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Fairfax 13-F posted


omagh
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From the Q3 10Q

 

"During the third quarter of 2010, the company added $546.1 of notional amount to its equity total return swaps – long positions for investment purposes..."

 

Equity derivatives: Notional amounts

Equity index total return swaps – short positions . . . 5,040.8

Equity total return swaps – short positions . . . . . . .518.4

Equity total return swaps – long positions . . . . . . . .1,131.9

 

Would this explain the drop in the equity portfolio holdings?

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From the Q3 10Q

 

"During the third quarter of 2010, the company added $546.1 of notional amount to its equity total return swaps long positions for investment purposes..."

 

Equity derivatives: Notional amounts

Equity index total return swaps short positions . . . 5,040.8

Equity total return swaps short positions . . . . . . .518.4

Equity total return swaps long positions . . . . . . . .1,131.9

 

Would this explain the drop in the equity portfolio holdings?

 

 

They have been moving money toward private deals that are not reported such as Kennedy-Wilson.  There is also the Canadian side which is not reported.  How much more RIM might there be held at the Northbridge group.  Then there are overseas investments. 

The 13f is not very representative of their total holdings any longer.  Its just a curiosity.

 

 

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Was the RIMM holding previously disclosed?

 

No, not as far as I can tell. Also, excellent user name, sir.

 

 

From the Q3 10Q

 

"During the third quarter of 2010, the company added $546.1 of notional amount to its equity total return swaps – long positions for investment purposes..."

 

Equity derivatives: Notional amounts

Equity index total return swaps – short positions . . . 5,040.8

Equity total return swaps – short positions . . . . . . .518.4

Equity total return swaps – long positions . . . . . . . .1,131.9

 

Would this explain the drop in the equity portfolio holdings?

 

 

Exactly, if you look at the Odyssey filings, you'll see that they added total return swaps of $151m on Kraft, $152m on USB, and $240m on WFC. So, net, they haven't sold any of those holdings. Nothing has happened re: these holdings. Specualtion about material events at FFH can stop.

 

My guess is they did this because the carry cost is lower than their opportunity cost elsewhere.

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Barminov, Grenville,

 

Can you explain the mechanics of what they have done with these holdings in terms of the derivative transactions and why they no longer show up on FFHs 13f?  A.

 

Al,

 

I'll give it a shot. There are two parties to a Total Return Swap, let's say Deutsche Bank and Fairfax. One party makes payments based on the agreed upon interest rate (either fixed or variable, usually variable). The other party makes payments based upon the total return of the underlying asset (dividends and capital gains). In this case the underlying asset is KFT, WFC and USB.

 

So, FFH bought $240m notional of swaps on WFC from Deutsche. They will pay Deutsche the agreed upon interest rate on $240m. Deutsche will pay FFH the total return on WFC. In the event that WFC goes down, FFH pays Deutsche the decrease. Effectively, FFH is long WFC and has the same economic interest as if they owned the stock on the upside and downside. The beauty of it is that they don't actually have to put up the cash to buy it. They just pay the agreed upon interest rate on the notional amount. 

 

They no longer show up on the 13-F because FFH doesn't actually own those shares, just the economic interest.

 

These swaps are big favorites of the hedge fund community because it's a cheap form of leverage and you could get around public reporting requirements to an extent...you could read up on The Children's Investment Fund v CSX for more info.

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Here's an example. Let's say you and I enter a Total Return Swap on a stock that's at $100. I agree to buy $100 notional amount from you and you will charge me 5% for the privilege. At the end of year one, the stock is at $145 and has paid dividends of $5. Assuming it settles yearly, at the end of that year I make a payment to you for $5 (5% interest on $100) and you make a payment to me of $50 (capital gain of $45 and dividend of $5).  

 

If, on the other hand, at the end of year one the stock is at $75 and has paid dividends of $5 it would look like this:

I will make a payment to you of $30 ($5 of interest on the $100 notional and $25 of capital losses) and you will pay me $5 (the dividend).

 

In reality, they usually just net out. So in the second example, I would simply pay you $25.

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Thanks for the shout out, Barminov.

 

I love that the government continues to fail to clamp down on large swap transactions that are wholly unnecessary...great for Fairfax (and hedge fund community), but would hate to find out which bank isn't hedging its position properly in these...

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It seems to me that the equity risk for FFH remains the same as before whether they hold the total return swaps or direct equity holdings. It appears to me that they just levered up the major equity positions, and have reduced the cash they put up. But they will suffer the same downside as well as enjoy the same upside. So why are they doing this? If they are prudent, they will have to hold more than enough cash to cover the downside of their swap contract.

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If that's true, I guess we should be better informed about it. What about counterparty risk? And what kind of cash reserves do we have to better protect ourselves against a decline of those equities?

 

These financial instruments do not seem plain vanilla stuff actually.

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If that's true, I guess we should be better informed about it. What about counterparty risk? And what kind of cash reserves do we have to better protect ourselves against a decline of those equities?

 

These financial instruments do not seem plain vanilla stuff actually.

This one shouldn't be terribly difficult for the counterparty to hedge... (if they were prudent). the bigger risk would be what Hamilton points out... having a counterparty that doesn't hedge properly.

 

It seems to me that the equity risk for FFH remains the same as before whether they hold the total return swaps or direct equity holdings. It appears to me that they just levered up the major equity positions, and have reduced the cash they put up. But they will suffer the same downside as well as enjoy the same upside. So why are they doing this? If they are prudent, they will have to hold more than enough cash to cover the downside of their swap contract.

 

Your maximum loss is the notional value of the contract plus interest... and that's hedged with the short equity swaps.  And the cash from the shares sold are probably invested in something relatively safe that could be used for this purpose, and if not, the rest of the portfolio is fairly large compared to any potential loss.  I really would tend to think that the other equity swaps serve the purpose sufficiently.

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Exactly, if you look at the Odyssey filings, you'll see that they added total return swaps of $151m on Kraft, $152m on USB, and $240m on WFC. So, net, they haven't sold any of those holdings. Nothing has happened re: these holdings. Specualtion about material events at FFH can stop.

 

My guess is they did this because the carry cost is lower than their opportunity cost elsewhere.

 

Hi barminov,

 

Thank you for confirming the switch between the common to TR swaps!

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If that's true, I guess we should be better informed about it. What about counterparty risk? And what kind of cash reserves do we have to better protect ourselves against a decline of those equities?

 

These financial instruments do not seem plain vanilla stuff actually.

This one shouldn't be terribly difficult for the counterparty to hedge... (if they were prudent). the bigger risk would be what Hamilton points out... having a counterparty that doesn't hedge properly.

 

It seems to me that the equity risk for FFH remains the same as before whether they hold the total return swaps or direct equity holdings. It appears to me that they just levered up the major equity positions, and have reduced the cash they put up. But they will suffer the same downside as well as enjoy the same upside. So why are they doing this? If they are prudent, they will have to hold more than enough cash to cover the downside of their swap contract.

 

Your maximum loss is the notional value of the contract plus interest... and that's hedged with the short equity swaps.  And the cash from the shares sold are probably invested in something relatively safe that could be used for this purpose, and if not, the rest of the portfolio is fairly large compared to any potential loss.  I really would tend to think that the other equity swaps serve the purpose sufficiently.

 

1) Counterparty risk exists whether the counterparty hedges their position or not. They could fail for unrelated reasons. But, given FFH's past caution with counterparty risk in their CDS positions, it should be reasonable to assume that they have covered this angle.

 

2) The question is why do the TRS, if not to obtain leverage? If leverage is the reason, then what's the rational? The only other reason I can think of for doing the long TRS is that maybe it reduces the burden of the periodic cash settlements for their short TRS positions - because the positions are offsetting. Without the long TRS, with the market moving against their short TRS positions, they may have had to pay up significant amounts of cash at each reset. While their (previous) long equity positions would have economically offset the losses on the short TRS, they would not have generated the cash to settle the short TRS.

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  • 2 weeks later...

...if you look at the Odyssey filings, you'll see that they added total return swaps of $151m on Kraft, $152m on USB, and $240m on WFC...

 

My guess is they did this because the carry cost is lower than their opportunity cost elsewhere.

 

barminov, what filings? where can one find those filings?

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...if you look at the Odyssey filings, you'll see that they added total return swaps of $151m on Kraft, $152m on USB, and $240m on WFC...

 

My guess is they did this because the carry cost is lower than their opportunity cost elsewhere.

 

barminov, what filings? where can one find those filings?

 

Hi dual_bid,

 

The TRS is listed in ORH NAIC Q3 filings. You can download the report at NAIC.com. It goes into depth about specific holdings including foreign stocks.

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...if you look at the Odyssey filings, you'll see that they added total return swaps of $151m on Kraft, $152m on USB, and $240m on WFC...

 

My guess is they did this because the carry cost is lower than their opportunity cost elsewhere.

 

barminov, what filings? where can one find those filings?

 

Hi dual_bid,

 

The TRS is listed in ORH NAIC Q3 filings. You can download the report at NAIC.com. It goes into depth about specific holdings including foreign stocks.

 

Hi Grenville, you probably meant ".org". Can you provide a direct link to the company's NAIC filings?

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