Corner of Berkshire & Fairfax Message Board

General Category => Fairfax Financial => Topic started by: KFS on March 08, 2019, 02:18:44 PM

Title: 2018 shareholders letter
Post by: KFS on March 08, 2019, 02:18:44 PM
2018 shareholders letter

https://s1.q4cdn.com/579586326/files/doc_financials/2019/2018-Shareholders-Letter.pdf

Title: Re: 2018 shareholders letter
Post by: investmd on March 10, 2019, 07:37:53 AM
Prem Watsa is an eternal optimist & infectious about it.
Anticipated returns of 15%/year - can hope that works out.

What do folks think of approx $1.5B/yr in buybacks? About 8% of market cap.
Title: Re: 2018 shareholders letter
Post by: Spekulatius on March 10, 2019, 11:56:08 AM
BIAL (Bangalore airports) seems like a nice business. I wish there was a direct way to invest in it.
Title: Re: 2018 shareholders letter
Post by: StevieV on March 10, 2019, 12:22:07 PM
Some unstructured thoughts:

(1) The underwriting seems to be under control and going reasonably well.

(2) I like the mea culpa on shorting.  Good to acknowledge mistakes and learn from them.

(3) I generally don't like exclamation points, and didn't care the sprinkling of them here.  Just say what you want to say.

(4) Nice dividend and interest income.

(5) The 15% "target" seems more of an aspirational target than a mid-range or average result target.  I'd prefer they communicate this differently.  Perhaps a range of possible returns depending upon equity, fixed income and underwriting returns.  They achieved neither the underwriting "target" or the investment target.

(6) Sort of a swing for the fences portfolio.  I own KW myself, and consider that more of a steady performer.  But, a lot of the others are more volatile businesses.

(7) Also not a fan of the opening - we would have done great, except we didn't.

(eight) I think the dividend and interest income, plus reasonable underwriting should be a good baseline driver of returns.  Equity returns will be a wild card.


----------------

Edited to write out the "eight".  Not sure why, but the board was automatically changing my number 8 to an emoji.  It wasn't showing up when I typed it, so I was not sure how to edit.  In any event, the last point is simply another of my thoughts, and I meant no special meaning for the last point.
Title: Re: 2018 shareholders letter
Post by: shalab on March 10, 2019, 06:17:34 PM
With FRFHF reporting, I always dig deeper. The headlines, including Prem's comments are unfortunately misleading.

Here is an example:

In page 11, Watsa says:

Henry Singleton from Teledyne was our hero as he reduced shares
outstanding from approximately 88 million to 12 million over about 15 years. We began that process by buying back
1.1 million shares since we began in the fourth quarter of 2017 up until early 2019 Ė about half for cancellation and
half for various long term incentive plans we have across our company

Page 83 of the annual report:

Diluted number of shares at the end of 2018 - 28.397 million
Diluted number of shares at the end of 2017 - 26.1 million

Using the diluted shares, I get a book value of 414 at the end of 2018. Reducing 10 dollars paid out as dividend, the book value is at 404.

2018 shareholders letter

https://s1.q4cdn.com/579586326/files/doc_financials/2019/2018-Shareholders-Letter.pdf
Title: Re: 2018 shareholders letter
Post by: shalab on March 10, 2019, 06:32:02 PM
Regarding BIAL ( or KIA ) being a good business, yes it is. However, many parts of the business is regulated by the government and rightly so.

Here is an article about the profit it made in 2017-2018. There is pressure on the government to reduce or cut the UDF (usage development fee) which has been the major source of profit.

https://economictimes.indiatimes.com/industry/transportation/airlines-/-aviation/bengaluru-airports-profit-soars-33-to-rs-848-crore/articleshow/67037829.cms
Title: Re: 2018 shareholders letter
Post by: chrispy on March 11, 2019, 07:41:15 AM
BIAL is also discussed further in the Fairfax India report.

The letter from Prem is fine, and I like it more then previous years. But, mentioning that value has been losing to growth and value will someday outperform again is a little ridiculous in this context. Their investment results aren't just trailing the indices by a percent of two, their picks have been bad. Hence why he always has to justify them.
Buy profitable, simple companies and stick to reasonable position sizes.
Title: Re: 2018 shareholders letter
Post by: petec on March 11, 2019, 08:53:44 AM
Buy profitable, simple companies and stick to reasonable position sizes.

That easy, huh? ;)

I'm kinda kidding. Kinda.
Title: Re: 2018 shareholders letter
Post by: StubbleJumper on March 11, 2019, 09:07:58 AM
I read the letter on Saturday and refrained from commenting for a couple of days.  A few opinions:

1) If Prem wants to emulate the people in Omaha and write a 20-page letter, he badly needs to hire an editor.  There's no shame it in, Warren has used an editor for years.  At times, the letter seemed to be effectively a stream of consciousness listing every little company that FFH owns, irrespective of whether anything interesting happened at those companies during 2018.  It's nice to get a bit of colour on those companies, but if there was a theme or message that was intended through that shotgun approach, it escaped me.  The repeated silliness stating, "the best is yet to come!!!!!!!!!!!" was very tiresome.  I could do with less pumping and exclamation points, and more operational performance. 

Could a guy like Rob Carrick or somebody like that help Prem to tighten up his prose?


2) There wasn't a great deal of broader insight transmitted in this letter.  Now, that's no criticism of Prem, but in past letters there have been observations or nuggets about the industry or financial markets that I have found useful (FWIW, I didn't find that I obtained much broader insight from BRK's letter this year either).


3) What can you say about a letter that basically says, "We would have done better if we hadn't made so many shitty investments."  It's pretty tough for Prem to polish that turd.


4) Prem did a pretty good job telegraphing FFH's operating earnings potential.  That, IMO, is the base upon which higher valuation will be achieved.


5) Why is there still conflicting messages about hedging?  On the CC, the CEO mishandled a discussion about a potential drawdown in equity markets.  Prem's letter went to great lengths to communicate that there would be no more equity hedging because FFH learned its lesson.  It also observes that US economic growth has been strong, rates have bumped up, inflation looks like it's bottomed out, there's a long runway, etc, but despite those clear and obvious conditions, FFH will continue to hold CPI derivatives worth a notional $114 billion.  About this, I am perplexed.  It's only a $25m market value, but if you are trying to communicate that you are moving on from hedging mistakes in the past, why not liquidate this position.  That large notional value demonstrates that FFH was only speculating on inflation to begin with (ie, if you were hedging you would choose a hedge ratio and then buy your protection...the CPI derivatives exceed FFH's combined assets and gross revenue for a year).  If Prem and Brian have changed their perspective about world markets (which is a legitimate thing to do, and there's no shame in changing your mind), just sell the damned things and recoup the $25m, which happens to be about $1/share of capital.


6) How did the India/Pakistan conflict escape mention?  What percentage of FFH shareholders' capital is in India, to what extent has the conflict recently affected asset valuations, and what's the way forward?  I understand that the Indian culture is somewhat more fatalistic than western culture, but I would have expected some sort of reflections from FFH about the situation and whether it at all changes their approach on a going-forward basis.


7) Underwriting has been good, even though cats pushed up the CR a little.  Did anyone else take a peek at the loss triangle in the annual (it was nice when the loss triangles of all the major subs were included in past years)?  The reserve redundancies have become ridiculous.  Now, this is better than the alternative where adverse development is ridiculous, but seriously, they have been systematically overestimating their accident year claims by ~10% (see page 70 of the AR).  As I said, this is better than the alternative, but at what point does an auditor call bullshit on this?  Or is it a happy circumstance where the current accident year is overestimated, but that is offset by reserve releases from previous years?


8) Am I alone in thinking that many of the smaller international insurance acquisitions look pretty shitty (see page 15 of the letter)?  I get that many of these countries are demonstrating rapid economic growth, which portends well for the size of the future insurance market.  But, stealing a term from President Trump, if you are going to invest in "shit-hole" countries, wouldn't it at least be nice if the investment was profitable?  Seriously, Prem has listed 15 international subsidiaries and when you round the numbers, 12 of them have a CR of 98 or higher.  Do you go to a shit-hole country for a CR of 98?  Return on invested capital doesn't look great (see page 59 of the AR).


9) I like the table presenting FFH's lottery tickets (see page 20 of the letter).  Chances are that FFH ends up taking a ~10% bath on that portfolio of higher-risk debt, but all it would take to offset that would be one or two good wins on the lottery tickets.  Currently, it looks like FFH's number is coming up for Seaspan, but it's still early.  Hopefully they'll match 5 or 6 numbers to hit the jackpot on a couple of those.


10) Am I alone in finding it ironic that Prem should mention Bitcoin and General Electric on the same page, but with different conclusions?  I find that both are impossible to value and have steered well clear!  Prem seems to hold one in disdain but embraces the other.  Interesting.



I've spent less productive Saturday mornings doing other things than reading the letter and perusing the AR, but nothing much changes for me after this release.  It's time for FFH to drop the excuses and to execute.  The market is from Missouri and is saying,  "Show me."



SJ
Title: Re: 2018 shareholders letter
Post by: petec on March 11, 2019, 09:52:26 AM

5) Why is there still conflicting messages about hedging?  On the CC, the CEO mishandled a discussion about a potential drawdown in equity markets.  Prem's letter went to great lengths to communicate that there would be no more equity hedging because FFH learned its lesson.  It also observes that US economic growth has been strong, rates have bumped up, inflation looks like it's bottomed out, there's a long runway, etc, but despite those clear and obvious conditions, FFH will continue to hold CPI derivatives worth a notional $114 billion.  About this, I am perplexed.  It's only a $25m market value, but if you are trying to communicate that you are moving on from hedging mistakes in the past, why not liquidate this position.  That large notional value demonstrates that FFH was only speculating on inflation to begin with (ie, if you were hedging you would choose a hedge ratio and then buy your protection...the CPI derivatives exceed FFH's combined assets and gross revenue for a year).  If Prem and Brian have changed their perspective about world markets (which is a legitimate thing to do, and there's no shame in changing your mind), just sell the damned things and recoup the $25m, which happens to be about $1/share of capital.


Haven't read the letter yet, but thanks for your summary - useful.

I'm not sure relating the notional to revenues or assets is useful. They'd only make the notional if absolute CPI went to zero, IIRC, and that seems unlikely! They could have made a couple of billion, maybe more in a depression, but nothing like the size of the notional. My major complaint is not that they hold this but that they should have structured their hedges this way: deep out of the money derivatives that offer outsized gains on low probability outcomes for (relatively) low absolute cost.

Re the other insurance operations, no, you're not alone, although several of these are in places where you can earn high real interest rates in fixed income with relatively little risk (e.g. Brazilian sovereign bonds). That transforms the economics of a 98% CR. Also, some of these businesses will probably benefit from operating leverage as they scale.
Title: Re: 2018 shareholders letter
Post by: wachtwoord on March 11, 2019, 10:18:30 AM
I agree the tone of the letter is infantile. I'm sure Watsa isn't infantile but coming across as such is not good.

I also believe Watsa's macro view is highly flawed. This wouldn't be an issue if he would act macro agnostic however he made huge bets in the past and even though he claims to have learned from the past I see him comment on Bitcoin which is a macro thing and quite clearly outside of his circle of competance. He seems to overly rely on his own ability on matters he knows little about which is a large risk going forward.

Finally I agree that the 3rd world insurance businesses look like crap. What's the plan there?
Title: Re: 2018 shareholders letter
Post by: StubbleJumper on March 11, 2019, 12:13:45 PM

5) Why is there still conflicting messages about hedging?  On the CC, the CEO mishandled a discussion about a potential drawdown in equity markets.  Prem's letter went to great lengths to communicate that there would be no more equity hedging because FFH learned its lesson.  It also observes that US economic growth has been strong, rates have bumped up, inflation looks like it's bottomed out, there's a long runway, etc, but despite those clear and obvious conditions, FFH will continue to hold CPI derivatives worth a notional $114 billion.  About this, I am perplexed.  It's only a $25m market value, but if you are trying to communicate that you are moving on from hedging mistakes in the past, why not liquidate this position.  That large notional value demonstrates that FFH was only speculating on inflation to begin with (ie, if you were hedging you would choose a hedge ratio and then buy your protection...the CPI derivatives exceed FFH's combined assets and gross revenue for a year).  If Prem and Brian have changed their perspective about world markets (which is a legitimate thing to do, and there's no shame in changing your mind), just sell the damned things and recoup the $25m, which happens to be about $1/share of capital.


Haven't read the letter yet, but thanks for your summary - useful.

I'm not sure relating the notional to revenues or assets is useful. They'd only make the notional if absolute CPI went to zero, IIRC, and that seems unlikely! They could have made a couple of billion, maybe more in a depression, but nothing like the size of the notional. My major complaint is not that they hold this but that they should have structured their hedges this way: deep out of the money derivatives that offer outsized gains on low probability outcomes for (relatively) low absolute cost.


Okay, I guess the starting point of the conversation should be, "What is FFH trying to hedge against?"  What would be the bad outcome of deflation that requires protection?  I can offer a few possibilities: 1) FFH's fixed interest debt increases in real terms as a result of deflation, 2) FFH's equity portfolio might be adversely affected by deflation, 3) the collectability of amounts from reinsurers might become dubious, 4) corporate bonds could become shakey, 5) other?

On the liability side, deflation might actually result in reserve releases because presumably IBNR would decline?  Deflation would be good for the real value of their sovereign bonds and possibly their munis.  What else?

So net it out: what's their net exposure?  What kind of hedge ratio should be selected for that notional exposure (somewhere between 0% and 100%)?

I thought I was being rather charitable when I compared the $100+ billion to their total assets.  If you assume that the entire asset base would be adversely affected by inflation with no offsetting benefit on liabilities, and if you were so risk averse that you wanted a 100% hedge ratio, you need what, ~$64 billion notional?  Being even more charitable, assume that a year of revenue would all be adversely affected with no offsetting benefit from expenses, that would be another $18-ish billion?  So in my wildest dreams, that wold be ~$80 billion notional protection required?

Hedging is hedging.  Speculation is speculation.  So which is FFH currently doing, and does it mesh in any way with Prem's broader macro observations in the letter?


Quote
Re the other insurance operations, no, you're not alone, although several of these are in places where you can earn high real interest rates in fixed income with relatively little risk (e.g. Brazilian sovereign bonds). That transforms the economics of a 98% CR. Also, some of these businesses will probably benefit from operating leverage as they scale.

Sure, that's the theory, but what do you make of page 59 in the AR (or for that matter, the Asia breakdown on page 115)?  Did we get a fair return on the capital that FFH has deployed? Adjusting for the risk of holding assets in shit-hole countries which do not always have a strong legal system, low levels of corruption, or stable central bank policy, are you happy with what you see on page 59?  What kind of return would be fair for the risks involved with shit-hole assets?


SJ
Title: Re: 2018 shareholders letter
Post by: Spekulatius on March 11, 2019, 06:31:23 PM
I have reduced my shares before the annual report came out, and sold most of my remaining shares, except a tracking position after reaiding this.

Reasons
1) share solution ( ~2M more shares). This isnít Teledyne.
2) continued book value losses.
3) too many crappy investments. FFH is really too complex for its size and itís not working.

I recycled some funds into BRK last Friday, but have further thinking to do how to reinvest the proceeds.
Title: Re: 2018 shareholders letter
Post by: rb on March 11, 2019, 07:31:31 PM
Re the other insurance operations, no, you're not alone, although several of these are in places where you can earn high real interest rates in fixed income with relatively little risk (e.g. Brazilian sovereign bonds).

If that's the case and you feel so confident then why don't you just go and buy a shitload of Brazilian bonds instead?
Title: Re: 2018 shareholders letter
Post by: TwoCitiesCapital on March 11, 2019, 08:53:09 PM
I have reduced my shares before the annual report came out, and sold most of my remaining shares, except a tracking position after reaiding this.

Reasons
1) share solution ( ~2M more shares). This isnít Teledyne.
2) continued book value losses.
3) too many crappy investments. FFH is really too complex for its size and itís not working.

I recycled some funds into BRK last Friday, but have further thinking to do how to reinvest the proceeds.

I've also reduced my shares, but it was basically because my thesis didn't play out. I loaded up on Fairfax expecting two things to happen:

1) Interest/Dividend income would dramatically increase over the following 2-3 year period due to rising rates which would lead to share price appreciation
2) Significant buybacks at prices from $450-550 USD would likely be accretive if income was to rise dramatically

I sold most of the shares that I had purchased based on disappointing outcomes in both regards.

10-year rates rose to 3.2% prior to falling back down to 2.6%. With low inflation and limited pressure in the near/mid-term from rising front-end rates, it's hard for me to make a case for rates to rise as significantly as originally anticipated. I'm not saying Fairfax should've played the short-term game, but they did miss an opportunity to lock in longer-term rates and the opportunity set for increasing interest income in the near-term appears challenged.

Further, buybacks have been less than I anticipated based on Prem's first comparison to Teledyne...and have been further diluted by compensation and share issuance that were unanticipated at the time of purchase.

I still some shares and would be willing to add in the low 400s near book value, but there doesn't appear to the be the catalyst for anything to change with the company or help them achieve the 15% ROE that I initially anticipated.
Title: Re: 2018 shareholders letter
Post by: petec on March 12, 2019, 01:49:27 AM
Re the other insurance operations, no, you're not alone, although several of these are in places where you can earn high real interest rates in fixed income with relatively little risk (e.g. Brazilian sovereign bonds).

If that's the case and you feel so confident then why don't you just go and buy a shitload of Brazilian bonds instead?

The childish answer is: because I already have a shitload of Brazilian equities.

The better answer is: because as you well know, a float-levered insureco with a sub-100% underwriting margin is going to return more than a sovereign bond even if 100% of its float is invested in that same sovereign bond. Fairfax's Brazil operation has underwriting profits, and has growth potential since insurance is underpenetrated in Brazil and the country is entering a cyclical upswing and possibly also a disinflationary boom (if the government gets its reforms done).

The majority of the underwriting losses in Fairfax's Latin American operations came from Argentina, which (unlike Brazil) is a hyperinflationary basket case - but it is undergoing some very promising reforms. Time will tell.
Title: Re: 2018 shareholders letter
Post by: petec on March 12, 2019, 01:56:06 AM
I agree the tone of the letter is infantile. I'm sure Watsa isn't infantile but coming across as such is not good.

I also believe Watsa's macro view is highly flawed. This wouldn't be an issue if he would act macro agnostic however he made huge bets in the past and even though he claims to have learned from the past I see him comment on Bitcoin which is a macro thing and quite clearly outside of his circle of competance. He seems to overly rely on his own ability on matters he knows little about which is a large risk going forward.

Finally I agree that the 3rd world insurance businesses look like crap. What's the plan there?

Out of interest do you think Watsa's style has changed or did you not like it from the start (whenever that was, for you)?

Watsa has as much right to comment on bitcoin as anyone else. Bitcoin can only be understood through two lenses: 1) crowd psychology and tulip bubbles and 2) fiat currency collapse. The first - which is the one he used - is well within his circle of competence as a value investor.

My framework for the third world insurance businesses is this: if one or two of them find that sweet nexus you occasionally get in insurance where a superb manager meets a superb opportunity, then you've seeded the next ICICI Lombard or First Capital. My guess is that's the game plan, but it's only a guess. The opportunity stems from the fact that in most of these places insurance will grow faster than GDP, because it is currently underpenetrated.
Title: Re: 2018 shareholders letter
Post by: petec on March 12, 2019, 02:41:53 AM

Okay, I guess the starting point of the conversation should be, "What is FFH trying to hedge against?"  What would be the bad outcome of deflation that requires protection?  I can offer a few possibilities: 1) FFH's fixed interest debt increases in real terms as a result of deflation, 2) FFH's equity portfolio might be adversely affected by deflation, 3) the collectability of amounts from reinsurers might become dubious, 4) corporate bonds could become shakey, 5) other?

On the liability side, deflation might actually result in reserve releases because presumably IBNR would decline?  Deflation would be good for the real value of their sovereign bonds and possibly their munis.  What else?

So net it out: what's their net exposure?  What kind of hedge ratio should be selected for that notional exposure (somewhere between 0% and 100%)?

I thought I was being rather charitable when I compared the $100+ billion to their total assets.  If you assume that the entire asset base would be adversely affected by inflation with no offsetting benefit on liabilities, and if you were so risk averse that you wanted a 100% hedge ratio, you need what, ~$64 billion notional?  Being even more charitable, assume that a year of revenue would all be adversely affected with no offsetting benefit from expenses, that would be another $18-ish billion?  So in my wildest dreams, that wold be ~$80 billion notional protection required?

Hedging is hedging.  Speculation is speculation.  So which is FFH currently doing, and does it mesh in any way with Prem's broader macro observations in the letter?

Quote
Re the other insurance operations, no, you're not alone, although several of these are in places where you can earn high real interest rates in fixed income with relatively little risk (e.g. Brazilian sovereign bonds). That transforms the economics of a 98% CR. Also, some of these businesses will probably benefit from operating leverage as they scale.

Sure, that's the theory, but what do you make of page 59 in the AR (or for that matter, the Asia breakdown on page 115)?  Did we get a fair return on the capital that FFH has deployed? Adjusting for the risk of holding assets in shit-hole countries which do not always have a strong legal system, low levels of corruption, or stable central bank policy, are you happy with what you see on page 59?  What kind of return would be fair for the risks involved with shit-hole assets?

SJ

I agree with your reasoning, but I think it is based on faulty facts:

1) Back when they were worried about debt bubbles collapsing Fairfax looked hard at how insurers performed in the great depression. They discussed this in investor meetings (can't remember if they discussed it in letters/calls). Obviously equities collapsed (= FFH book value virtually gone). More surprisingly underwriting profits disappeared too as cash-poor insurers desperately competed to write premiums in the face of collapsing demand. The result was not that there were offsetting drivers in insureco P&Ls, but a total meltdown which most companies did not survive. I think that fear is what drove their entire hedging programme - both equity and deflation swaps.

2) As I understand it if you buy $100bn notional and CPI drops 10% below strike, you make $10bn. To make the full notional amount of $100bn, CPI would have to fall 100%, which is unlikely since it implies that the CPI basket of goods would cost nothing and the value of money would be infinite. Given that Fairfax regularly highlighted that CPI dropped 17% in both the GD and in Japan post-bubble, I assume that's the kind of thing they were worried about if things got really bad. If so, $110bn notional protected at most $20bn of assets. In fact I think it was quite a bit less because IIRC Fairfax bought the swaps below strike, meaning you needed several % deflation before you made money. In more likely scenarios, upside was never going to be more than $2-3bn. So under no realistic assumption did they exceed a 100% hedge ratio.

I don't really care what they do with a $25m position, so I won't argue on that one.

Haven't got to the AR yet so can't answer your last question.
Title: Re: 2018 shareholders letter
Post by: Spekulatius on March 12, 2019, 04:22:31 AM
I have reduced my shares before the annual report came out, and sold most of my remaining shares, except a tracking position after reaiding this.

Reasons
1) share solution ( ~2M more shares). This isnít Teledyne.
2) continued book value losses.
3) too many crappy investments. FFH is really too complex for its size and itís not working.

I recycled some funds into BRK last Friday, but have further thinking to do how to reinvest the proceeds.

I've also reduced my shares, but it was basically because my thesis didn't play out. I loaded up on Fairfax expecting two things to happen:

1) Interest/Dividend income would dramatically increase over the following 2-3 year period due to rising rates which would lead to share price appreciation
2) Significant buybacks at prices from $450-550 USD would likely be accretive if income was to rise dramatically

I sold most of the shares that I had purchased based on disappointing outcomes in both regards.

10-year rates rose to 3.2% prior to falling back down to 2.6%. With low inflation and limited pressure in the near/mid-term from rising front-end rates, it's hard for me to make a case for rates to rise as significantly as originally anticipated. I'm not saying Fairfax should've played the short-term game, but they did miss an opportunity to lock in longer-term rates and the opportunity set for increasing interest income in the near-term appears challenged.

Further, buybacks have been less than I anticipated based on Prem's first comparison to Teledyne...and have been further diluted by compensation and share issuance that were unanticipated at the time of purchase.

I still some shares and would be willing to add in the low 400s near book value, but there doesn't appear to the be the catalyst for anything to change with the company or help them achieve the 15% ROE that I initially anticipated.

I agree on all counts. I think itís fair to say that the thesis as most of us envisioned it a year ago didnít play out and is unlikely to play out in the near term future.
Title: Re: 2018 shareholders letter
Post by: vinod1 on March 12, 2019, 04:31:11 AM
StubbleJumper makes very good points. However, I think shorting and CPI bets are better understood from the perspective of Mr. Watsa the individual.

Rewind back to the 2007-2009 period. Fairfax reported massive gains on the CDS portfolio, and many of us who have loaded up on Fairfax and its subs felt great at that time and patting ourselves on our backs for this. 

How would this have felt for Prem? After all, we Fairfax investors were on a high just from taking advantage of Fairfax gains. He is one of the handful of investors who came out with billions of dollars of gains directly during the period. For 3 years book value exploded and it is hardly a stretch to think he must have felt like a genius, especially when every other company is wallowing in misery.

I can recall a period like that, when my LEAPS on BAC paid off big time, then after a couple of months of research on O&G companies, invested in Sandridge Energy LEAPS and they paid off like 5x in a few short months. I was on a high and contrary to my normal behavior invested in HP LEAPS with very little research. Fortunately, it is only 0.1% of portfolio and to make a long story short, the HP LEAPS went to zero the moment Leo Apotheker did a deal with Autonomy.

I think the "rush" from the 2007-2009 gains might have been a contributing factor. It was never about hedging.

If you are really concerned about Great Depression type scenario, do you invest in crappy companies like Blackberry, Sandridge Energy, Greek/Irish banks, restaurants?

Further look and what he has done on the business side, he went ahead and bought a bunch of other companies.

Is this what you expect when you are preparing another Great Depression?

(Hat tip to UCCMAL for pointing these out in one of the earlier discussions.)

One more thing. Even when you have hedged 100% of the equity portfolio, you promise to investors 15% annual returns? There is a snowball chance in hell that you would reach that objective without a major market crash.

The only logical explanation that fits the facts is that Prem is expected a market crash and the S&P 500 shorts and CPI portfolio is a market call. Pure and simple. It is a market call that did not work out.

All the explanations - avoiding 1-100 year event, hedging, etc. do not fit the facts.

Prem is a wonderful person from everything that I gather. He has build a multi billion dollar company from scratch. Nothing can take these things away from him.

But as investors we have to separate Prem the wonderful person from Prem the CEO. He got the market call wrong. It happens. The problem is not being able to acknowledge it. Calling it hedging is just plain wrong.   

Vinod


Title: Re: 2018 shareholders letter
Post by: petec on March 12, 2019, 06:48:41 AM
StubbleJumper makes very good points. However, I think shorting and CPI bets are better understood from the perspective of Mr. Watsa the individual.

Rewind back to the 2007-2009 period. Fairfax reported massive gains on the CDS portfolio, and many of us who have loaded up on Fairfax and its subs felt great at that time and patting ourselves on our backs for this. 

How would this have felt for Prem? After all, we Fairfax investors were on a high just from taking advantage of Fairfax gains. He is one of the handful of investors who came out with billions of dollars of gains directly during the period. For 3 years book value exploded and it is hardly a stretch to think he must have felt like a genius, especially when every other company is wallowing in misery.

I can recall a period like that, when my LEAPS on BAC paid off big time, then after a couple of months of research on O&G companies, invested in Sandridge Energy LEAPS and they paid off like 5x in a few short months. I was on a high and contrary to my normal behavior invested in HP LEAPS with very little research. Fortunately, it is only 0.1% of portfolio and to make a long story short, the HP LEAPS went to zero the moment Leo Apotheker did a deal with Autonomy.

I think the "rush" from the 2007-2009 gains might have been a contributing factor. It was never about hedging.

If you are really concerned about Great Depression type scenario, do you invest in crappy companies like Blackberry, Sandridge Energy, Greek/Irish banks, restaurants?

Further look and what he has done on the business side, he went ahead and bought a bunch of other companies.

Is this what you expect when you are preparing another Great Depression?

(Hat tip to UCCMAL for pointing these out in one of the earlier discussions.)

One more thing. Even when you have hedged 100% of the equity portfolio, you promise to investors 15% annual returns? There is a snowball chance in hell that you would reach that objective without a major market crash.

The only logical explanation that fits the facts is that Prem is expected a market crash and the S&P 500 shorts and CPI portfolio is a market call. Pure and simple. It is a market call that did not work out.

All the explanations - avoiding 1-100 year event, hedging, etc. do not fit the facts.

Prem is a wonderful person from everything that I gather. He has build a multi billion dollar company from scratch. Nothing can take these things away from him.

But as investors we have to separate Prem the wonderful person from Prem the CEO. He got the market call wrong. It happens. The problem is not being able to acknowledge it. Calling it hedging is just plain wrong.   

Vinod

Totally agree with this (except that in this letter he has finally come out and simply said the equity hedges were wrong and "dangerous"). In fact to "crappy companies" I would add overlevered companies. Why the hell do you get involved with Resolute if you fear a deflationary depression?

My referencing the Great Depression was simply to point out that they actually did a lot of research into what happens to insurecos in a deflation, but came to a different conclusion to the one that SJ speculated on.

Ultimately both factors are at play - the overconfidence drives the market call, but there has to be a thesis to give it a veneer of respectability and dispel any cognitive dissonance. The thesis (that insurecos really suffer in a depression) was sound - the issue was they wildly overestimated their competence in calling the market/economy.

Anyway, I've bored myself to death about the hedges so I will stop.
Title: Re: 2018 shareholders letter
Post by: wachtwoord on March 12, 2019, 10:47:25 AM
I agree the tone of the letter is infantile. I'm sure Watsa isn't infantile but coming across as such is not good.

I also believe Watsa's macro view is highly flawed. This wouldn't be an issue if he would act macro agnostic however he made huge bets in the past and even though he claims to have learned from the past I see him comment on Bitcoin which is a macro thing and quite clearly outside of his circle of competance. He seems to overly rely on his own ability on matters he knows little about which is a large risk going forward.

Finally I agree that the 3rd world insurance businesses look like crap. What's the plan there?

Out of interest do you think Watsa's style has changed or did you not like it from the start (whenever that was, for you)?

Watsa has as much right to comment on bitcoin as anyone else. Bitcoin can only be understood through two lenses: 1) crowd psychology and tulip bubbles and 2) fiat currency collapse. The first - which is the one he used - is well within his circle of competence as a value investor.

My framework for the third world insurance businesses is this: if one or two of them find that sweet nexus you occasionally get in insurance where a superb manager meets a superb opportunity, then you've seeded the next ICICI Lombard or First Capital. My guess is that's the game plan, but it's only a guess. The opportunity stems from the fact that in most of these places insurance will grow faster than GDP, because it is currently underpenetrated.

I think Watsa and Fairfax are very good value investors and underwriters. I don't believe they have any sort of edge at a macro level and therefore are adding variance with zero reward (at best, in reality it comes at a cost). I wish they would focus on what they are good in cause this would be a world class investment (I am a shareholder btw).

I mentioned Bitcoin because it's indicative of him having (and sharing in the context of his annual shareholder letter) an opinion about something he does not comprehend while having confidence in his uninformed opinion. In the case of Bitcoin I don't mind as he isn't basing an investment decision on it, but his certainty in the face of a flawed understanding scares me.
Title: Re: 2018 shareholders letter
Post by: obtuse_investor on March 12, 2019, 05:20:08 PM
Great conversation, everyone.

Meta thought: I am only hearing ffh bears. No bulls around. I happen to be agreeing with the bears. Maybe itís just my frustration.

Second level thinking: if I am hearing so much negativity about this business, this is probably a better time to buy than to sell.
Title: Re: 2018 shareholders letter
Post by: petec on March 13, 2019, 01:34:32 AM
Great conversation, everyone.

Meta thought: I am only hearing ffh bears. No bulls around. I happen to be agreeing with the bears. Maybe itís just my frustration.

Second level thinking: if I am hearing so much negativity about this business, this is probably a better time to buy than to sell.

Put me down as a (long term) bull. I sleep like a baby with this position - although I probably wouldn't without the robust debate on here, which really makes me think, so thanks all.

Unrelated but interesting: https://www.imf.org/en/News/Articles/2019/03/11/na031119-greece-economy-improves-key-reforms-still-needed

I know being "among the best performers in the Eurozone" isn't saying much, but it's better than being among the worst. I think Eurobank could be an exceptional investment as the economy starts to reflate.

Title: Re: 2018 shareholders letter
Post by: Dazel on March 13, 2019, 05:02:51 AM
There is nothing new....
Looking forward....I like where they sit....lots of options.
Time to perform that simple.

Dazel
Title: Re: 2018 shareholders letter
Post by: petec on March 13, 2019, 06:32:38 AM
There is nothing new....
Looking forward....I like where they sit....lots of options.
Time to perform that simple.

Dazel

Dazel you were bullish on the buyback - how do you feel about that now and in particular have you satisfied yourself about the options?
Title: Re: 2018 shareholders letter
Post by: Dazel on March 13, 2019, 03:01:53 PM

Petec,

I get it...a good year is expensive in share dilution because of share based awards....but profits will go into more buybacks which will bring the share count down the next year... Itís incentive that is not being met which is why 89888 shares were issued the insurance companies that did well I am assuming.
So if Fairfax performs I can worry if not the buy back continues at a good clip unabated by share based awards.
Why not just pay cash bonuses from profits if it is a good year and take the share count down? Surely no one is begging for more shares the price has not moved in years!
Title: Re: 2018 shareholders letter
Post by: shalab on March 14, 2019, 03:24:29 AM
This is also a year when the cash declined at the holding company and debt increased. As noted in page 19 of AR

Financial Position
The  following  table  shows  our  financial  position,  excluding  consolidated  non-insurance  companies,  at  the  endof 2018:

Holding company cash and investments (net of short sale and derivative obligations)1,550.6
Borrowings Ė holding company3,859.5



Petec,

I get it...a good year is expensive in share dilution because of share based awards....but profits will go into more buybacks which will bring the share count down the next year... Itís incentive that is not being met which is why 89888 shares were issued the insurance companies that did well I am assuming.
So if Fairfax performs I can worry if not the buy back continues at a good clip unabated by share based awards.
Why not just pay cash bonuses from profits if it is a good year and take the share count down? Surely no one is begging for more shares the price has not moved in years!
Title: Re: 2018 shareholders letter
Post by: Dazel on March 14, 2019, 08:54:16 AM

I am not concerned with the drop in holdco cash vs debt....they bought back more of their subs and they had a miserable year investing not unlike everyone else this time. I have argued and continue to argue their massive cash position and treasury position puts them in position to outperform the Markelís of the world who got caught in quarter four of 2018. This has allowed them to fund AGT, Seaspan, Greek eurobank-real Estate merger funding if needed and to give Blackberry the courage to make a game changing acquisition and most importantly to me...to give Brian Bradstreet the ability to print cash (I like the corporate bond position and hope that he went bigger in quarter one...it is likely up 10 to 15%=$700m to $1b from dec 31). Fairfax and Premís gift are operating companies not stock picking. They are vultures....it has cost them lately but thatís how they built Fairfax. Bradstreet and the insurance companies give me enough confidence that they will create very solid operating earnings...the investing side needs to do very little to create big numbers from the 2018 low.

In quiet year this year...Fairfax should make $3b pretax.
Title: Re: 2018 shareholders letter
Post by: ourkid8 on March 14, 2019, 09:19:35 AM
Dazel, $3B maybe too aggressive but let's use the numbers that Prem has provided to us in his annual letter as a starting point:

A 15% return on equity implies earnings of approximately $2 billion, so paying approximately $300 million in dividends would leave us with $1.7 billion for stock buybacks and tuck-in acquisitions.

In quiet year this year...Fairfax should make $3b pretax.
Title: Re: 2018 shareholders letter
Post by: Spekulatius on March 14, 2019, 03:32:53 PM

I am not concerned with the drop in holdco cash vs debt....they bought back more of their subs and they had a miserable year investing not unlike everyone else this time. I have argued and continue to argue their massive cash position and treasury position puts them in position to outperform the Markel’s of the world who got caught in quarter four of 2018. This has allowed them to fund AGT, Seaspan, Greek eurobank-real Estate merger funding if needed and to give Blackberry the courage to make a game changing acquisition and most importantly to me...to give Brian Bradstreet the ability to print cash (I like the corporate bond position and hope that he went bigger in quarter one...it is likely up 10 to 15%=$700m to $1b from dec 31). Fairfax and Prem’s gift are operating companies not stock picking. They are vultures....it has cost them lately but that’s how they built Fairfax. Bradstreet and the insurance companies give me enough confidence that they will create very solid operating earnings...the investing side needs to do very little to create big numbers from the 2018 low.

In quiet year this year...Fairfax should make $3b pretax.

MKL isn’t really cash constrainted, imo. Rather than adding bonds, how about reducing debt and specifically the preferred?. They pay about $350M in interest annually. I doubt adding some bonds at prevailing interest rates is effective vs just reducing interested rate expense ciampreferred or bond buybacks.
Title: Re: 2018 shareholders letter
Post by: shalab on March 16, 2019, 01:52:46 PM
1-2 Billion after-tax is difficult without gains from investments. (let alone 3B). I would take out income (net realized gain from investments) from equity/stock sales. Where will the money come from? It is one to dream big and another to make it happen.

Then you would have to assume that there won't be further dilution.

Overall, I don't see chances very bright to get 15% on equity on a continuous basis. It may happen one year because of gains in stocks or investment gains.

There are simpler and better opportunities out there.



I am not concerned with the drop in holdco cash vs debt....they bought back more of their subs and they had a miserable year investing not unlike everyone else this time. I have argued and continue to argue their massive cash position and treasury position puts them in position to outperform the Markelís of the world who got caught in quarter four of 2018. This has allowed them to fund AGT, Seaspan, Greek eurobank-real Estate merger funding if needed and to give Blackberry the courage to make a game changing acquisition and most importantly to me...to give Brian Bradstreet the ability to print cash (I like the corporate bond position and hope that he went bigger in quarter one...it is likely up 10 to 15%=$700m to $1b from dec 31). Fairfax and Premís gift are operating companies not stock picking. They are vultures....it has cost them lately but thatís how they built Fairfax. Bradstreet and the insurance companies give me enough confidence that they will create very solid operating earnings...the investing side needs to do very little to create big numbers from the 2018 low.

In quiet year this year...Fairfax should make $3b pretax.
Title: Re: 2018 shareholders letter
Post by: Dazel on March 17, 2019, 08:42:20 PM


I am okay with $3b pretax probably $1.3b first quarter...will go from there.
I donít agree with the crowd normally and have been wrong here before but not often...I am happy to be against the crowd.

Good luck to all!
Title: Re: 2018 shareholders letter
Post by: Dazel on March 18, 2019, 06:26:28 AM


I am aware it is a bold call and certainly would not bet the house on it...but Fairfax is coming from a very low level on Dec 31 2018...why not have 2019 be a big year for Fairfax...they are certainly due.
Title: Re: 2018 shareholders letter
Post by: Spekulatius on April 13, 2019, 09:07:07 PM
Pretty good commentary from the shareholder meeting
https://www.woodlockhousefamilycapital.com/blog/notes-from-toronto (https://www.woodlockhousefamilycapital.com/blog/notes-from-toronto)
Title: Re: 2018 shareholders letter
Post by: shalab on April 14, 2019, 04:13:35 PM
Parsad said this in the other thread. I think that discussion belongs here.

FFH is definitely a viable business and is in a different league compared to BH or PGNT (ethics). Prem has achieved a lot and he doesn't need to compare himself to anyone. He and his family is set for generations as they virtually control FFH. However, FFH as an investment is a different story for folks trying to increase their own wealth by investing their hard earned dollars. I don't think there is a need to say they aim for 15% return or that they will emulate Singleton. One of the legacies of Singleton is that his family is one of the largest land owners in America. May be that is what Prem is alluding to when he says he will emulate Singleton - his family will be one of the richest in Canada for generations. These claims are misleading and unnecessary. If anything, it tarnishes his legacy.

He has been the chancellor of university of waterloo, has given money to charity (Dakshana foundation) etc. He can do more of these and his legacy will be safe.

There are many honest, capable managers in corporate america - one can invest in one or many of these companies or the entire group through an index. Over a lifetime, one can get very good results through the index, especially with dividend reinvestment.

Quote
Feel free to throw me and everyone else under the bus, but you jackasses should probably remove FFH from that list...Prem's given you nearly 35 years of outperformance.

Yeah there have been periods where he has under performed...even long stretches...but he's walked the walk and talked the talk better than anyone else other than Buffett.  Even Buffett had a tough time the last few years, and he's as close to perfect in the industry as anyone has ever seen!

So if your bar is Buffett and only Buffett, then that is a statistical population of one!  If your bar is ethical, honest investment company CEO's that you can trust your money with and have a good chance of outperforming for the long-term with interest aligned, it may be nominally higher and Prem would be in that group.  Cheers!

Thanks for posting.

Pretty good commentary from the shareholder meeting
https://www.woodlockhousefamilycapital.com/blog/notes-from-toronto (https://www.woodlockhousefamilycapital.com/blog/notes-from-toronto)
Title: Re: 2018 shareholders letter
Post by: Jurgis on April 14, 2019, 11:32:14 PM
Pretty good commentary from the shareholder meeting
https://www.woodlockhousefamilycapital.com/blog/notes-from-toronto (https://www.woodlockhousefamilycapital.com/blog/notes-from-toronto)

Not bad. But I think there's a lot of anchoring to Watsa's 15% return goal.
Title: Re: 2018 shareholders letter
Post by: coc on April 15, 2019, 09:39:18 AM
It doesn't strike anyone as strange that the company states a 15% IRR goal (over and over, year after year) when it hasn't achieved that in the last 5, 10, 15, 20, or 25 year periods?

It's one thing to call it "aspirational" but one could interpret that as "deeply misleading".
Title: Re: 2018 shareholders letter
Post by: petec on April 15, 2019, 09:54:53 AM
It doesn't strike anyone as strange that the company states a 15% IRR goal (over and over, year after year) when it hasn't achieved that in the last 5, 10, 15, 20, or 25 year periods?

It's one thing to call it "aspirational" but one could interpret that as "deeply misleading".

This is a personal view, but the 15% is now being expressed as 95% CR and 7% return on investments. I see no issue in targeting those metrics over the long term. What they've achieved in the past doesn't have to be a guide to what they aspire to in the future, especially when they've sworn not to repeat the biggest mistake of all (the huge naked hedge).

That said, I couldn't care less that they target 15% and I find it surprising that people on here focus so hard on it. That's not a criticism, it's just that I have never had the sense that they manage towards the 15% goal in a bad way. Their mistakes are plenty, but they are so long term in approach that personally I don't think the mistakes stem from stretching to get to 15% - and that's the main negative of having a public goal. So I just ignore it, and focus on whether I think 95% and 7% are achievable (probably and probably not, respectively) and whether I'd be happy owning Fairfax at the current price if the ROE was say 10% over the long haul (yes with bells on).
Title: Re: 2018 shareholders letter
Post by: Viking on April 15, 2019, 11:25:48 AM
Pretty good commentary from the shareholder meeting
https://www.woodlockhousefamilycapital.com/blog/notes-from-toronto (https://www.woodlockhousefamilycapital.com/blog/notes-from-toronto)

Thanks for posting. The author has other interesting posts :-)
Title: Re: 2018 shareholders letter
Post by: Spekulatius on April 15, 2019, 03:49:33 PM
It doesn't strike anyone as strange that the company states a 15% IRR goal (over and over, year after year) when it hasn't achieved that in the last 5, 10, 15, 20, or 25 year periods?

It's one thing to call it "aspirational" but one could interpret that as "deeply misleading".

This is a personal view, but the 15% is now being expressed as 95% CR and 7% return on investments. I see no issue in targeting those metrics over the long term. What they've achieved in the past doesn't have to be a guide to what they aspire to in the future, especially when they've sworn not to repeat the biggest mistake of all (the huge naked hedge).

That said, I couldn't care less that they target 15% and I find it surprising that people on here focus so hard on it. That's not a criticism, it's just that I have never had the sense that they manage towards the 15% goal in a bad way. Their mistakes are plenty, but they are so long term in approach that personally I don't think the mistakes stem from stretching to get to 15% - and that's the main negative of having a public goal. So I just ignore it, and focus on whether I think 95% and 7% are achievable (probably and probably not, respectively) and whether I'd be happy owning Fairfax at the current price if the ROE was say 10% over the long haul (yes with bells on).

I regard the 15% ROE as an aspirational goal at this point. What irks me more than FFH not even close to reaching this goal is the increasing share count (by 2.4M shares last year) that shalab pointed out. Itís even more irritating with all the talk about Singleton and quite frankly, it looks like he is talking one thing and doing just the opposite. Did someone ask a question regarding the share dilution and how it squares with the talk about buybacks? There might be a good explanation for this, but itís odd that itís not addressed in the annual report or in the shareholders meeting.
Title: Re: 2018 shareholders letter
Post by: Gregmal on April 15, 2019, 04:01:04 PM
It doesn't strike anyone as strange that the company states a 15% IRR goal (over and over, year after year) when it hasn't achieved that in the last 5, 10, 15, 20, or 25 year periods?

It's one thing to call it "aspirational" but one could interpret that as "deeply misleading".

This is a personal view, but the 15% is now being expressed as 95% CR and 7% return on investments. I see no issue in targeting those metrics over the long term. What they've achieved in the past doesn't have to be a guide to what they aspire to in the future, especially when they've sworn not to repeat the biggest mistake of all (the huge naked hedge).

That said, I couldn't care less that they target 15% and I find it surprising that people on here focus so hard on it. That's not a criticism, it's just that I have never had the sense that they manage towards the 15% goal in a bad way. Their mistakes are plenty, but they are so long term in approach that personally I don't think the mistakes stem from stretching to get to 15% - and that's the main negative of having a public goal. So I just ignore it, and focus on whether I think 95% and 7% are achievable (probably and probably not, respectively) and whether I'd be happy owning Fairfax at the current price if the ROE was say 10% over the long haul (yes with bells on).

I regard the 15% ROE as an aspirational goal at this point. What irks me more than FFH not even close to reaching this goal is the increasing share count (by 2.4M shares last year) that shalab pointed out. Itís even more irritating with all the talk about Singleton and quite frankly, it looks like he is talking one thing and doing just the opposite. Did someone ask a question regarding the share dilution and how it squares with the talk about buybacks? There might be a good explanation for this, but itís odd that itís not addressed in the annual report or in the shareholders meeting.

There is a certain personality/salesmanship type that follows the below playbook;

Tout positive events
Spin mid spectrum events in your favor
Ignore bad events

There is an even more unique type that can take that last one and without guilt say it is actually something different and wholly positive.

There is no tolerance it seems, from many when a certain businessman, now politician does this sort of mind trickery, but it appears there is still tolerance for it on the investment front.

It is my belief that no profitable business trading below IV should ever be issuing shares. Period. Maybe, and only maybe in very minimal amounts, to certain key employees, but thats it. There is no excuse here.
Title: Re: 2018 shareholders letter
Post by: petec on April 16, 2019, 12:47:44 AM
@Spek my understanding is that the share issuances relate to the management restructuring - as you know there's been a huge shift in who manages what and in effect they wanted the new movers and shakers to have more equity. What annoys me is that they haven't given any detail around whether this might continue, whether there was a performance-based element, whether those employees have committed to buying shares in the market with salary, etc. Actually it doesn't just annoy me, it staggers me.
Title: Re: 2018 shareholders letter
Post by: MarioP on April 16, 2019, 09:07:37 AM
It doesn't strike anyone as strange that the company states a 15% IRR goal (over and over, year after year) when it hasn't achieved that in the last 5, 10, 15, 20, or 25 year periods?

It's one thing to call it "aspirational" but one could interpret that as "deeply misleading".
So I just ignore it, and focus on whether I think 95% and 7% are achievable (probably and probably not, respectively) and whether I'd be happy owning Fairfax at the current price if the ROE was say 10% over the long haul (yes with bells on).

Pete Iím really surprise that you  think FFH will probably not achieve 7% investment returns. Long term itís less than a S&P500 index. Iím more septic about 95% CR when the loss from catastrophes are include
Title: Re: 2018 shareholders letter
Post by: petec on April 16, 2019, 09:19:30 AM
It doesn't strike anyone as strange that the company states a 15% IRR goal (over and over, year after year) when it hasn't achieved that in the last 5, 10, 15, 20, or 25 year periods?

It's one thing to call it "aspirational" but one could interpret that as "deeply misleading".
So I just ignore it, and focus on whether I think 95% and 7% are achievable (probably and probably not, respectively) and whether I'd be happy owning Fairfax at the current price if the ROE was say 10% over the long haul (yes with bells on).

Pete Iím really surprise that you  think FFH will probably not achieve 7% investment returns. Long term itís less than a S&P500 index. Iím more septic about 95% CR when the loss from catastrophes are include

That's 7% across the whole portfolio, ~70% of which has to be invested in fixed income for regulatory reasons (quite rightly). 7% was very doable when treasuries yielded 5%. Much harder now - the extra work the equities have to do is far greater.
Title: Re: 2018 shareholders letter
Post by: Parsad on April 16, 2019, 04:27:57 PM
It doesn't strike anyone as strange that the company states a 15% IRR goal (over and over, year after year) when it hasn't achieved that in the last 5, 10, 15, 20, or 25 year periods?

It's one thing to call it "aspirational" but one could interpret that as "deeply misleading".
So I just ignore it, and focus on whether I think 95% and 7% are achievable (probably and probably not, respectively) and whether I'd be happy owning Fairfax at the current price if the ROE was say 10% over the long haul (yes with bells on).

Pete Iím really surprise that you  think FFH will probably not achieve 7% investment returns. Long term itís less than a S&P500 index. Iím more septic about 95% CR when the loss from catastrophes are include

That's 7% across the whole portfolio, ~70% of which has to be invested in fixed income for regulatory reasons (quite rightly). 7% was very doable when treasuries yielded 5%. Much harder now - the extra work the equities have to do is far greater.

As far as I know, they aren't required to have 70% in fixed income for regulatory reasons...where did you get that from? 

I think they could do 7% no problem long-term, as long as Brian Bradstreet is also there.  They will have to find someone as gifted as Brian to join Hamblin-Watsa.  I don't think they can rely on the young guys they have there already, because it's not something you just can learn...like picking equities, there is an art to fixed income as well. 

Brian is one of the best...Francis is damn good...but I don't know how much depth there is at Hamblin-Watsa on the fixed income side.  It's a project they need to work on over the next 2-3 years.  Find that guy!  Cheers!
Title: Re: 2018 shareholders letter
Post by: petec on April 17, 2019, 01:04:16 AM
It doesn't strike anyone as strange that the company states a 15% IRR goal (over and over, year after year) when it hasn't achieved that in the last 5, 10, 15, 20, or 25 year periods?

It's one thing to call it "aspirational" but one could interpret that as "deeply misleading".
So I just ignore it, and focus on whether I think 95% and 7% are achievable (probably and probably not, respectively) and whether I'd be happy owning Fairfax at the current price if the ROE was say 10% over the long haul (yes with bells on).

Pete Iím really surprise that you  think FFH will probably not achieve 7% investment returns. Long term itís less than a S&P500 index. Iím more septic about 95% CR when the loss from catastrophes are include

That's 7% across the whole portfolio, ~70% of which has to be invested in fixed income for regulatory reasons (quite rightly). 7% was very doable when treasuries yielded 5%. Much harder now - the extra work the equities have to do is far greater.

As far as I know, they aren't required to have 70% in fixed income for regulatory reasons...where did you get that from? 

I think they could do 7% no problem long-term, as long as Brian Bradstreet is also there.  They will have to find someone as gifted as Brian to join Hamblin-Watsa.  I don't think they can rely on the young guys they have there already, because it's not something you just can learn...like picking equities, there is an art to fixed income as well. 

Brian is one of the best...Francis is damn good...but I don't know how much depth there is at Hamblin-Watsa on the fixed income side.  It's a project they need to work on over the next 2-3 years.  Find that guy!  Cheers!

I phrased that badly. What I meant was: they have to have a lot in fixed income for regulatory reasons and generally the weighting has been around 70%. In fact I think it's probably more like 75% on average - off the top of my head I can't recall a time when they had >30% in equities although I may be wrong. I don't ever expect them to have much more than their own book value invested in equities and I don't get the impression they feel they can add much equity exposure from today's starting point. I draw that assumption from various sources.

Anyway the core point is that the S&P is not a fair benchmark for the entire portfolio, as was implied by the post I was replying to. I think they might do 7%, but with fixed income priced where it is I'm happier with an assumption of 5% or 6%. However the float leverage means that even with the portfolio performing below the S&P, BV growth could beat it. And I think the debt+warrant deals are a very smart way to juice returns in a low rates environment - I hope to see more of them.

Totally agree that the fixed income bench is opaque and replacing Bradstreet is a huge project. Frankly it worries me if you don't know who's behind him in the queue - I thought you knew everything ;)
Title: Re: 2018 shareholders letter
Post by: Cigarbutt on April 17, 2019, 07:10:31 AM
The historical return on bonds has been exceptional, explains a lot of the "excess" return earned over the years and, looking at a table that has been included up to the 2017 annual report and at other disclosures, FFH bond returns over 10 to 15 yr periods have mostly beat the return on the S&P, by a wide margin in some periods. This will be very hard to repeat.

From a long-term perspective, in the last 10 years, bond exposure has been 2-3x common stock exposure. The proportional exposure was 4-5x in the 2003-7 period and about 10x in the 1999-2001 period. So the times, they are changin'.

Whatever regulatory or risk management reasons and similar to Berkshire Hathaway, the cash and fixed income portion of the portfolio has remained quite constant in comparison to liability reserves. Using: (cash + cash equivalents + bonds + preferred) / (Insurance contract liabilities minus recoverable from reinsurers) as a relatively crude but quite accurate measure, the ratio has been 1.06 +/- 0.06 over the last 10 years and 1.03 +/- 0.03 over the last 8 years.

At this point, for better or for worse, the 7% pre-tax expected return on the 1425.97 USD investments per share has a lot to do with the net exposure to equity investments in the portfolio.
Title: Re: 2018 shareholders letter
Post by: coc on April 17, 2019, 09:33:09 AM
There is no specific regulatory requirement, but Fairfax could never put so much in equities that a major drop (of 50% type magnitude or more) would impair their claims-paying ability or their solvency as an insurer. Rather than look at it as ďdoes fixed income cover claims?Ē, you might want to see it in reverse ďdoes my capital cover my equity portfolio?Ē

At the end of the day, the claims are a revolving door. In any one period, Fairfax does not need access to most of its investments. But it does need to be (comfortably) solvent at all times.

Even Berkshire, with all of its earnings sources, has rarely had its equity portfolio greater than its actual shareholdersí equity (in other words, a leveraged equity portfolio).

Imagine for a second that Fairfax put 150% of its capital in equities ó so call it $16 billion ó which then fell 50% in a market rout. With $3 billion of capital left, they would be in very, very dire straits as an insurance company - the regulators could force them to raise capital, stop underwriting, dilute, etc.

So there are limits - but not hard limits. This is my understanding.
Title: Re: 2018 shareholders letter
Post by: TwoCitiesCapital on April 17, 2019, 09:50:57 AM
It doesn't strike anyone as strange that the company states a 15% IRR goal (over and over, year after year) when it hasn't achieved that in the last 5, 10, 15, 20, or 25 year periods?

It's one thing to call it "aspirational" but one could interpret that as "deeply misleading".
So I just ignore it, and focus on whether I think 95% and 7% are achievable (probably and probably not, respectively) and whether I'd be happy owning Fairfax at the current price if the ROE was say 10% over the long haul (yes with bells on).

Pete Iím really surprise that you  think FFH will probably not achieve 7% investment returns. Long term itís less than a S&P500 index. Iím more septic about 95% CR when the loss from catastrophes are include

That's 7% across the whole portfolio, ~70% of which has to be invested in fixed income for regulatory reasons (quite rightly). 7% was very doable when treasuries yielded 5%. Much harder now - the extra work the equities have to do is far greater.

Agreed here. 7% is going to be very difficult in an environment where 10-year Treasuries yield 2.5%.

Bradstreet has been amazing in bonds, and the return has been exceptional - but that all occurred primarily in an environment where yields were falling (i.e. bonds purchased gaining value).

Starting from yields of 2.5% with the bulk of the portfolio in short-term debt, we don't have that tailwind. Brian may make some very prescient moves (a la selling portfolio following Trump's election), but that primarily results in losses avoided - not gains to the bottom line that count towards that 7%. That will generally be the case if we're in an extended period of rising rates like Prem believes.

Until interest rates are significantly higher, and the portfolio deployed into longer-term debt collecting the higher rates, a consistent 7% hurdle/average is going to be very difficult on the investment side.



Title: Re: 2018 shareholders letter
Post by: Cigarbutt on April 17, 2019, 01:08:16 PM
There is no specific regulatory requirement, but Fairfax could never put so much in equities that a major drop (of 50% type magnitude or more) would impair their claims-paying ability or their solvency as an insurer. Rather than look at it as ďdoes fixed income cover claims?Ē, you might want to see it in reverse ďdoes my capital cover my equity portfolio?Ē

At the end of the day, the claims are a revolving door. In any one period, Fairfax does not need access to most of its investments. But it does need to be (comfortably) solvent at all times.

Even Berkshire, with all of its earnings sources, has rarely had its equity portfolio greater than its actual shareholdersí equity (in other words, a leveraged equity portfolio).

Imagine for a second that Fairfax put 150% of its capital in equities ó so call it $16 billion ó which then fell 50% in a market rout. With $3 billion of capital left, they would be in very, very dire straits as an insurance company - the regulators could force them to raise capital, stop underwriting, dilute, etc.

So there are limits - but not hard limits. This is my understanding.
They have described before a "doomsday" scenario stress test, periodically used against their portfolio which would still result in their continued ability to write insurance business: 50% drop in the stock market and a 20% drop in convertibles and preferreds. This issue was raised at a recent conference call but I felt the answer was less satisfying.

I guess it's about the dual definition of financial flexibility (protect the downside and take advantage of opportunities).

Looking back, interesting to remember two episodes.

1-In 1999, they reported a 1,24B unrealized loss on their bond portfolio (about 10% of their bond position and about a third of shareholders' equity). They noted then that the unrealized loss had no impact on regulatory capital although I guess they had to show or explain how they could hold the bonds to maturity. About 50% of the bonds had a put feature with the potential to lengthen duration and maximize gain in a decreasing interest rate environment. Not only did the unrealized loss disappear but realized gains became significant, contributing to the great bond record. Given what they had to deal with around that time, share price declined and they did buy about 8% of shares outstanding in 1999-2000 with an average price of 258.38, not a great deal from today's observation point.

2-In 1990, they reported a 34M unrealized loss (26M from common and preferred stocks) which was about a third of shareholders' equity. The unrealized losses reversed remarkably and, in passing and with their share price going down with the mood of the time, were able to spend 17,46M and buyback 1.8M of their shares (average price of 9$ and about 25% of SO) and I would say that was one of their best transactions.

What's the point?

FFH have financial flexibility but IMO downside protection is not fortress-like and, because of that, the hypothetical ability to benefit may be muted.

This post made me re-read part of the 2001 annual report and that makes it quite obvious how things have changed. The most frequent reason (re)insurers run into trouble is inadequate reserving but asset quality is also something to consider under various scenarios.