Fairfax 2024

[dartmonkey]

1 hour ago, 73 Reds said:

Yeah, high share price was always the reason or excuse given but today one can easily buy fractional shares.  The other issue is two classes of stock but some of us remember when there was only one class and they weren't so expensive.  Not that Buffett would give a sh-t one way or another; in fact he probably prefers to be excluded for the same reason why Groucho Marx would never be a member of a club that would have him.

The point is not that the public has a hard time buying shares, it's that the Dow Jones has a weird weighting system where each company is weighted by its share price, not by its market cap (the latter being how most indexes are weighted, like the S&P 500). That means that Apple, the company with the highest market cap ($3.5t) has a 3.8% weight because of its $228 share price, slightly less than American Express which has a 3.9% weight because its share price is $238, even though AmEx has a market cap of $171b, 1/20th of Apple's. Including Berkshire with its $620,000 A-share price would make Berkshire 99% of the index. 

 

Of course, nowadays, they could select the B-shares and that would make Berkshire the DJ element with the 4th largest weight (after United Health Group, Microsoft and Goldman Sachs). Since 2017, the DJ has excluded companies with multiple classes of shares, but Berkshire would easily have been in the top 30 companies in 2017 so I don't know why they weren't included prior to 2017.

Edited July 9 by dartmonkey
edited to correct a mistake, I said Honeywell instead of American Express...

[Xerxes]

Yes. In fact Apple 7-1 share split some decade ago was to get to DOW as a candidate. 

[gfp]

And honestly nobody cares about the Dow Jones Industrial Average anymore.  How much money is even indexed to it?

[SafetyinNumbers]

4 hours ago, dartmonkey said:

Rebalances happen every 3 months, next one in September. 

 

One of the rules is that no company should constitute less than 0.2% of the index (obviously, the average is 100%/60=1.67%). Right now, the smallest constituent is Algonquin Power and Utilities (AQN), which, at $5.621b market cap, constitues 0.202% of the index, so they are flirting with ejection. They are in a sector (Energy) which is already heavily represented, at 17.9%; unfortunately for the prospects of Fairfax inclusion, so are Financials, at 34.4%. They could turf Canadian Apartment Properties Real Estate Investment Trust (CAR.UN) which is at 0.28% and put Fairfax in, given that Fairfax is #31 by market cap of Canadian companies, so would seem to belong to the TSX60 which is in principal "designed to represent leading companies in leading industries. Its 60 stocks make it ideal for coverage of companies with large market capitalizations and a cost-efficient way to achieve Canadian equity exposure."

 

I'm guessing it won't happen yet, but it would be a nice surprise, if you like that sort of thing.

 

26th biggest in the Composite which is the population set for the 60 assuming Blackrock isn’t taking basis risk, they have AQN at 22bps so a decent amount of room. 
 

Most people dismiss FFH as a potential add because the Financials are already overweight but at some point it becomes too big to ignore especially given the likely forward book value growth. The longer it takes the better. 
 

 

Edited July 9 by SafetyinNumbers

[gfp]

Best bet is for two Canadian financials to merge or someone gets bought out, creating an open spot.  Fairfax could be pretty undeniably huge by the time they enter.  

[dartmonkey]

16 hours ago, gfp said:

Best bet is for two Canadian financials to merge or someone gets bought out, creating an open spot.  Fairfax could be pretty undeniably huge by the time they enter.  

Yeah, that would make sense, although it would still increase the allocation to Financials, already by far the biggest proportion at 34%.

 

That includes banks, insurance companies and asset managers: going by their rank in market cap for Canadian companies, the financial sector of the TSX60 includes banks: #1 Royal Bank, #2 TD Bank, #11 BMO, #12 Scotiabank, #16 CIBC and #27 National Bank; insurance companies: #14 Manulife, #25 Intact Financial, #28 SunLife, and #29 Great-West Lifeco; and also asset managers: #9 Brookfield Corp (BN), #44 Power Corp and #48 Brookfield Asset Mgmt (BAM). Fairfax has the #31st biggest market cap in Canada, so if included it would be the smallest of the 5 insurance companies but 2 of the 3 asset managers and almost as big as the #6 bank, National Bank.

 

But if they dumped the smallest TSX60 component, Algonquin Power and Utilities, which is #88 with its market cap of $6.3b (CAD), and replaced it with Fairfax which is #26 at $38b, it would add roughly a bit more than 1% to the already big Financial sector. If balancing the sectors is also a goal of the index, then it might make more sense to dump the smallest financial (#48 BAM) and replace it with #31 Fairfax.

 

Ultimately, the problem is that the index can not do everything it sets out to do: include the biggest Canadian companies, but keep sector representation similar to their importance in the Canadian economy. Given that we don't know how much importance is given to the different objectives, it is hard to say what they might do, as long as the smallest company (Algonquin) stays above the 20 bp criterion; right now at 20.2 bp, they are just 1% over.

 

What is the biggest Canadian company that is NOT in the TSX60? Is it #31 Fairfax? It looks like #20 Lululemon, headquarters in Vancouver, takes that honour, probably because they are not listed on the TSX. Then there is #36 CGI, headquarters in Montreal, an IT services company which does have a TSX listing. #45 Ivanhoe Mines is up about 100% in the last year which probably explains their absence. #49 GFL, a waste manager, is a third the size of Waste Connections (WCN) which is in the index. Those seem to be the biggest Canadian companies not included. 

Edited July 10 by dartmonkey
explanation for lulu's absence

[Hoodlum]

I should have posted in this thread.

 

I found some additional details from AM Best on why we are not seeing a softening of the insurance market and that this is likely not changing for the next few years unless we have new entrants in the market.  It would seem that new entrants are not able to secure funding as the traditional sources for these funds are able to take advantage of the Hard Market through better availability of Insurance-linked Securities (ILS).

 

https://www.reinsurancene.ws/no-new-class-of-reinsurers-despite-best-returns-since-1993-am-best/

 

Quote

Dan Hofmeister, Associate Director, AM Best, commented, “A class of startup reinsurers usually quickly forms to capitalize on the interruption in the reinsurance demand-supply equilibrium. Many of these new reinsurer formations merge or are acquired as the market cycle returns to the soft phase of the cycle.”

 

The ratings agency notes that this hard market is different from prior ones in that it was not the result of a single, large event, but instead by the accumulation of a series of property cat events, which led to underwriting losses and earnings events for the majority of market players.

 

Regardless of the causes and differences of this hard market, AM Best feels that it will take “at least a few years” for both pricing and conditions to soften. And while it’s come as a surprise to many that a Class of 2023 or Class of 2024 failed to materialise, the ratings agency notes that this was not for lack of effort or talented executives, but that ultimately, none of the rumoured entrants made it past the fundraising stage.

 

“AM Best has issued a number of preliminary credit assessments on business plans from high profile management teams, which have had similar difficulties in fundraising,” said Carlos Wong-Fupuy, senior director, AM Best. “Many of them note that large, passive capital investors, such as sovereign wealth funds, endowments and pension funds, still have healthy levels of interest in the industry.”

 

AM Best’s report also states that private equity-venture capital investors aren’t currently interested in supporting startup non-life reinsurers.

Part of the reason for this lack of interest, according to AM Best, may also include competitive conditions in the reinsurance market and the availability of insurance-linked securities (ILS) that may have more appeal in a hard reinsurance market given their concentrated nature.

 

“The existence of a healthy ILS market appears to have diminished the franchise value of property catastrophe business to investors. Investors today appear much keener to allocate funds to shorter-term ILS instruments to capitalize on the hardened underwriting conditions, rather than in a rated balance sheet. As long as these alternative entry points exist, we don’t foresee capital flowing into the new reinsurers to support hardened property rates and conditions,” says AM Best.

 

Edited July 10 by Hoodlum

[MMM20]

Can anyone explain why specifically index inclusion would be a major catalyst for Fairfax? I’ve seen a bunch of examples recently where stocks have gotten into major indexes and then dropped, or vice versa. Is there something about Fairfax and/or the Canadian markets that makes it an especially strong thesis?

[SafetyinNumbers]

5 minutes ago, MMM20 said:

Can anyone explain why specifically index inclusion would be a major catalyst for Fairfax? I’ve seen a bunch of examples recently where stocks have gotten into major indexes and then dropped, or vice versa. Is there something about Fairfax and/or the Canadian markets that makes it an especially strong thesis?

I think it matters because FFH is particularly under owned by Canadian active managers benchmarked to the Composite. Of course, it will depend on the price individual shareholders are willing to give up their shares (recently 1.2x trailing book). A new permanent shareholder of a million shares plus that adds with passive inflows regardless of the price is a nice to have and may help with multiple expansion but it’s no guarantee. 

[MMM20]

On 7/9/2024 at 10:24 AM, MMM20 said:

Wondering what the board makes of this...

 

Prop Cat Is Significantly Underpriced This Year https://iansbnr.com/prop-cat-is-significantly-underpriced-this-year/

 

"One of the great mistakes of the financial crisis was mortgage underwriters and investors thinking they would be OK because their models told them what a bad outcome looked like and that they would be OK under that outcome. The problem, of course, was the models accounted for 'normal' stress and not an extreme stress. I fear the same thing is happening this year in the prop cat market. Underwriters are ignoring the elevated risk of a historically active season and continuing to price off the cat models. You would price the odds of who wins the Presidential election differently before the debate vs. afterwards in response to new information. Well, we have lots of information that suggests it won’t be a normal hurricane season, so why are reinsurers pricing cat treaties like it is a normal year?"

 

Bueller? Bueller?

[gfp]

2 minutes ago, MMM20 said:

Bueller? Bueller?

 

 

Well I'm just impressed that Weston Hicks commented on his article.  I assume it was the real Weston Hicks.

[Thrifty3000]

2 hours ago, gfp said:

 

 

Well I'm just impressed that Weston Hicks commented on his article.  I assume it was the real Weston Hicks.

I noticed Mark Dwelle commented on the article about Fairfax / Muddy Waters.

[Thrifty3000]

2 hours ago, MMM20 said:

Bueller? Bueller?

I read it. It’s consistent with all the other chatter about hurricane risk being elevated this year. However, I’m not so sure insurers - especially Fairfax - are as unprepared as he suggests.

 

It sounds like we can expect increased losses from storm damage this year, however, my understanding has been:

 

- cat prices had already increased by at least the levels he suggested were necessary to absorb a record year of losses.

 

- insurers have pulled way back, or completely exited, high storm risk areas like Florida, which means the insurers have already opted out of the areas - like Miami - that he is most concerned about.

 

- insurers have been able to write policies with much more favorable terms/limits/riders, which will further reduce risk.

 

- in the case of Fairfax, they opted to pump the reinsurance brakes pretty hard during the second half of last year. They backed away from a sizable chunk of business, while they also decided to hold their overall reinsurance volume relatively steady yoy.

 

I assume if Fairfax doesn’t make an insurance profit this year that plenty of its competitors will be in a far worse world of hurt, which would actually be a huge opportunity for FFH to pounce on - while its dividend checks keep flooding in. 

[petec]

16 hours ago, Hoodlum said:

“The existence of a healthy ILS market appears to have diminished the franchise value of property catastrophe business to investors. Investors today appear much keener to allocate funds to shorter-term ILS instruments to capitalize on the hardened underwriting conditions, rather than in a rated balance sheet. As long as these alternative entry points exist, we don’t foresee capital flowing into the new reinsurers to support hardened property rates and conditions,” says AM Best.

 

Don't ILS also represent capital coming into the market? Why doesn't this depress prices? Seems to me the capital just comes in a different way.

[nwoodman]

1 hour ago, petec said:

 

Don't ILS also represent capital coming into the market? Why doesn't this depress prices? Seems to me the capital just comes in a different way.

Was thinking the same.  Good for MKL though.  It seems more a case of new capital acting rationally given the science around climate change would indicate the frequency and severity of Cats is up and to the right.

[Hoodlum]

2 hours ago, nwoodman said:

Was thinking the same.  Good for MKL though.  It seems more a case of new capital acting rationally given the science around climate change would indicate the frequency and severity of Cats is up and to the right.

 

Yes, it would seem that the ILS infusion in this scenario is directed at a specific area of need.  It looks like we may avoid the more abrupt overall switch from hard to soft market that we typically see after a prolonged hard market.  That could change if reinsurance experiences large losses this hurricane season, as that could provide the impetus for new entrants.

[nwoodman]

1 minute ago, Hoodlum said:

 

Yes, it would seem that the ILS infusion in this scenario is directed at a specific area of need.  It looks like we may avoid the more abrupt overall switch from hard to soft market that we typically see after a prolonged hard market.  That could change if reinsurance experiences large losses this hurricane season, as that could provide the impetus for new entrants.

True, thanks for posting the articles. There is a lot to cover in this space, the insight on ILS was really interesting. Whichever way you cut it this market is not necessarily following the usual playbook.  I would stop short of saying it is different this time, but insurance pricing power, like energy prices all feed into inflation, with a commensurate effect on lesser players ability to write.
 

 I may be at risk of repeating myself, but like Berkshire, Fairfax now has access to a considerable amount of quantitive and qualitative economic data.  I think the path to $100bn (say 3X) of equity is easier, not harder than what they have experienced to date. There really is a critical mass that leads to some pretty great outcomes IMHO.

[Hoodlum]

I only become familiar with the ILS instruments over the past few days.  Does anyone see any potential issues with how these are used today.  I would think this would have less oversight then the Reinsurance businesses and I become wary whenever an investment instrument becomes more in vogue.  

[TwoCitiesCapital]

2 hours ago, Hoodlum said:

I only become familiar with the ILS instruments over the past few days.  Does anyone see any potential issues with how these are used today.  I would think this would have less oversight then the Reinsurance businesses and I become wary whenever an investment instrument becomes more in vogue.  

 

The primary complaint over the last decade has been the amount of capital that flooded into the market due to ILS was largely what was keeping insurance pricing too low and keeping the market soft. Investors loved these things as a truly diversified income stream. 

 

This is good as tens of millions of investors should be better able to absorb the risk than a handful of reinsurers and there is no systemic risk.  

It's bad because most of those investors likely lack the same expertise in pricing as the reinsurance industry has and so may be more likely to underprice the risk - which will eventually lead to their exit from the market OR an improvement in their pricing. 

 

Not sure which is more likely, but these are products that have now been around 10+ years so I would hope the market participants are better at pricing the ILS 

[MMM20]

On 7/10/2024 at 11:53 AM, SafetyinNumbers said:

I think it matters because FFH is particularly under owned by Canadian active managers benchmarked to the Composite. Of course, it will depend on the price individual shareholders are willing to give up their shares (recently 1.2x trailing book). A new permanent shareholder of a million shares plus that adds with passive inflows regardless of the price is a nice to have and may help with multiple expansion but it’s no guarantee. 

 

Is that amount of incremental price-insentitive demand for shares (~5%?) typical for a major index inclusion? I do think you're probably on to something with how tightly held the shares are by long-term shareholders.

 

Edited July 11 by MMM20

[SafetyinNumbers]

1 hour ago, MMM20 said:

 

Is that amount of incremental price-insentitive demand for shares (~5%?) typical for a major index inclusion? I do think you're probably on to something with how tightly held the shares are by long-term shareholders.

 

I think it depends on the market and the benchmark. When I left UBS in 2012, the estimate was about 4% of the shares outstanding for the 60. I assume that’s probably up a bit since then. 
 

I’m hopeful there are enough long term holders who won’t want to pay taxes, that the P/B multiple will expand on entry and continue to expand as the flows persist. It might be a pipe dream though if it’s truly quants that control the multiple (i.e. are the marginal buyer).

[giulio]

https://www.wsj.com/finance/regulation/home-insurance-premiums-surge-states-approve-8656877d?mod=itp_wsj,djemITP_h

It is not just storms and hurricanes, don't forget wildfires! So far it has been a busy season and it could get worse in the coming months.

 

G

[ValueMaven]

I'm starting to view my position in FFH as a 'bond w/upside' ... I realize this is a very simplistic view - but it helps me have conviction in all of the different drivers of value + the risk/reward left in the name.  FFH is my 3rd largest holding!

[Junior R]

10 minutes ago, ValueMaven said:

I'm starting to view my position in FFH as a 'bond w/upside' ... I realize this is a very simplistic view - but it helps me have conviction in all of the different drivers of value + the risk/reward left in the name.  FFH is my 3rd largest holding!

What is your other 2

[ValueMaven]

43 minutes ago, Junior R said:

What is your other 2

 

Berkshire and Constellation