Your 2008/2009 Experience

[yadayada]

Any thoughts on the inverted yield curve? When overnight rates spike above long term rates (especially if this spike is significant), it basicly means that the large players in the money market think there is a good chance the FED will interfere soon. I supose that trick wont work anytime soon tho with these rates. Also interesting if you read that latest hedge fund book by schwager, almost all these guys were prepared for it and saw it coming in different ways. Even one of the value investors. So i guess you cant really call it a black swan event.

 

I read a study that whenever this happened, a recession followed somewhere within 6-18 months more then 50% of the time. If you read the big short and listen to burry you will also hear that alot of large players in the mortgage industry knew what was up almost a year before. That also happened to be when you saw the large inverted spread.

 

Thoughts?

 

Oh and I supose you gotta keep your eye open on what is happening in the economy. I wasnt investing back then, but one thing I hear is that alot of people saw that there was a real estate bubble going on. Getting curious in situations like that could really pay off.

[Packer16]

In 2008, it looks like you had leveraged real estate and stocks.  Now it appears some of the leverage is out of the system (at least the most unstable - private funds lent to uncreditwothy folks) replaced in part by gov't financing and the fed purchases.  I like how you looked at the bond market and saw the credit risk was there then where able to translate it to stocks.  Now it appears we are in the opposite situation with firms having alot of cash and low debt along with households deleveraging.  I was looking at credit card write-off numbers and FICO scores in CC pools and both of these are improving very fast as banks don't appear to be lending to high risk individuals.  This in combination of relatively low stock allocations in personal portfolios and a dis-inflationary environment would point to increased valuation despite average valuations.  It appears the credit portion of the boom has not started as of yet so the potential decline in a downturn will be more in 20 to 30% variety versus the 50%+ variety was saw in 2008.  I think Howard Marks has made this observation and is going forward with caution. 

 

My biggest mistake was to buy "cheap" financials going into the crisis without realizing the fundamentals had deteriorated so much.  Both Berkshire and Fairfax saved my bacon so I could invest after the crash.  Now I am requiring a pretty big margin of safety and have been selling stocks with lower price MoS and buying those with higher price MoS.

 

Packer     

[giofranchi]

I see.

 

Well, I can only say that it has been worth it for me to learn about them.  It's sort of nice the way you can write the $25 strike call and use the proceeds to purchase two $8 strike puts.  This way, you can put 100% of your present capital into the stock at $8 per share during a panic (by either purchasing the underlying common stock, or by flipping each $8 put into an $8 call).  So if it goes from $16, down to $8, and then back up to $16 you can double your money even though the stock never appreciated from present levels.  And instead if the stock doesn't go into a panic, but rather it goes from $16 to $25 over those same two years, you can make 56%.  That's not a horrible thing either way -- panic or no panic.

 

You get to preserve your buying power, and at the same time you don't have miss out on gains if there is no panic.

 

And really it costs nothing at all -- only gets expensive if the stock goes over $25... but if that is to be considered an expense, then you have a much bigger expense if you are instead in cash all that time.

 

Thank you, Eric!

This truly sounds great! As I have said, much work for me to do in options and much room for growth… As you have said, it surely will be worth the effort! ;)

 

Cheers,

 

Gio

 

[giofranchi]

One more thing about FFH and the 2008/2009 experience.

In three years (2007, 2008, and 2009) FFH’s BVPS increased 146%.

Now, you might argue FFH is not as well positioned to take advantage of a market panic as it was back then in 2007, but I guess no one can say it didn’t take advantage of the last panic effectively enough!

I don’t care about what its stock price did during those three years. All I care about is that during the panic its BVPS compounded at 35% annual three years in a row.

That’s all I really need to know. If FFH nowadays is positioned half as well as it was back then in 2007, to take advantage of any future market panic, I am correct in my business judgment, and therefore satisfied (even if I have no clue about what its stock price might do in the future). :)

 

Gio

 

[giofranchi]

So given those shackles it puts on their investing freedom, one would hope the insurance operations would be extremely good in order to make up for this -- lots of underwriting profit.  Where is it?

 

Operating profits from insurance and reinsurance operations as of September 2013 were $160 million, or 2.12% FFH’s equity at 2012 year end. This is a 2.8% ROE annualized. To get to 15%, you only need 12.2% from investments. Given their leverage, a return of more or less 5.7% from their portfolio of investments is needed. Historically they have averaged 9.4% annual on their portfolio of investments. If this is not a margin of safety, I have never seen one. :)

 

Gio

 

[DoddDisciple]

In trying to analyze the 2008/2009 experience come full circle, I want to share something that can hopefully answer the question of "when do you get back in?" 

 

He mentioned that when you start seeing net-nets (excluding Chinese frauds) that actually have a good underlining business, it is time to tip back into the market.  A good example is Tellular was trading at liquidation value, the company was buying back stock, and the underlining alarm business is a very high quality with recurring revenue.  When you can find those for sale, just buy a basket .  If there is a drawn out recession/depression, the buyback in shares and the growing cash balance will serve as a catalyst to drive the price higher.  There were a handful of companies that exhibits these characteristics during the darkest days.

 

Did you deal with any international net-net investing during this period? How did you curate your net-net basket? Just basic screens or did you have a shortlist of stocks that you were interested in at a cheaper price?

[ERICOPOLY]

So given those shackles it puts on their investing freedom, one would hope the insurance operations would be extremely good in order to make up for this -- lots of underwriting profit.  Where is it?

 

Operating profits from insurance and reinsurance operations as of September 2013 were $160 million, or 2.12% FFH’s equity at 2012 year end. This is a 2.8% ROE annualized. To get to 15%, you only need 12.2% from investments. Given their leverage, a return of more or less 5.7% from their portfolio of investments is needed. Historically they have averaged 9.4% annual on their portfolio of investments. If this is not a margin of safety, I have never seen one. :)

 

Gio

 

They are tremendous investors and can achieve much of what you talk about if they were to shut down the insurance operation.  You say they only need 12.2% from investments.  What, and they need to run an insurance operation for that... why?  Insurance forces them into a lighter equity allocation during market cheapness periods (they have an insurance regulator and they have credit ratings to worry about).  During periods of high interest rates and poor equity prospects, the bonds really shine -- but they don't shine so bright when there are low interest rates.

 

Hasn't Chou Funds kicked the crap out their returns the last 5 years without an insurance operation to worry about?

 

I mention Chou because he's about as FFH as you get without actual working there anymore (he used to be a VP there).  So they should be able to achieve what he can achieve (he uses the same philosophy).

[giofranchi]

So given those shackles it puts on their investing freedom, one would hope the insurance operations would be extremely good in order to make up for this -- lots of underwriting profit.  Where is it?

 

Operating profits from insurance and reinsurance operations as of September 2013 were $160 million, or 2.12% FFH’s equity at 2012 year end. This is a 2.8% ROE annualized. To get to 15%, you only need 12.2% from investments. Given their leverage, a return of more or less 5.7% from their portfolio of investments is needed. Historically they have averaged 9.4% annual on their portfolio of investments. If this is not a margin of safety, I have never seen one. :)

 

Gio

 

They are tremendous investors and can achieve much of what you talk about if they were to shut down the insurance operation.  You say they only need 12.2% from investments.  What, and they need to run an insurance operation for that... why?  Insurance forces them into a lighter equity allocation during market cheapness periods.

 

Hasn't Chou Funds kicked the crap out their returns the last 5 years without an insurance operation to worry about?

 

I mention Chou because he's about as FFH as you get without actual working there anymore (he used to be a VP there).

 

Actually, I said they only need 5.7%... to get to a ROE of 12.2%, which, with 2.8 percentage points added by underwriting profits, gets you to a 15% ROE.

If I am not mistaken, it was Mr. Buffett who said some time ago:

If I had to start it all over again, I would never buy BRK. Instead, I would buy a small insurance and grow from there.

 

Gio

[ERICOPOLY]

 

Actually, I said they only need 5.7%... to get to a ROE of 12.2%, which, with 2.8 percentage points added by underwriting profits, gets you to a 15% ROE.

Gio

 

I understood you, the trouble is that the 12.2% is not a tough hurdle for guys like this to achieve running a plain vanilla equities fund.  It's well below their historical equity returns actually.

 

Suppose these guys come up with a really fancy system that takes a lot of their energy, and they merely achieve a return that Chou can achieve WITHOUT the fancy system and his job is easier because of it?

 

 

[giofranchi]

I understood you, the trouble is that the 12.2% is not a tough hurdle for guys like this to achieve running a plain vanilla equities fund.  It's well below their historical equity returns actually.

 

Suppose these guys come up with a really fancy system that takes a lot of their energy, and they merely achieve a return that Chou can achieve WITHOUT the fancy system and his job is easier because of it?

 

Well, let’s just forget for a moment about this board, which is filled with genius investors! ;), and look at the statistics about hedge and mutual funds around the world… To outperform the S&P500 by 3% annual you probably must be in the top 1%. If the S&P500 is priced to achieve something like 3% annual for the next 10 years, like a believe, you have to be able to choose one fund among the top 1% performers to get a 6% return, and you won’t benefit from leverage.

If you want a 12.2% return (an outperformance of 9 percentage points each year) probably you must be able to pick one fund among the top 0.1% performers… and maybe that won’t still be enough!

Or else, you buy FFH.

 

Gio

 

[ERICOPOLY]

I understood you, the trouble is that the 12.2% is not a tough hurdle for guys like this to achieve running a plain vanilla equities fund.  It's well below their historical equity returns actually.

 

Suppose these guys come up with a really fancy system that takes a lot of their energy, and they merely achieve a return that Chou can achieve WITHOUT the fancy system and his job is easier because of it?

 

Well, let’s just forget for a moment about this board, which is filled with genius investors! ;), and look at the statistics about hedge and mutual funds around the world… To outperform the S&P500 by 3% annual you probably must be in the top 1%. If the S&P500 is priced to achieve something like 3% annual for the next 10 years, like a believe, you have to be able to choose one fund among the top 1% performers to get a 6% return, and you won’t benefit from leverage.

If you want a 12.2% return (an outperformance of 9 percentage points each year) probably you must be able to pick one fund among the top 0.1% performers… and maybe that won’t still be enough!

Or else, you buy FFH.

 

Gio

 

Seriously though, I looked in an annual report back around 2007 or so, and HWIC's annualized return (since inception) on equities was over 17%.

 

This is why I merely ask how much more they achieve by having all the risk of insurance added to the fold.

 

They could lose 20% of book value later on today if their luck is bad.  Or it could be the worst case of 10% or so that they have modeled.

 

The reason you've heard of Alexander Hamilton is that he was a young boy living in the West Indies on a day that they were hit with a huge hurricane and a huge earthquake on the same day!  He wrote an account of this experience that circulated in worldwide newspapers. Some wealthy businessmen were impressed by his intellect and funded his studies at Kings College in the US -- the rest is history.

 

[crastogi]

I see.

 

Well, I can only say that it has been worth it for me to learn about them.  It's sort of nice the way you can write the $25 strike call and use the proceeds to purchase two $8 strike puts.  This way, you can put 100% of your present capital into the stock at $8 per share during a panic (by either purchasing the underlying common stock, or by flipping each $8 put into an $8 call).  So if it goes from $16, down to $8, and then back up to $16 you can double your money even though the stock never appreciated from present levels.  And instead if the stock doesn't go into a panic, but rather it goes from $16 to $25 over those same two years, you can make 56%.  That's not a horrible thing either way -- panic or no panic.

 

You get to preserve your buying power, and at the same time you don't have miss out on gains if there is no panic.

 

And really it costs nothing at all -- only gets expensive if the stock goes over $25... but if that is to be considered an expense, then you have a much bigger expense if you are instead in cash all that time.

 

Thank you, Eric!

This truly sounds great! As I have said, much work for me to do in options and much room for growth… As you have said, it surely will be worth the effort! ;)

 

Cheers,

 

Gio

 

Hi all - great discussion.  I like the idea of deferring gains as long as possible, while protecting the downside.  When i log onto my broker (TD ameritrade) the longest duration option I see is May 14.  Do i need to be looking elsewhere?

 

Regards

[giofranchi]

So you think that investing is less risky than insurance? Just look at Mr. Brindle: he shuns investing altogether and relies solely on insurance!

It's always about people. It's people that matter! So, choose the right partners and let them do what they do best!

 

Gio

[ERICOPOLY]

So you think that investing is less risky than insurance? Just look at Mr. Brindle: he shuns investing altogether and relies solely on insurance!

It's always about people. It's people that matter! So, choose the right partners and let them do what they do best!

 

Gio

 

What would FFH's returns be if they relied solely on insurance?

 

Now we're getting to the meat of my argument. 

 

[Uccmal]

So you think that investing is less risky than insurance? Just look at Mr. Brindle: he shuns investing altogether and relies solely on insurance!

It's always about people. It's people that matter! So, choose the right partners and let them do what they do best!

 

Gio

 

What would FFH's returns be if they relied solely on insurance?

 

Now we're getting to the meat of my argument. 

 

 

How about bankrupt... And no,

I am not kidding. 

 

The investment gains saved their bacon more than once. 

 

[wachtwoord]

Please continue this argument I really appreciate it (but have no valid contribution, other than thank you).

[original mungerville]

I think if they relied solely on insurance and purchased acquisitions at book value, Uccmal is correct - they'd be toast.

 

I think if they relied solely on insurance and, as they did, purchase acquisitions below book value, that works out to be about 0% annual growth in book value per share over 25 years.

 

This is a long way of saying that, for the past 25 years, almost all of the growth in book value per share has come from investment gains.

 

Now, the big question is, what happens going forward? What's the mix? I think we see more organic growth, purchases closer to book or above book (higher quality), and better underwriting over time. I also think we see major lessons from hedging (I know I just learnt one!), and some lessons on individual company purchases. Of course the lessons from the 2000-2006 period will never be forgotten. As well, probably investment gains in percentage terms will decrease due to size. I am not pretending to understand what all of the above means going forward.

 

 

 

[original mungerville]

Ya, around late January early February (2005 I think), the rate on 30 year treasuries dropped and they were sitting on almost $1 billion in gains earned at various subs including Odyssee Re and thank god for consolidated taxation in the US which permitted Odyssee to push up taxes to the holdco (instead of to Uncle Sam) on those gains to supply the holdco with liquidity.

 

This is when the stock was at around 100 something (150?) I don't remember, but all I knew was that by x-mas 2004 they looked like they were toast and by late January early February, the gains saved their bacon as Uccmal said.

 

I think I am getting the year right.

 

 

[giofranchi]

This of course is difficult to answer. But I like what I see. I see Mr. Watsa buying insurance companies that are good companies, and no more deeply troubled at a steep discount. Of course, this is the way to go buying whole companies. Furthermore, I have great respect for Mr. Barnard and what he has achieved at OdysseyRe. And the idea to put him in charge of all insurance and reinsurance operations is a valid one. Is Mr. Barnard a good underwriter? Is Mr. Watsa a good investor? If you answer yes to both questions, you should be an investor in FFH.

 

Gio

[Palantir]

Don't most insurance companies make poor returns on operations without the assistance from the investment portfolio?

[ERICOPOLY]

Common sense tells me "B" that I would rather buy insurance from:

 

A)  a company that invests the premiums in short-duration treasuries

B)  a company that puts 50%+ in stocks

 

Just kidding!  It's "A".

 

 

So, to what degree does the investment portfolio influence the underwriting results?  It must work (to some degree) in favor of Mr. Brindle's underwriting result and against Mr. Barnard's.

 

Don't the ratings agencies care?  And don't the customers care about the insurance ratings?

 

To answer Giofranchi -- it's not that I believe insurance is less risky than investing, rather I believe the risks are additive.  In other words, you can have a major cataclysmic underwriting result during a major stock market panic (and bond market panic).  They can all happen at the same time -- a perfect storm.

 

You just have equity market risk if you only invest in equities.  You just have bond market risk if you only invest in bonds.  You just have insurance market risk if you only invest in short duration T-bills.

 

 

[wisdom]

But, not BRK and few others. BRK has -ve cost on float - they get paid to underwrite.

[wisdom]

For FFH -

 

The hedges and cash at holdco negate/reduce a lot of the risks. This is a lesson learned from BRK - $20B cash at all times.

[ERICOPOLY]

For FFH -

 

The hedges and cash at holdco negate/reduce a lot of the risks. This is a lesson learned from BRK - $20B cash at all times.

 

I agree with that -- however keeping all this cash around costs money.  You have to knock that off the underwriting results to account for the true cost of insurance operations.

[ERICOPOLY]

Anyways, over on the SHLD thread people are arguing that the retail business detracts from the value of the assets.

 

I'm simply asking if the insurance operations detract from the value of HWIC -- they would not have the float, but they could go heavier into equities when the opportunity is ripe.  And I don't mean Kraft and Johnson and Johnson when American Express is trading at tangible book value!