain holdings.  I reassert that caution about the quality of losses for 2022 and the quality of some of the gains in 2023.  FFH has demonstrated every intention to hold the bulk of its fixed income portfolio to maturity.  Therefore, we would be well served to completely ignore the M2M losses that we saw in 2022 and the M2M gains that we will probably see from the fixed income port in 2023.  It's a nothing.

 

The one thing that we might get from the M2M losses/gains on the fixed income port is that sometimes Mr. Market responds to headline EPS numbers.  Last fall, Mr. Market hated FFH's EPS numbers and the stock traded off to US$450ish.  That was a very attractive buying opportunity.  Will we shoot the other direction in 2023?  Will the M2M gains result in Mr. Market giving us an attractive selling opportunity?

 

As a shareholder, the bond gains and losses are pretty irrelevant from an economic perspective, but maybe stupidity will reign in the opposite direction in 2023?  If it happens, I'll take it.  Just remember, M2M gains/losses on bonds for Fairfax are not real or relevant in any way.

 

SJ

 
@StubbleJumper i agree philosophically with what you are saying. The challenge is most investors do not follow insurance companies closely enough to be able to ‘look through’ volatility in investments. Especially a company like Fairfax with all of its complexity. So when investment markets go down a lot (like last year), and earnings and BV get hit, most investors do not adjust their numbers. They look at reported numbers and take them at face value. Same with most analysts.

 

So in Q4 and again in Q1 we will likely see big gains in equities as stock prices return to fair value. We also will see gains in bonds as interest rates normalize (go lower). In turn, this will normalize Fairfax’s BV - which in Fairfax’s case means it will increase a fair bit. And given P&C insurers are largely valued primarily using BV, a higher BV should result in a higher share price.

—————

It will be interesting to see what changes Fairfax has made to its investment portfolio in Q4:
1.) bonds: Dec 31, 2021 average duration was 1.2 years. Sept 30, 2022 average duration had increased to 1.6 years. Did Fairfax extend duration further out in Q4? Hopefully, yes. 

2.) stocks: Fairfax has been very active adding to their equity holdings all year. This added exposure will benefit shareholders in many different ways. Fairfax also tends to be very opportunistic in down markets so i am looking forward to seeing if they have done anything creative to get extra exposure to stocks while prices are low (total return swaps?).

Edited February 2, 2023 by Viking

[glider3834]

On 2/2/2023 at 1:46 PM, StubbleJumper said:

 

People should ignore this.  Three or four years ago, I expressed caution about quality of earnings when Fairfax cobbled together some paper gains from reorganizing certain holdings.  I reassert that caution about the quality of losses for 2022 and the quality of some of the gains in 2023.  FFH has demonstrated every intention to hold the bulk of its fixed income portfolio to maturity.  Therefore, we would be well served to completely ignore the M2M losses that we saw in 2022 and the M2M gains that we will probably see from the fixed income port in 2023.  It's a nothing.

 

The one thing that we might get from the M2M losses/gains on the fixed income port is that sometimes Mr. Market responds to headline EPS numbers.  Last fall, Mr. Market hated FFH's EPS numbers and the stock traded off to US$450ish.  That was a very attractive buying opportunity.  Will we shoot the other direction in 2023?  Will the M2M gains result in Mr. Market giving us an attractive selling opportunity?

 

As a shareholder, the bond gains and losses are pretty irrelevant from an economic perspective, but maybe stupidity will reign in the opposite direction in 2023?  If it happens, I'll take it.  Just remember, M2M gains/losses on bonds for Fairfax are not real or relevant in any way.

 

 

SJ

SJ
 

I would agree in terms of being conservative as an investor & thinking about BV impact, assume they hold to maturity & those unrealised losses will reverse.

 

At same time, we know HWIC are very active, value, bond managers who focus on total return ie investment gains not just yield eg When Greek bond yields went from 8% to 1%, they realised gains over 300mil euro over 2019-2021 - selling Greek Govt bonds & re-distributing into Greek T Bills etc. That one investment move has probably driven a big chunk their return on Eurolife FFH investment. 

 

 

IMHO I think there is 'alpha' in Fairfax's fixed income investment team that should be factored into their P/B multiple. Hamblin Watsa's 5,10 & 15 years record versus benchmark was last published in 2017 (see below) , so I am hoping there might be an update in the 2022 annual return.

 

 

 

 

 

 

 

 

Edited February 3, 2023 by glider3834