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Pimco on the other side of Prem's deflation hedge?


rogermunibond
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I find the way the press handles this a little bizzare.  Pimco has sold these hedges to get a premium.  FFH has purchased these hedges as insurance with an investment protential.  Neither side is all in.  In fact I would argue that FFH is actual betting in favour of mild inflation with the rest of their holdings in coal, oil, cable, insurance, real estate, and consumer discretionary.  The deflation protection makes up a miniscule amount of their investments, similar to the Total Return Swaps.  They also buy insurance like this, only when it is cheap.  Over time the premiums on these two hedges will make little difference to FFHs cash flow but if an event occurs the profits will be extreme.  Typical bet from the FFH bond desk. 

 

My reference article for my rant:

 

http://www.theglobeandmail.com/globe-investor/investment-ideas/watsa-and-gross-face-off-over-us-deflation/article1709230/

 

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Neither side is all in.  In fact I would argue that FFH is actual betting in favour of mild inflation with the rest of their holdings in coal, oil, cable, insurance, real estate, and consumer discretionary.  The deflation protection makes up a miniscule amount of their investments, similar to the Total Return Swaps.

 

i dont agree ffh is betting in fav of mild inflation. i think they are just investing in cheap stocks with possible "event" driven optionality, ie stocks that might benefit from recapitalizations or reversals of extreme negative industry macro trends. and they are hedged against these with major index total return swaps.

 

and when you combine their CPI downside bet with their large bond bets having a relatively long avg duration (tho i realize these may not be intended for investments or held to maturity, but rather actively traded), it seems clear ffh is positioned for disinflation or worse.

 

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Link01 - Agree to disagree. 

 

The flip side of this is that Pimco is in no way at odds with FFH.  If there is in fact deflation would there not be a flight to the safety of bonds that pay a positive fixed interest rate, thus driving up the price of Pimco's Trillion dollars of bond holdings?

 

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Link01 - Were just talking past one another.  This bet is gravy for Pimco, not the meat and potatoes.  They will likely get the fee income and never have to pay out.  If there is significant deflation then they will pay out up to 8 b.  On the other side of their balance sheet they have a trillion dollars in bonds that will all be worth more, enough to easily pay off the settlement on the deflation bet. 

 

FFH has invested 175 M on this bet which is designed to hedge against the possibility of deflation and the effect on their insurance float.  It is cheap insurance and tiny compared to the relative size of past bets as compared to the total float at the time (i.e. Nasdaq puts, CDSs, Government Bonds).  They have a few billion in equities and private equity investments on the other side of the equation.  It is my opinion, regardless of what the Bloomberg columnist says, that neither side is placing a specific bet for or against inflation, or against one another.  Both have more invested in a normal recovery rather than a deflation scenario. 

 

FFH is purportedly investing in Japanese real estate.  Real estate is not a deflationary bet, and is in fact the absolute opposite.  Same with the bailout of the Brick, Sandridge, ABH etc. 

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