Fairfax 13-F posted

[Grenville]

...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?

 

Yes, it is .org. You will need to create a login id to search the database. Here is the title of the filing.

 

2010 Quarter 3 Financial Data for Odyssey Amer Reins Co (Cocode: 23680)

[twacowfca]

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.

 

 

oec2000, is what you're describing an example of what some have called "portable alpha"?  if so, does anyone know the pros and cons of this or similar strategies?  Also, as Eric has mentioned, what are the tax consequencies?

[oec2000]

 

oec2000, is what you're describing an example of what some have called "portable alpha"?  if so, does anyone know the pros and cons of this or similar strategies?  Also, as Eric has mentioned, what are the tax consequencies?

 

Sorry, didn't see this until now.

 

I have no clue what portable alpha is. I would imagine that there are tax consequences to the switch on the long positions but they are probably offset by the losses they suffer on the short swap positions. I'm not particularly knowledgeable on US taxation so would defer to other people on the board who understand taxes better.

 

I am convinced now that they are doing this purely for cashflow management purposes. The economic impact (in terms of P&L is, I believe, not material).

[Rabbitisrich]

I'm not familiar with the application of portable alpha, but the concept is simply to hedge out the volatility associated with a benchmark, so that your asset or portfolio return can be attributed to your selection skill.

 

In the case of Fairfax, they seem to be long specific stocks while hedged against broad market indices, so I don't think that they are using a portable alpha strategy. My guess is that portable alpha is more like being long Citigroup while shorting the BKX.

[twacowfca]

I'm not familiar with the application of portable alpha, but the concept is simply to hedge out the volatility associated with a benchmark, so that your asset or portfolio return can be attributed to your selection skill.

 

In the case of Fairfax, they seem to be long specific stocks while hedged against broad market indices, so I don't think that they are using a portable alpha strategy. My guess is that portable alpha is more like being long Citigroup while shorting the BKX.

 

What FFH is doing is similar to what WEB did, beginning in the 1960's.  I think he hints about that perhaps in his Jan 1965 letter without giving details.  Alice quotes him  saying that he and Charlie somewhat later went to universities and borrowed their stocks to short as a market basket approximation for a hedge when the market got frothy.

 

WEB said that hedging may have helped reduce their volatility, but the effect was not major, and they ended the practice.

[oec2000]

Actually the portable alpha issue does not arise with the swap positions because the swaps are merely a synthetic substitute for their long stock positions. The answer to whether they are pursuing an alpha strategy lies with their original equity positions they took. To the extent that they put on the equity positions first and then put on the index shorts much later suggests that this was not what they had in mind.

 

In any case, the question is why they converted their long equity positions into swaps since this does not alter their economic position. Was it to get leverage (I don't think so) or some other reason (my guess is cashflow matching)?