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Interview With Prem Watsa - Gurufocus


Parsad
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Prem is spot on....

 

 

You're a Ben Graham fan right? So Ben Graham almost went bankrupt in the ‘30s, and this is an interesting point, I keep thinking about this all the time, so Ben Graham was reflecting in the ‘30s and he writes, if you were not bearish, if you're not concerned about the economy in 1925, not in 1927, 28, 29, but in 1925, there was only a 1/100 chance that you survived the depression, because what'd you have looked at was if you were not bearish in 1925, you'd have seen the crash in 1929, drop 50%, and you'd have come right in and thought of it as an opportunity, because the Dow Jones dropped from 400 to 200, went back up to 300, and the second leg after that was a killer, dropping about 90%!! That was a worry, a lot of problems at the time, and I keep thinking of that because the second leg, I have seen in many industries, oil drilling and farm equipment, that second leg can be vicious, and we might well be entering that second stage.

 

That's what you have to be concerned about, I'm not saying that will happen, I'm just saying a reading of history, of the ‘30s and of the Japanese environment of the last 20 years, should get one cautious, because of course at that time people didn't expect this either, they didn't expect what happened. And there are a lot of similarities. For example, 0% interest rates, we haven't had that since the ‘30s, those types of interest rates. Ten percent deficits, a 10% deficit in the U.S., you have to go back to that time period to see 10% deficits year after year.

 

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Liked it a lot, worth the wait.  ;D

 

Let us hope Prem isn't proven right this time and that we can continue deleveraging without a big bang. Reminds me if have to finish 'The Great Depression: A Diary'!

 

 

Interesting to note how much faith he is putting in the management of many of his investments like BoI, RIMM and DELL. I keep thinking about that excellent paper on UU investments posted here some time ago when I hear Prem talking about his deflation bet and such investments with many unknown variables.

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Understanding the debt dynamics leads to natural concerns about the E and consequent wariness about superficial PE analysis...I worry, just like Prem.  As I have long asserted, the margin of safety needs to be MUCH higher than usual in this environment.  And at the right margin of safety for a great business, we will all make a lot of money.

 

 

Right now, people look at the S&P 500 and think it's cheap, they think earnings will be at $100 selling at 12x earnings, perhaps less, and the worry of course is that the earnings will not be at 100, that they could be significantly less for the second half of this year and next year, so this environment is one that we worry quite a bit. That's why for ourselves, our stock positions are almost 90% hedged, we have a lot of Treasury bonds and municipal bonds, and we have those deflation contracts.

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Owner of DELL for the exact same reasons cited by Prem -- have posted comments previously on the DELL thread.

 

Have stayed away from RIMM but worth a look since Prem seems to have such high confidence in managment.  Agree w his reasoning but have been disappointed by the stumbles under their watch.

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Parsad,

 

The following quote from Prem settles the little debate you and I had in 2008/09 and just recently where I have been saying that in these markets you should stay hedged whereas you have disagreed stating the only reason Watsa does it is because he is running an insurance company with market to market capital requirements. While he does allude to that in relation to pension fund management and mutual funds because those are relative games, he makes clear in this quote that if you are running your own money (as most of us are on this board), you should be hedged:

 

"If you are managing your own money, as we are with the insurance company portfolios, you will want to be hedged because we do not want to incur impairments or the loss of capital, whereas mutual funds and pension funds are more focused on performing relative to their peers."

 

Do you agree that this settles this difference of opinion?

 

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And Templeton agrees as well, hedging into 2007/08 was appropriate:

 

"Watsa: John Templeton was my mentor, I'll tell you, I've known him for 30 years, he passed away a few years ago, but John Templeton was always a long-term investor in common stock. I remember in 1999-2000 he said to me, "Prem, buy bonds, forget about common stock, they're too risky." Then, more recently, four-five years ago, he always hedged, and he said "In this environment, what I like to do is buy the best things I like, and I short the things I really don't like."

 

But I try to be neutral, sometimes more short than long, but that's John Templeton. So John, one of the key lessons he taught me was to be flexible. His investment philosophy was always value oriented, long term, buy at the point of maximum pessimism, but be flexible in your thinking, and that's what we try to apply."

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Parsad,

 

The following quote from Prem settles the little debate you and I had in 2008/09 and just recently where I have been saying that in these markets you should stay hedged whereas you have disagreed stating the only reason Watsa does it is because he is running an insurance company with market to market capital requirements. While he does allude to that in relation to pension fund management and mutual funds because those are relative games, he makes clear in this quote that if you are running your own money (as most of us are on this board), you should be hedged:

 

"If you are managing your own money, as we are with the insurance company portfolios, you will want to be hedged because we do not want to incur impairments or the loss of capital, whereas mutual funds and pension funds are more focused on performing relative to their peers."

 

Do you agree that this settles this difference of opinion?

 

 

No, it doesn't.  I always said that if you are fully invested, then hedging would be a good idea.  We are rarely ever fully-invested.  Our hedge is cash, and we move in and out of cash as the market gives us opportunity.  I don't hedge otherwise, and I won't do it ever, other than the occasional purchase of market puts when things seem completely out of whack.  The other circumstance in which you may want to hedge, is if you are close to retirement or require a significant portion of your nestegg in the near future, where you would be in some distress if your investments fell dramatically.  Otherwise, no point in hedging because of the frictional costs.

 

What Prem makes completely clear in that article, as I've always said, is that they hedge because their capital levels would decrease if markets dropped, which would mean they couldn't write as much business.  If markets fell enough, and they are leveraged 4-1 asset to equity, they could lose their qualified credit rating for property casualty insurance, in effect putting the whole business into run-off.  So there is a very distinct reason why Prem hedges, and that is because of the insurance business.  Cheers!

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Interesting to note how much faith he is putting in the management of many of his investments like BoI, RIMM and DELL. I keep thinking about that excellent paper on UU investments posted here some time ago when I hear Prem talking about his deflation bet and such investments with many unknown variables.

 

That's what I noted too. Not the specific companies, but how qualitative he is and how important top quality management is.

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Interesting comment from him about the Japanese Life companies.  7/10 went bust.  Thinking of AIG in particular, and maybe MFC, and certainly others I am not aware of.  (I'm bearish on MFC since the rally in bonds and long term rates)

 

UCCMal...I actually don't think AIG as much as LNC/MET/PRU...also how does GWO CN continue to trade at multiples of book when it is just north of the U.S. border and does material amounts of business in the United States and Western Europe...

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One thing that I find facinating about Fairfax is the consistancy with which they operate. There have been some minor changes in their thinking over the years such as paying dividends and the 20% to 15% annual target reduction but the changes are always explained at least to my satisfaction. It takes a great team to stay so focussed and disciplined.

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Interesting comment from him about the Japanese Life companies.  7/10 went bust.  Thinking of AIG in particular, and maybe MFC, and certainly others I am not aware of.  (I'm bearish on MFC since the rally in bonds and long term rates)

 

 

UCCMal...I actually don't think AIG as much as LNC/MET/PRU...also how doesn't GWO CN continue to trade at multiples of book when it is just north of the U.S. border and does material amounts of business in the United States and Western Europe...

 

 

I agree here -- AIG's life insurance runs through SunAmerica.  (There's 2% exposure via Chartis International, but that's negligible, IMO.)  AIG's "revenues" come to about $77 billion and SunAmerica accounts for $15 billion of those --> of which only about 50% comes from life insurance.

 

I'm guessing what killed the life insurance companies was contracts set with certain yield assumptions that got blown out when yields dropped from 7%-8% to 1%.  I don't believe our yield assumptions were as high for domestic life insurance companies as they were for Japanese life insurance companies...

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Parsad,

 

The following quote from Prem settles the little debate you and I had in 2008/09 and just recently where I have been saying that in these markets you should stay hedged whereas you have disagreed stating the only reason Watsa does it is because he is running an insurance company with market to market capital requirements. While he does allude to that in relation to pension fund management and mutual funds because those are relative games, he makes clear in this quote that if you are running your own money (as most of us are on this board), you should be hedged:

 

"If you are managing your own money, as we are with the insurance company portfolios, you will want to be hedged because we do not want to incur impairments or the loss of capital, whereas mutual funds and pension funds are more focused on performing relative to their peers."

 

Do you agree that this settles this difference of opinion?

 

 

No, it doesn't.  I always said that if you are fully invested, then hedging would be a good idea.  We are rarely ever fully-invested.  Our hedge is cash, and we move in and out of cash as the market gives us opportunity.  I don't hedge otherwise, and I won't do it ever, other than the occasional purchase of market puts when things seem completely out of whack.  The other circumstance in which you may want to hedge, is if you are close to retirement or require a significant portion of your nestegg in the near future, where you would be in some distress if your investments fell dramatically.  Otherwise, no point in hedging because of the frictional costs.

 

What Prem makes completely clear in that article, as I've always said, is that they hedge because their capital levels would decrease if markets dropped, which would mean they couldn't write as much business.  If markets fell enough, and they are leveraged 4-1 asset to equity, they could lose their qualified credit rating for property casualty insurance, in effect putting the whole business into run-off.  So there is a very distinct reason why Prem hedges, and that is because of the insurance business.  Cheers!

 

Sanj, speaking of hedging, if you only own FFH is that in itself a hedge or will Fairfax's stock also tank in a stock market crash despite their own hedges?

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Sanj, speaking of hedging, if you only own FFH is that in itself a hedge or will Fairfax's stock also tank in a stock market crash despite their own hedges?

 

It would depend on what the general sentiment is in the market.  If people are seeking liquidity at any cost, not unlike the crunch time in 2008/2009, then Fairfax stock will tank too.  But usually, a stock like Fairfax would fall after much of the market, because investors finally give in and start selling the stocks that have held up, because they need the money or want to buy cheaper investments. 

 

The thing is, investors shouldn't confuse stock price with intrinsic value.  They see the stock price go down and they panic, when really they should only panic if intrinsic value is decreasing.  Fairfax's stock price today is nearly 33% lower than its peak 12 years ago, yet intrinsic value (book value being an approximation) has increased about 300%!

 

So at some point, investors would recognize that the hedges prevented serious damage to intrinsic value, and the stock would eventually move back closer to intrinsic value.  Cheers!

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Think Value

Sanj, speaking of hedging, if you only own FFH is that in itself a hedge or will Fairfax's stock also tank in a stock market crash despite their own hedges?

 

It would depend on what the general sentiment is in the market.  If people are seeking liquidity at any cost, not unlike the crunch time in 2008/2009, then Fairfax stock will tank too.  But usually, a stock like Fairfax would fall after much of the market, because investors finally give in and start selling the stocks that have held up, because they need the money or want to buy cheaper investments. 

 

The thing is, investors shouldn't confuse stock price with intrinsic value.  They see the stock price go down and they panic, when really they should only panic if intrinsic value is decreasing.  Fairfax's stock price today is nearly 33% lower than its peak 12 years ago, yet intrinsic value (book value being an approximation) has increased about 300%!

So at some point, investors would recognize that the hedges prevented serious damage to intrinsic value, and the stock would eventually move back closer to intrinsic value.  Cheers!

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Cash available to buy deeply discounted companies with a margin of safety to intrinsic value with good management is a perfect hedge!

 

**************************************************************************

 

 

 

Parsad,

 

The following quote from Prem settles the little debate you and I had in 2008/09 and just recently where I have been saying that in these markets you should stay hedged whereas you have disagreed stating the only reason Watsa does it is because he is running an insurance company with market to market capital requirements. While he does allude to that in relation to pension fund management and mutual funds because those are relative games, he makes clear in this quote that if you are running your own money (as most of us are on this board), you should be hedged:

 

"If you are managing your own money, as we are with the insurance company portfolios, you will want to be hedged because we do not want to incur impairments or the loss of capital, whereas mutual funds and pension funds are more focused on performing relative to their peers."

 

Do you agree that this settles this difference of opinion?

 

 

No, it doesn't.  I always said that if you are fully invested, then hedging would be a good idea.  We are rarely ever fully-invested.  Our hedge is cash, and we move in and out of cash as the market gives us opportunity.  I don't hedge otherwise, and I won't do it ever, other than the occasional purchase of market puts when things seem completely out of whack.  The other circumstance in which you may want to hedge, is if you are close to retirement or require a significant portion of your nestegg in the near future, where you would be in some distress if your investments fell dramatically.  Otherwise, no point in hedging because of the frictional costs.

 

What Prem makes completely clear in that article, as I've always said, is that they hedge because their capital levels would decrease if markets dropped, which would mean they couldn't write as much business.  If markets fell enough, and they are leveraged 4-1 asset to equity, they could lose their qualified credit rating for property casualty insurance, in effect putting the whole business into run-off.  So there is a very distinct reason why Prem hedges, and that is because of the insurance business.  Cheers!

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Hi Ben Graham,  FFH makes a good hedge but not perfect.  Cash is as close to perfect as you get.  Holding 100% FFH is probably not the smartest thing either.  In the event of a major American or European disaster FFH will get hammered along with everything else.  Even Prem doesn't have 100% in FFH.  He's probably pulled out at least 50 million since 2002 in dividends.

 

Sanj, is also restricted in his ability to hold any one stock, lilely find better deals, so cash is not an unreasonable substitute.  There is also the possibility of redemptions at any time.  It doesn't serve ones results to have to sell FFH at $250 two weeks after an US East Coast tsunami. 

 

50% position - more than I'd like but everything else is down.

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My key takeaway from reading Prem's comments is how much he is in the minority. I have not read much in the gerneral press that explains things the way Prem has. I think most people on this board are close to being fully invested with minimal hedges.

 

Do we know an ugly 'second down leg' is coming? No, of course not. And history does not repeat exactly but it does tend to rhyme...

 

The other wild card is these things take years to play out; I can see how over time markets and investors get burned out (and cashed out).

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The thing I'm confused about is how he repeats over and over again that their focus is combined ratios and profitable underwriting... However on this board everyone is constantly talking about how they are a mediocre insurance writing operation, and their real strength is the investing side.  If I remember correctly their recent combined ratios have not been stellar.  How do we reconcile what he says about their focus on underwriting profit, and their lack of underwriting profit??  Can someone more experienced w/ FFH explain this?  thanks..

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I didn't love his explanation on why he owns pretty awful companies like RIMM, DELL and LVLT. Seems more relying on 'hoping' their management will be able to turn the companies around rather than anything concrete.

 

I'm not sure why you think these companies are awful, particularly DELL.  LVLT is overlevered but has been doing the right things for a number of years (and FFH has done very well owning their debt).  DELL is extremely profitable, cheap, and buying back a ton of shares.  I don't have anything intelligent to say about RIMM, but I think it is worth looking at the returns FFH has made on "awful" companies like the brick group, international coal, sandridge energy etc . . .  You pay a high price for a rosey concensus

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