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FFH Investment Question


Viking
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I have been trying to understand the current FFH investment approach and I am having trouble reconciling Prem's apparent concerns regarding the economy/outlook and FFH shift into risk assets.

 

Prem has repeatedy compared our current situation to that of Japan after their bubble burst in 1989/1990. Until Nov of last year they had about as conservative portfolio makeup as one could have (US Treasuries/stocks fully hedged & CDS). His most recent comments still talk to concerns regarding the economy which suggests he has not altered his view that we could be at the early stages of economic decline.

 

I am not complaining about the investment moves since Nov; they have been good (US stock purchases) to brilliant (shift from US Treasuries to US tax free municipals & corporates) with the odd dog mixed in (CAN stock purchases  - Brick, Canwest - & Abitibi bonds).

 

When I look at the total portfolio today I see a VERY LARGE weighting to risk assets. As we saw in March when the markets sold off, FFH book value dropped (end of Q1) to US$254 from $278'ish. Yes, today it is likely in the US$300 range. However, it would not surprise me to see US stock averages tank again in October (to lower than March lows) as people come to understand what Prem is saying... the economy is not going to bounce back quickly and we could see 5 or 10 years of deflation. With the shift to risk assets in the investment portfolio and with all the hedges off FFH could quite easily see a $50 to $75 move in book value ($300-$75) back to US$225.

 

At current prices, FFH is a solid buy. However, to go overweight with FFH, one has to feel strongly that the stock market averages lows are likely behind us; to be bullish on FFH current prospects I think one also has to be reasonably bullish on the outlook for risk assets. What do others think? 

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I think you have to decouple the stock market from the economy. Whether stocks are cheap or not has very little to do with the economy.

 

We can all say that IF XYZ happens, then OF COURSE stocks will go down... and we may (or may not) be right.

 

Prem is focusing on the strongest players (generally) right now because these companies will increase their value FASTER during bad times.  Whether the market agrees is not of consequence (in my opinion).

 

I don't say this to sounds like a true value believer or anything stupid (I'm pragmatic if nothing else), but the fear of what stupid people will *maybe* sell great stocks for, is a different fear than that of your stocks value getting demolished in a big recession.

 

I don't know if my above rambling explains Prem's thoughts, but it's how I think... ;-)

 

Ben

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Prem said that they moved into equities only when they thought the prices had become much more reasonable, and that they could withstand another 50% drop from where they had fallen.  So, he's factored in a total 75% drop in equities from the peak, and that they could survive such a catastrophic correction. 

 

If such a thing did happen, then book value would naturally fluctuate.  Eventually though, those stocks would recover and book value would increase.  They also would have a lot of bonds and cash that they could deploy to average down further, and enjoy a bigger bang on the way up. 

 

Finally, individual stocks can move independently of the market, so some of Prem's investments may not be long-term.  He may already be increasing the amount of cash they are holding, as prices continue to rise.  Cheers! 

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Hi Viking,

 

The weighting to risky assets is not that large. There was around $4 billion in stocks at the end of March out of a portfolio of $18 billion (I include holdco). They still have over $3 billion in cash and over $9 billion in bonds. However, I don't know exactly out of the $9 billion what is in treasury, corporate and municipals.

 

It may look very risky compared to some portfolios of other insurance/reinsurance companies that you investigated recently, but not vs Fairfax historically. The other thing that I think reduces the risk significantly is the shift out of long term treasuries to municipals and some corporates. There is no way that the yield differential will go back to the huge gap that we have seen. So that gain is in the bank, however if the yield on long term treasuries keep increasing then it will put pressure on these other bonds. The only way out is to be all in cash.

 

In terms of being confident in risky assets to buy into Fairfax, I think it is slightly the opposite. Basically, Fairfax is priced like nothing positive occured since March 31. So if the market keeps marching forward, you have these gains for free plus whatever comes next. If the market goes back to the March lows for all their stocks and they keep them all, then the current price discounts that already.

 

On a longer term basis, this is a great market for Prem & Co. There are bargains available and with a murky economic picture there is going to be shifts from one sector to another, from pessimism to optimism and back and forth which will allow them to continually trade value.

 

Cardboard

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Keep in mind that 1) some of this will be an inflation hedge (bonds fall & equities rise), 2) they are not necessarily long-term positions, 3) they very likely also have some down side protection on these positions, & 4) if they got stuck with them - they're generally holdings that you wouldn't mind adding to if the price were right. Relatively little risk.

 

SD

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Good question Viking.

 

There is risk and there is the pricing of risk. Two years ago, market was underpricing risk. Now, market is overpricing risk. Maybe not in all cases, but in the case of munis backed by Berkshire, they did get a juicy return at a low fundamental risk. I mean, it's even safer than if they bought Berkshire bonds directly because they are not the first payers. Who would have tought that you would get this for an approximately 9% before tax yield equivalent?

 

In the case of several canadian companies investments, that's a very different story.

 

In the case of most of their largest US equities, these are mostly fundamentaly strong companies at intrinsicaly cheap prices.

 

Can all of these investments go lower in value over a short to medium of time? Absolutely.

Still, are most of these investments are fundamentaly a good deal? Ultimately time will be the final judge, but I'm optimistic that 5 to 10 years from now, we'll take a look at what Fairfax has done since the fall of 2008 and conclude that it was brillant.

 

But......only time will tell.

 

 

 

 

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It's about time we start the 7 fat years.

 

Really, I can't imagine another industry other than Insurance and Banking that has pricing power in 2009 and for sure 2010.  Through FFH we'll get CR benefit and through our largest holdings (USB and WFC) we'll get the increase in NIM benefit.  My underwriter friends who I still keep close contact say "3 to 5% increase is the new flat quote."  This isn't coming from a $100MM premium a year type of company, but the new DOW addition.  If you have the #1 largest pure insurance company passing that kind of language, well then my 2010 hard market predictions from last year solidify my 90% position in FFH. 

 

Also, while the stability in earning power provided by the muni portfolio allow for a sigh of relief, I think the benefit to the combined ratio will make all the Crum concerns meaningless.  The Markel guys in their annual meeting pretty much explained the Terra Nova situation as a company that did north of $1B in premiums with a high CR (i.e. unprofitable) and now doing $600MM with 3 consecutive years of underwriting profit.  Understanding retention within a book of business (tails, frequency, severity, etc.) and ridding of unprofitable premium at a insurance company can take a while for the ship to turn.  If the numbers from the last two quarters are correct, you have to believe that's what C&F is going through.  Northbridge has gained intrinsic value as well, from what I know, the business was so bad  (see truck tonnage) that some players have exited.

 

I'm also positive, like some of the others that we've sold a portion of the WFC holdings, only because of FIFO.

 

 

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Ben, I would agree with you that normally stock prices and the economy are somewhat separate. The difference to me is debt deflations. The 1930's saw 90% drop in markets that took years and Japan saw similar results: catastrophic losses for equities that took years to play out. With $4 billion in stocks (of $18 billion total) and more in corporate bonds I am not sure that FFH has the ability to 'double down' from here should equities go even lower from their March lows.

 

Sanj, since I have been following FFH I will say that they have demonstrated to be very opportunistic with their investments. Q2 will be fun to see what they have realized and what they have purchased!

 

Cardboard, yes, I have done a bit of a deep dive on many of the reinsurers and how Hamblin Watsa manages investments is unique in the industry. If they can join the top 20% in underwriting FFH/ORH will do exceptionally well going forward! I also appreciated your comments regarding past portfolio weightings (like in the 90's) and will review in a little more detail to better understand what they are capable of doing in a stock market they view as fairly valued.

 

Sharper, regarding the hedges and other reasons they are holding certain things, I agree that there is much going on beneath the surface. They are clearly playing chess and not checkers. They also have the feel of a hedge fund in how they manage investments.

 

Partner, I am trying to get better at that looking out 5 to 10 years thing (and holding too). My 'brain cramp' is whether this is a great time to overweight and with FFH trading at current book (US$254) I am not sure that it is dirt cheap (given the near term investment gains could be transitory). 

 

Shah, if I was more comfortable that insurance pricing was firming (reinsurance pricing is firming) then that would then provide me with a higher level of confidence that future earnings would be solid and investment gains could be viewed as more of a wild card. Thanks for sharing what you are hearing regarding insuranace pricing!

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