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Some FFH conference call highlights


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- Underwriting discipline all across Fairfax. Looking at the expense ratio going up because of reduced volume of insurance business (underwriting discipline), don't look to reduce the staff significantly and want to retain talent.


My personal observation: it's all about thinking over the long term (clap clap clap).


- They have not hedged back their stock portfolio. Think that if they have choosen stocks properly, they and FFH shareholders will be quite happy in 4-5 years. There is still interesting investment opportunities in the stock and bond markets. Remind them the (1976-1984?) period.


My personal observation: seem to be very happy with what they own actually.


- Prefer a lumpy 15% CAGR than a smooth 12% CAGR.


Personal observation: Me too! As always, be prepared to handle more difficult quarters and years. A stock portfolio is volatile and when you have a very significant part of your equity in stocks, then book value per share will also fluctuate accordingly.


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Perhaps the preference for lumpy returns reflects recognition of the limitations of modern portfolio management theory plus the intention of making money off of the suckers who fail to recognize these limitations. As Nassim Taleb explains in his book The Black Swan, the best position can be to lose money slowly (e.g. by buying options) waiting for the rare event to occur in which one makes an amount of money that is virtually impossible if returns are normally distributed. The theory that this kind of strategy may be what Prem has in mind when he says he likes the returns to be lumpy is consistent with the strategy of buying credit default swaps and U.S. treasuries a few years ago when they were cheap, then selling them recently when their prices jumped.


The performance measures of modern portfolio management theory penalize the portfolio manager whose returns are lumpy, leading companies like General Electric to boost their stock prices by smoothing the returns using accounting gimmicks. In this respect, modern portfolio management theory can be quite misleading, for the portfolio with the lumpy returns can be the better portfolio in the sense of being much less risky. That our business schools continue to churn out graduates steeped in the notion that data are normally distributed guarantees a steady supply of suckers.

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That was, by far, the shortest Farifax conference call I've ever heard!  I think there were only three questions.  Prem and Greg pretty much said...made money, great shape, insurance companies are alright, investors will be happy in the future, and markets move up and down so book will too.  And then probably the most uninformed analyst I've heard (I'm pretty sure he was an analyst) asked the last question on where Fairfax should trade, what does the portfolio look like presently, and is the insurance market firming.  Unless something goes wrong, I think we should get used to these short conference calls.  Cheers!  

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I counted 5 questions:


#1 Jeff @ Cormark on investment gains.  They didn't sell much.  Convertible bonds, those with an imbeded put, index SWAPs, options, etc...  are marked to market -- so they impact earnings.  All equity positions float with the market and affect book value.


#2  Ryan Pitan (?) Increase in ratios.  Insurance 101.  Fairfax also matches investments as a cheap way to hedge currency exposure.  Sometimes mucks with combined ratios.  ie.  Lose on operating side and Gain on investment side.


#3  Mark Dwelle @ RBC (formerly Ferris, Baker Watts) Washington, DC -- I think Mark is the most informed and familiar analyst covering FFH.  He asked about the increased position in ICO which they would never comment on.  Sometimes I think analysts just join the queue immediately after joining a call.  It's in their best interests to ask a question so they do.  There wasn't much meat on the bone today.


#4 Paul O'Neil (Talisman Global)  asked about book value at July 30.  Sometimes they will offer a glimpse.  If so, they would usually issue a press release.  Prem suggested he check out a filing and mark changes to the equity portfolio...  like the rest of us.


#5  (Blank) Colbey of Jac Investments -- Thoughts on re-hedging stock portfolio. 


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That was, by far, the shortest Fairfax conference call I've ever heard!


Yes, me too! So here is the recipe for FFH to save on long-distance calls for the future FFH conference calls.


1- Make dust

2- Explain your dust comprehensively





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#4 Paul O'Neil (Talisman Global)  asked about book value at July 30.  Sometimes they will offer a glimpse.  If so, they would usually issue a press release.  Prem suggested he check out a filing and mark changes to the equity portfolio...  like the rest of us.




For the first quarter they mentioned gains in April as it offset some of the declines in the first quarter.


The second quarter saw gains – I’m assuming July did too  - so as it didn’t offset anything from the 2nd quarter maybe they are just keeping their powder dry for the 3rd quarter. If FFH pick up some hurricane losses in excess of expectation then the gains will hopefully offset them – or limited hurricane losses will see just further increases in the equity position and hopefully more equity per share.


Good move not to call anything.



Shame no analysts asked about the lawsuit against the shorts. I doubt if anything would have been revealed but it would have been nice to remind people that its still ongoing with potentially a positive financial outcome..


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Couple of thoughts that immediately sprang to mind:


Why so few questions. OK partly it’s the day before a long weekend, but doesn’t it also reflect a greatly reduced media/industry interest? If the BV multiple is to rise over the near term, we need more buyers than sellers – so where is that $ flow coming from?   


Trade versus value play. This is hurricane season, and FFH does not appear to be a market hottie – so why would you NOT expect the BV multiple to drift downward as we move through the quarter? Then if you believe that 1.25x is reasonable & you can buy at .90x (or less) - aren’t you really making your money from trading versus holding? Then doubling it - if you actually see FFH as being a long term value play.


Why such UW variation. Lot of possibilities, but perhaps the real issue is that they haven’t bought out other carriers & used their expertise to extract the synergies. Additional float, economy of scale, etc. Buying in your own subs (NB) boosts financial return, but has no impact on the UW. 


Long term operations. ORH is inherently riskier business, so if you can already lay off some of the non-systemic equity risk (via the publics holding) – why would you want to take it back anytime soon, when even WEB is backing away from cat risk? Alternatively why would you NOT have ORH make other reinsurance acquisitions to grow its entire business?


Value Trap. For the foreseeable future FFH is going to be primarily an investment vehicle – so wouldn’t its NAV always be discounted for its UW operation, because it is not directly comparable to other investment funds? Especially as it would seem to be that only with a great effort at the annual AGM – do they get anything close to an insurance coy valuation.


Another great quarter, but you have to ask why are we not getting the bounce that we might expect.




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There is no tangible reason I can think of as to why Markel for example is 1.4 or 1.5 BV and FFH is 0.9.  They are similar operations.  Markel's 1st Q was pretty weak on both investing and underwriting. 


I expect it is just a matter of time before both companies trade at 2x or greater again. 


A much higher price to book would be very useful as currency right now.  Unfortunately, it is not to be at this moment. 

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Sharper, I believe Mr. Market IS now valuing FFH and ORH at as higher multiple when you compare to their peer group (than it was in past years); and, yes, FFH is still trading below the top group (such as Markel). I also see both FFH and ORH getting more press in analyst reports regarding investment gains/losses (not just operating income).


The key issue right now with both FFH and ORH valuations is:

1.) insurnace/reinsurance stocks are in a multi-year soft market

2.) credit market has been unfreezing

3.) investment gains/losses in Q2 have markedly improved for most insurers

4.) hurricane season has been a non event (so far)


A number of insurers were on the ropes in March. The possible catalysts for a hard market (no access to capital, wosening of financial markets, catastrophes) have not happened.


My guess is FFH and ORH will continue to come back into favour over time and move up the insurance food chain and command a higher multiple.


One piece (not to beat a dead horse) that I do not understand is why the CR is above 100 at NB and C&F. I am having a hard time understanding that it is simply becasue they are holding on to their good people in anticipation of the hard market. Many other well run insurers have a CR well under 100 and their business is shrinking and they are unlikely to be firing people they need when the hard market comes. My amateur guess is the various companies reserve quite differently. FFH had little in the way of prior year reserve releases to assist CR this quarter. Other companies continue to post solid CR numbers and many continue to have large reserve releases.


Perhaps the answer is simply that other companies are dipping in to prior year reserves aggressively to hold up their CR and maintain their operating income numbers (given investment income is falling quite dramatically due to extremely low bond yields). Listening to the Q&A from the WR Berkley conference calls the past two quarters was interesting as old man WR has the perception that more than a few insurance companies are swimming naked (under-reserving) and once the tide goes out (an event happens or enough time goes by) the hard market will be here... 

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The UW doesn't bother us as FFH doesn't discount the liability, & has a far lower income simply because it isn't chasing yield. Best guess; if that 'measurement difference' is around 5 on the CR, they're actually writing at close to break-even & playing to their strength - investment.


We think the bigger issue is the inherent MTM BV volatility, multiplied by the UW exposure. Eg: major flooding/hurricane damage concurrent with a 20% drop in NA indexes - in 1 quarter. Not that long ago no one believed in black swans - but now they show up on a regular basis (AIG?). A non P&C investor is going to take a sizeable discount for the perceived risk. A normal business risk to an experienced P&C investor, & a frustration as we never get to intrinsic value.


But if you see the change in BV multiple as essentially being a seasonally driven annual business cycle - then the nature of this investment changes dramatically. If the ROE is 15%, a round trip would generate a fairly reliable 75% of BV [(1.25-.9)x2x(1+.15/2)] vs 15% for a buy/hold - or 5x as much. Even if you only capture 40% of the potential 75% you're still 2x better off.


Not an approach for everyone, but it doesn't hurt to be flexible.
















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