The Era of Uncertainty - Francois Trahan & Katherine Krantz

[Packer16]

Shorting is out of my circle of competence and has a timing component and technical component (borrowing shares) that I have not done well with in the past.  I am willing to buy a long-term warrant as it cuts off my downside and issue of borrowing share is removed.  So I guess I am stuck with long asset selection.  I have always had a hard time with long/short strategies as there few undervalued and overvalued assets at a given time, the possibility of error is doubled and the markets have an upward bias.  I have a hard enough time with long only. 

 

The one note on Templeton's internet strategy was that he would take advantage of removal of lock-ups as a timing factor in going short (he went short when the lock-ups expired) and thus removed a portion of the time uncertainty component of shorting.  Given the pre-IPO markets that exist today,  I am not sure this shorting strategy would work today.

 

Packer 

[giofranchi]

If you don’t like shorting a single stock, there are of course many other ways to buy some protection:

1) shorting indices through put options or swap contracts (like FFH is doing),

2) shorting indices through ETFs,

3) investing with those managers who buy protection (Mr. Watsa, Mr. Einhorn, etc.),

4) keeping a higher percentage of cash than usual,

5) buying some gold.

Imho, the idea is very simple: during a secular bear market, you want to invest aggressively only when prices are depressed and nobody wants stocks (you will have plenty of opportunities!), the rest of the time you’d better be cautious and strive to preserve capital.

You know, I am really no finance guy, I am an engineer and a businessman. I know few finance guys, but a lot of businessmen: and no businessman I know of does it, without buying some insurance! Not a single one. Everyone knows that even the best business is dealing with uncertainty. And acts accordingly. If mighty Nestlé buys insurance against the price of cocoa, why should we disregard the importance of some protection?

 

giofranchi

 

[Cardboard]

I find it hilarious when "investors" say that they can understand Fairfax, but can't understand AIG. I think it means either that they have not tried at all to understand AIG or they don't understand Fairfax.

 

It is also funny to read someone defending an investment in Fairfax or GLRE, but staying away from investments with much larger discount to intrinsic value due to macro concerns. What happens to the value of defensive bonds in a macro free fall and with a company that has essentially no equity exposure (AIG)?

 

We are back to buying yesterday's favourite or so called jockey stocks. It is a form of value investing, but one that excludes the most promising opportunities because someone is unwilling to find these most promising on their own and is instead relying on someone else to do the investments.

 

I hope Giofranchi that you are not charging huge fees to your investors for essentially riding someone else coattails or investment abilities. You should be paid for having discovered the "investors" for them, but after that, to keep charging a fee year after year seems wrong. It goes back to your earlier comment that you could not understand why Ackman would tear apart MBIA financials while on vacation in Tuscany. He was simply trying to be the best for himself and his investors and truly loves investing, finding new ideas, the best ideas. Not riding someone else coattails. 

 

Cardboard

[giofranchi]

Cardboard,

 

I didn't say that I cannot understand AIG, but just that I have not studied that company. I have read what has been written on this board about AIG and I find it very convincing. But I won’t make an investment on that basis alone. Instead, I should spend much more time on AIG: at least, as much time as I spent on FFH and GLRE.

Unfortunately, my company is an engineering firm and I have also other responsibilities, besides trying to allocate the free cash it generates the best way that I know of… I just don’t have the time to study every investment opportunity that comes along!

As long as insurance is concerned, the first thing I look for is a really good management. That’s why I chose to study FFH and GLRE, while giving up on AIG. That’s not to say that AIG’s management is worse than Mr. Watsa or Mr. Einhorn and their teams! Please, don’t misunderstand me! Maybe, AIG's management is even better! It is just that I had read Mr. Watsa’s shareholders letters and found them very interesting and thoughtful, I had read Mr. Einhorn’s book “Fooling Some of the People All of the Time” and found it very informative. So, it just happened that I knew something about Mr. Watsa and Mr. Einhorn, while I knew nothing about AIG’s management. That’s all!

 

And, don’t worry, I don’t charge any fee for allocating my firm’s free cash!!

 

Now, the “riding someone else coattails” thing is true! But I think that Mr. Buffett studied and showed the world one of the greatest business model of all time. And I really like to partner with someone who have understood Mr. Buffett’s lessons and has been able to replicate that business model. An investment in Berkshire Hathaway in the 70s would have meant “riding Mr. Buffett’s tail”, right? Well, I would have liked it very very much nonetheless!!

Maybe, I let Mr. Watsa and Mr. Einhorn choose my investments, but please consider two things:

1) they work with float, while I cannot;

2) to let Mr. Watsa and Mr. Einhorn choose my investments gives me the possibility to work harder on my firm’s engineering operations, that way hopefully increasing its free cash.

And don’t think that I don’t like doing some research or finding new ideas: I like it very much! It is just that I don’t have as much time to do that, as many of you probably have… But I do research as much as I can!

 

As a side note, most of what I write might seem naïve to many of you. Many of you are long dated and very successful money manager, while I am just a CEO who tries to give the deserved importance to capital allocation. Please, bear with me and be patient! Even if I have much more to learn from you than vice versa!

Thank you very much!

 

giofranchi

 

[Cardboard]

Well, let me apologize Giofranchi. I thought based on previous comments that you were a money manager with clients. Fund of funds make me angry since they often charge large fees to effectively let money being managed by someone else instead of telling their investors to invest directly with the true managers and to skip the intermediary. Obviously, I totally misunderstood your situation.

 

In your case, it would certainly make sense to focus on stocks and funds that you could hold for a very long time even if it means sacrificing some returns. You don't have the time to keep rotating from one cheap stock to another all the time which means a fair bit of research and essentially being an active portfolio manager. At the same time, I really don't understand why you worry so much about macro or spend any time on it since your focus is on the long haul.

 

Cardboard

[txlaw]

Imho, the idea is very simple: during a secular bear market, you want to invest aggressively only when prices are depressed and nobody wants stocks (you will have plenty of opportunities!), the rest of the time you’d better be cautious and strive to preserve capital.

 

You know, I am really no finance guy, I am an engineer and a businessman. I know few finance guys, but a lot of businessmen: and no businessman I know of does it, without buying some insurance! Not a single one. Everyone knows that even the best business is dealing with uncertainty. And acts accordingly. If mighty Nestlé buys insurance against the price of cocoa, why should we disregard the importance of some protection?

 

giofranchi

 

The question is, protection from what?

 

In your Nestle example, Nestle is buying protection on the price of cocoa because it is a material input that will have a direct effect on the cash flows generated from selling products that use cocoa. 

 

It is quite different, however, to buy protection (or seek protection in holding cash or gold) against what investors in the secondary market will bid for a cross section of businesses on the secondary market (the S&P 500, for example) at a given point in time.  The core tenet of Graham-style "value investing" is that intrinsic value and market price of a publicly traded company are two different things.  When you advocate abstaining from purchasing what appears to be 30-cent dollars laying around because you believe the majority of businesses available on the secondary market are priced fairly or even overvalued, you are ignoring the notion that the main risk an investor faces is a permanent loss of capital and not volatility in what the market will pay for shares in the company. 

 

Of course, competent "value investors" will take into account macro factors when valuing the investee companies they own.  If the US is at risk of deflation, for example, one can expect that NIMs for banks will remain at cyclical lows for a while, and this will materially affect the banking business in the near term.  Thus, valuations should take macro factors into account.

 

It is one thing to pay attention to macro in order to assess how the operations of your investee companies are likely to turn out.  It is quite another thing to pay attention to macro in order to predict general price levels available on the secondary market in order to time a bargain purchase binge.

[giofranchi]

Well, let me apologize Giofranchi. I thought based on previous comments that you were a money manager with clients. Fund of funds make me angry since they often charge large fees to effectively let money being managed by someone else instead of telling their investors to invest directly with the true managers and to skip the intermediary. Obviously, I totally misunderstood your situation.

 

In your case, it would certainly make sense to focus on stocks and funds that you could hold for a very long time even if it means sacrificing some returns. You don't have the time to keep rotating from one cheap stock to another all the time which means a fair bit of research and essentially being an active portfolio manager. At the same time, I really don't understand why you worry so much about macro or spend any time on it since your focus is on the long haul.

 

Cardboard

 

 

Cardboard,

I don’t like the fund of funds idea either. It is not that I judge unfair to pay someone who lets other people do all the hard work… I believe in paying for performance, not in paying for number of hours worked. If someone could identify the 5 fund managers, who will have the best track record for the next 10 years, I will pay gladly for his services!

Instead, I don’t like the fund of funds idea, because I don’t like the mutual/hedge-fund industry. It has got a fundamental flaw that systematically leads to both unpredictability and underperformance. In the words of Mr. Ackman:

 

“The principal weakness we share with most other money managers is the fact that our capital base is not permanent, and we therefore keep cash on hand and/or own passive liquid investments which we can sell to meet potential investor demands for capital. To address this weakness in our open end hedge fund structure, later this year, we intend to launch the private phase of Pershing Square Holdings, Ltd., which we expect to eventually list on the London Stock Exchange.”

 

I didn’t invest in Pershing Square the hedge-fund, but I will be happy to invest in Pershing Square Holdings Ltd. at an attractive price. Paraphrasing Mr. Buffett, investing is really the best business, and I always like to quote Mr. Munger:

 

“I don’t think General Motor should have wiped out the shareholders. That was a huge failure of management. If you think about it, Berkshire is a collection of failed businesses, that are gone. And here it is, this wonderful thriving place! As our businesses failed, our shareholders did not fail. We adapted. We took the money out of the failing businesses and bought other businesses. General Motors did not pass that test. They destroyed their shareholders…”

 

You could show me a 100 pages report on the future of Apple, and give me all the right reasons why it won’t end up like General Motor one day, and you will anyway fail to convince me… Instead, I am convinced that a Berkshire Hathaway, led by Mr. Buffett and Mr. Munger, will never fail. Of course, you need to know and bet on the jockey… but he or she doesn’t really have to be a genius! Take, for instance, the Tisch family of Loews Corp.: arguably, they have never been as successful as the Mr. Buffett and Mr. Munger pair, but they achieved a 15% CAGR in stock price for 50 years nonetheless! That’s 1000 times their original capital: an astonishing creation of wealth! Or take Tom Gayner of Markel Corp.: he almost only invests in blue-chip stock at fair prices, anyone with a Morningstar account could do that! Well, Markel Corp. has achieved a 17% CAGR in book value per share for the last 20 years. Not bad at all!

Add, on top of all this, the benefit of float, and I think it is easy to understand why I like FFH and GLRE so much!

 

Now, to your question about my “macro worries”: while I undoubtedly could stomach a 30%-40% decline in stock prices, I’d lie, if I say that it would be easy. Certainly, it would be much easier with a lot of cash at hand to scoop up bargains! Furthermore, despite the fact that I am my firm’s largest shareholder, I am not the only shareholder. And I am not so sure that my partners would be so calm and cool headed as to think about the long run, while drowning in a storm… If I am forced to cut or even suspend the dividend, because of a 30%-40% decline in equity, I will have to answer unpleasant questions! More: we are still relatively young (got incorporated in 2004 and started doing business in 2005), and our business model is still unproven – I try to squeeze as much free cash as I can out of engineering consulting operations, that need almost no maintenance and growth capital, while redeploying all that cash in “Berkshire Hathaway kind of businesses” at fair prices – So, it is also a matter of confidence: I am willing to leave some fiches on the table now, to safeguard confidence, should something go wrong. Finally, my firm operates in Italy, and the business environment in Italy right now is dire. Even more so in the civil and infrastructure sector! Engineering operations will surely suffer and won’t generate as much cash as they did in the past… at least for a while. To put a 30%-40% decline in equity on top of that, would be really imprudent of me!

 

giofranchi

[giofranchi]

txlaw,

I never said “don’t buy bargains”. I just said “buy bargains and buy some protection”. At Leucadia National they are reducing debt (which is another form of protection), while guaranteeing: “Never fear, if a good deal comes along we will find a way”.

Mr. Julian Roberston said: “I believe that the best way to manage money is to go long and short stocks. My theory is that if the 50 best stocks you can come up with don’t outperform the 50 worst stocks you can come up with, you should be in another business.”

Is there a time when you should be content to just lock in the spread between the great bargains you have purchased and the worst 50 stocks you could find? Or a fully invested long only strategy is always the best way to use capital?

 

giofranchi

[giofranchi]

Or take Tom Gayner of Markel Corp.: he almost only invests in blue-chip stock at fair prices, anyone with a Morningstar account could do that! Well, Markel Corp. has achieved a 17% CAGR in book value per share for the last 20 years. Not bad at all!

 

I hasten to point out that what I wrote about Mr. Gayner was just meant to emphasize the soundness of the Berkshire-type business model, not to underestimate Mr. Gayner’s abilities as an investor! Far from me! I have only the greatest respect for Mr. Gayner and I will very gladly invest with him. I am also comfortable with the fact that, due to the soundness of the business model, and paraphrasing Mr. Buffett, a manager doesn’t have to do extraordinary things to get extraordinary results!

 

giofranchi

[twacowfca]

"John Templeton made a good deal of money for his own accounts in 2000 by a twin-track strategy of shorting shares in Internet stocks and making a leveraged bet on long-dated U.S. government bonds, which he expected to rise sharply in price as interest rates continued to fall.

 

TEMPLETON'S Way with Money

 

giofranchi

 

And George Soros lost a huge chunk of all the money he had ever made by being about a year early  shorting the internet bubble stocks.

[twacowfca]

txlaw,

I never said “don’t buy bargains”. I just said “buy bargains and buy some protection”. At Leucadia National they are reducing debt (which is another form of protection), while guaranteeing: “Never fear, if a good deal comes along we will find a way”.

Mr. Julian Roberston said: “I believe that the best way to manage money is to go long and short stocks. My theory is that if the 50 best stocks you can come up with don’t outperform the 50 worst stocks you can come up with, you should be in another business.”

Is there a time when you should be content to just lock in the spread between the great bargains you have purchased and the worst 50 stocks you could find? Or a fully invested long only strategy is always the best way to use capital?

 

giofranchi

 

 

Ed Thorp was one of the first to model that type of long/short strategy in a systematic way.  It produced returns of about 20% per annum during the first 10 years he used it, but only about 6% per annum when he gave it up to the increased competition about a decade ago. 

[twacowfca]

Well, let me apologize Giofranchi. I thought based on previous comments that you were a money manager with clients. Fund of funds make me angry since they often charge large fees to effectively let money being managed by someone else instead of telling their investors to invest directly with the true managers and to skip the intermediary. Obviously, I totally misunderstood your situation.

 

In your case, it would certainly make sense to focus on stocks and funds that you could hold for a very long time even if it means sacrificing some returns. You don't have the time to keep rotating from one cheap stock to another all the time which means a fair bit of research and essentially being an active portfolio manager. At the same time, I really don't understand why you worry so much about macro or spend any time on it since your focus is on the long haul.

 

Cardboard

 

 

Cardboard,

I don’t like the fund of funds idea either. It is not that I judge unfair to pay someone who lets other people do all the hard work… I believe in paying for performance, not in paying for number of hours worked. If someone could identify the 5 fund managers, who will have the best track record for the next 10 years, I will pay gladly for his services!

Instead, I don’t like the fund of funds idea, because I don’t like the mutual/hedge-fund industry. It has got a fundamental flaw that systematically leads to both unpredictability and underperformance. In the words of Mr. Ackman:

 

“The principal weakness we share with most other money managers is the fact that our capital base is not permanent, and we therefore keep cash on hand and/or own passive liquid investments which we can sell to meet potential investor demands for capital. To address this weakness in our open end hedge fund structure, later this year, we intend to launch the private phase of Pershing Square Holdings, Ltd., which we expect to eventually list on the London Stock Exchange.”

 

I didn’t invest in Pershing Square the hedge-fund, but I will be happy to invest in Pershing Square Holdings Ltd. at an attractive price. Paraphrasing Mr. Buffett, investing is really the best business, and I always like to quote Mr. Munger:

 

“I don’t think General Motor should have wiped out the shareholders. That was a huge failure of management. If you think about it, Berkshire is a collection of failed businesses, that are gone. And here it is, this wonderful thriving place! As our businesses failed, our shareholders did not fail. We adapted. We took the money out of the failing businesses and bought other businesses. General Motors did not pass that test. They destroyed their shareholders…”

 

You could show me a 100 pages report on the future of Apple, and give me all the right reasons why it won’t end up like General Motor one day, and you will anyway fail to convince me… Instead, I am convinced that a Berkshire Hathaway, led by Mr. Buffett and Mr. Munger, will never fail. Of course, you need to know and bet on the jockey… but he or she doesn’t really have to be a genius! Take, for instance, the Tisch family of Loews Corp.: arguably, they have never been as successful as the Mr. Buffett and Mr. Munger pair, but they achieved a 15% CAGR in stock price for 50 years nonetheless! That’s 1000 times their original capital: an astonishing creation of wealth! Or take Tom Gayner of Markel Corp.: he almost only invests in blue-chip stock at fair prices, anyone with a Morningstar account could do that! Well, Markel Corp. has achieved a 17% CAGR in book value per share for the last 20 years. Not bad at all!

Add, on top of all this, the benefit of float, and I think it is easy to understand why I like FFH and GLRE so much!

 

Now, to your question about my “macro worries”: while I undoubtedly could stomach a 30%-40% decline in stock prices, I’d lie, if I say that it would be easy. Certainly, it would be much easier with a lot of cash at hand to scoop up bargains! Furthermore, despite the fact that I am my firm’s largest shareholder, I am not the only shareholder. And I am not so sure that my partners would be so calm and cool headed as to think about the long run, while drowning in a storm… If I am forced to cut or even suspend the dividend, because of a 30%-40% decline in equity, I will have to answer unpleasant questions! More: we are still relatively young (got incorporated in 2004 and started doing business in 2005), and our business model is still unproven – I try to squeeze as much free cash as I can out of engineering consulting operations, that need almost no maintenance and growth capital, while redeploying all that cash in “Berkshire Hathaway kind of businesses” at fair prices – So, it is also a matter of confidence: I am willing to leave some fiches on the table now, to safeguard confidence, should something go wrong. Finally, my firm operates in Italy, and the business environment in Italy right now is dire. Even more so in the civil and infrastructure sector! Engineering operations will surely suffer and won’t generate as much cash as they did in the past… at least for a while. To put a 30%-40% decline in equity on top of that, would be really imprudent of me!

 

giofranchi

 

Actually, GM did take money out of their declining business and buy other businesses that were then spun off.  Perot Systems lives on now as part of Dell.  Hughes Aerospace is now Direct TV.

 

Allstate and Discover Financial Services that were birthed by Sears are now worth much more than their surviving parent SHLD

 

Kodak lives on as Eastman Chemical.

 

These companies did not reinvent themselves as well or as extensively as BRK, however.  BRK is not wedded to any legacy business going forward.  Its corporate culture mainly resides with its BOD, Warren, Charlie and three managers in their home office, plus numerous shareholders tutored by Warren.

 

:)

[giofranchi]

txlaw,

I never said dont buy bargains. I just said buy bargains and buy some protection. At Leucadia National they are reducing debt (which is another form of protection), while guaranteeing: Never fear, if a good deal comes along we will find a way.

Mr. Julian Roberston said: I believe that the best way to manage money is to go long and short stocks. My theory is that if the 50 best stocks you can come up with dont outperform the 50 worst stocks you can come up with, you should be in another business.

Is there a time when you should be content to just lock in the spread between the great bargains you have purchased and the worst 50 stocks you could find? Or a fully invested long only strategy is always the best way to use capital?

 

giofranchi

 

 

Ed Thorp was one of the first to model that type of long/short strategy in a systematic way.  It produced returns of about 20% per annum during the first 10 years he used it, but only about 6% per annum when he gave it up to the increased competition about a decade ago. 

 

 

twacowfca,

I am not saying that I will never remove my hedges! I am just saying that, in an environment that made Leucadia’s managers state “opportunities meeting our investment criteria are few and far between”, I am not comfortable being greedy, and I am satisfied to get a 6% per annum return as the spread between my long ideas and the hedges I put in place. If and when valuations improve, I will surely remove all my hedges and I will be fully invested, employing a long only value based strategy.

 

Anyway, it is clear by now that all of you disagree with me. So, probably, it is true that there is some weakness in my temperament… just like PlanMaestro suggested at the beginning… He stated: “The only thing to conclude is that that investor doesn't have the temperament for the game and he would be better off buying an index fund and forgetting about it.” …Hey! Wait… Buy an index fund?! I would never do that!! Actually I am shorting indices right now!!  Ahahahahahahah!! I am utterly hopeless…  :(

 

giofranchi

 

[twacowfca]

txlaw,

I never said “don’t buy bargains”. I just said “buy bargains and buy some protection”. At Leucadia National they are reducing debt (which is another form of protection), while guaranteeing: “Never fear, if a good deal comes along we will find a way”.

Mr. Julian Roberston said: “I believe that the best way to manage money is to go long and short stocks. My theory is that if the 50 best stocks you can come up with don’t outperform the 50 worst stocks you can come up with, you should be in another business.”

Is there a time when you should be content to just lock in the spread between the great bargains you have purchased and the worst 50 stocks you could find? Or a fully invested long only strategy is always the best way to use capital?

 

giofranchi

 

 

Ed Thorp was one of the first to model that type of long/short strategy in a systematic way.  It produced returns of about 20% per annum during the first 10 years he used it, but only about 6% per annum when he gave it up to the increased competition about a decade ago. 

 

 

twacowfca,

I am not saying that I will never remove my hedges! I am just saying that, in an environment that made Leucadia’s managers state “opportunities meeting our investment criteria are few and far between”, I am not comfortable being greedy, and I am satisfied to get a 6% per annum return as the spread between my long ideas and the hedges I put in place. If and when valuations improve, I will surely remove all my hedges and I will be fully invested, employing a long only value based strategy.

 

Anyway, it is clear by now that all of you disagree with me. So, probably, it is true that there is some weakness in my temperament… just like PlanMaestro suggested at the beginning… He stated: “The only thing to conclude is that that investor doesn't have the temperament for the game and he would be better off buying an index fund and forgetting about it.” …Hey! Wait… Buy an index fund?! I would never do that!! Actually I am shorting indices right now!!  Ahahahahahahah!! I am utterly hopeless…  :(

 

giofranchi

 

I don't disagree with you.  I like your posts.  The point is that variations on old hedge fund strategies, even with extra bells and whistles are now producing mediocre returns.  We are all subject to the "no place to hide" milieu of inflated nominal values as a result of central bank operations.

 

You have some ideas that are the best of the bad lot available.

BRK and FFH are the most defensive.  BRK has decent upside if asset prices continue to rise, plus the amazing, but not absolute, protection of the Buffett Put.  FFH offers the best opportunity to profit in a steep deflationary sell off.

 

Other selective insurance companies with short duration assets will

Profit greatly when monetary inflation finally breaks out into price inflation.  Certain commodity cos will also benefit then.  :)

[Packer16]

Since you are located in Italy, do you see any bargains in that part of the world.  It certainly is depressed and from what I see it appears Italy will stay in the Euro.  TIA.

 

Packer

[giofranchi]

Packer16,

truth be told, personally I don’t like Italian companies right now. If Italy stays in the Euro, we will be stuck with a very overvalued currency and will end up like Japan in a painful debt-deflationary spiral: our stock market will stay very depressed for a very long time! I just don’t see how we could be able to close the gap of productivity with Germany, which, vice versa, will go on benefiting from an undervalued currency. Imho, if Italy stays in the Euro, that gap will get wider and wider. Instead, if Italy leaves the Euro, the new Lira will depreciate by 40%: it is only then that I would buy a basket of very undervalued Italian stocks!

 

I really think that prices can be deceiving in Italy right now: take for instance Cattolica Assicurazioni. It is an Italian insurance company with €1,3 billion in equity, €15 billion in total investments, of which 90% are in short and medium term Italian government bonds. Right now it trades at 0,45 x book value. And for good reasons! What if the Italian government defaults on 15% of its debt? Is it so far-fetched? How would you incorporate that risk in your assessment of the worth of the company? I really don’t know. My only answer is to stay away. Yes! Even if 0,45 x book value looks like a wonderful price for a company with an history that goes back 116 years!

 

Well, actually we can always believe that modern countries cannot default, and we can always assume that Italians will all become Germans… then, yes!, everything will be OK and Cattolica Assicurazioni is a great bargain! ???

 

giofranchi

 

[twacowfca]

That view of local conditions reminds me of a conversation with a friend of a friend that happended in 2007.  He was from mainland China, and he had a Ph.D from a US Univ.  He had a green card to work in the US as a permanent resident. 

 

I asked him about investing in China, and he looked at me as if I were crazy.  Then he told me this story:

 

He was five years old when The Great Proletarian Cultural Revolution  was proclaimed in the 1970's.  His parents were expelled from the city to the countryside because they were educated.  Somehow they survived by eating garbage and doing work that was at the lowest level of society.

 

Three years ago, he went back to China and brought back a bride he had never met.  They have two lovely children, and they appreciate the security of living in the US.  Every penny of their considerable savings stays in the US.

[txlaw]

txlaw,

I never said “don’t buy bargains”. I just said “buy bargains and buy some protection”. At Leucadia National they are reducing debt (which is another form of protection), while guaranteeing: “Never fear, if a good deal comes along we will find a way”.

Mr. Julian Roberston said: “I believe that the best way to manage money is to go long and short stocks. My theory is that if the 50 best stocks you can come up with don’t outperform the 50 worst stocks you can come up with, you should be in another business.”

Is there a time when you should be content to just lock in the spread between the great bargains you have purchased and the worst 50 stocks you could find? Or a fully invested long only strategy is always the best way to use capital?

 

giofranchi

 

I guess my response is that I don't see the point of buying market protection if you have the ability to pick up 30-cent dollars and can deploy the cash generated from your engineering company on an ongoing basis (unless you're worried about your firm's operating results given the macro environment). 

 

As to whether there is a time to lock in "the spread between the great bargains you have purchased and the worst 50 stocks you could find," I suppose it depends on one's goals.  I personally am not a big fan of absolute return strategies.  My goal is to maximize total return and the only way to do that consistently, I believe, is to accept volatility.  If you are managing OPM, though, perhaps that is the best way to keep your own business stable and to allow your investors/clients to sleep at night.  Or if you want to lock in a return in order to redeploy capital into purchasing a business that you will control, that might be a good reason to engage in the hedging strategy you're talking about.  Or if you are managing an inherently leveraged insurance company that has capital level requirements and insured obligations that it must meet on an ongoing basis, then it isn't necessarily irrational to hedge against a general decline in market price levels, particularly if you do not have a fortress balance sheet.

 

Ultimately, I believe it depends upon knowledge of your abilities, temperament, and the particular situation you are in. 

[giofranchi]

Every penny of their considerable savings stays in the US.

 

Amen!

 

 

[giofranchi]

(unless you're worried about your firm's operating results given the macro environment). 

 

Unfortunately, that is exactly what I am worried about…!

 

So, undoubtedly that one is a reason, perhaps the most important one. But it is not the only reason. The S&P500 has more than doubled from its 2009 low, the Russell2000 is even more frothy, and I don’t like prices that double in what I think is still a secular bear market, in what I think is still an extremely overleveraged economy, in what I think is still a very weak job market (and don’t forget that the first jobless recovery was 1932-1937… the one we are living through is the second jobless recovery… a bad omen! “The Forgotten Man” by Amity Shlaes is a very good book on the topic, that probably most of you have already read). Of course, I do not even like the fact that all the money creation around the world had the effect to shrink the yield of “safe havens”, prompting investors to look for yield somewhere else, the stock market. Of course, I don’t even like that corporate margin are at a all time high: maybe it is legitimate to argue that a sector or two could go on expanding their margins, but, imho, it is very doubtful that the whole S&P500 could do so on a sustainable basis. It would mean that "Capital" in the future will be entitled to higher returns than in the past… Why? Ok, I know, that’s too much macro… and macro is unreliable!

Let’s just put it this way: I am worried about my firm's future operating results and I don’t like prices that double in little more than 3 years!

 

giofranchi

 

[giofranchi]

I think the Hussman 2012AR just published can add a little perspective: on page 1 you can see the Hussman Strategic Growth Fund performance since inception. More interesting still, you can see its performance both with and without hedges. From 2000 until the first half of 2011 its true performance (hedged) was always superior to the hypothetical performance without hedges. It was just last year that the unhedged strategy outperformed the hedged one. Imho, that is a red flag about the state of the market, and should not be ignored.

Furthermore, if you know Mr. Hussman, you also are aware of the fact that he completely missed the 2009-2010 recovery. An unfortunate “mistake” that neither Mr. Watsa nor Mr. Einhorn committed. Hadn’t he missed the 2009-2010 recovery, the Strategic Growth Fund performance would have been much better! I think he learned some lessons and won’t do the same mistake again in the future.

Anyway, even with the 2009-2010 mistake, the Strategic Growth Fund is still ahead of the Russell 2000 Index and way ahead of the S&P500 Index.

 

giofranchi

annrep12.pdf