ERICOPOLY

TIPS are probably the best of the options the govt is issuing, but I haven't looked at how they are priced today. I totally don't get the logic between taxing us on the CPI adjustment -- isn't the purpose to return us the real value of our principle (suspend your disbelief in the CPI as measure of real value for a minute just for this exercise)?

Precisely Eric. If anything the risk-free rates should be significant higher due to the fact that every nation runs a fiat based currency. And the date is not 100 years ago but rather 1971. That is the most important date to look at. Post 1971 and Pre 1971 when trying to understand these things. The crux of the matter is that since 1971, as influenced by the majority of the electorate, the politicians have been increasingly relying on the fiat money system to subsidize their lack of fiscal discipline (blaming both dems and R's here) each time PUNISHING the saver for the debtor. It has done nothing but created a long cycle in hard asset appreciation and significantly increased the real value of commodities - the essential ingredients that allow an industrial society to flourish. Did technology help soften these effects along the way? Of course it did, the most important of which was the ubiquity of the internet imho. But we have now reached the end of this experiment with all nations employing a fiat standard, all nations employing ZIRP, and all nations employing a significant transfer payment program as a percentage of global GDP. It doesn't feel like socialism yet because there was in fact a major deflationary event that is still in its final innings (since 2008 lehman). One of you posted a wealth video the other day. The primary reason for the asymmetric distribution is that savers have been marginalized leaving only those with large bases of capital (as a percentage of nominal GDP) to flourish and creating a situation where even respectable savers, prudent savers, find their way back to the lower quartiles when taking into account taxes, inflation, and distribution to heirs over time (splitting of the nest-egg). A risk-free rate of return has been one of the cornerstones of trust in the economy since the late 1600's. It has allowed for terms such as retirement and leisure to be introduced into what our view of capitalism should be.Unfortunately for savers today unless you have 8 figures you will be hard pressed to generate a risk-free rate of return which could cover your outlays. We talked about this before. I know many investors with $2-5mm that are reaching into their principal for the first time in their lives. This is a de-facto wealth redistribution. I am not sure how it will end but I have always chosen the contrarian route when making long-term investments. Right now the most contrarian route of all is to pile up unencumbered cash. Keyword: "Unencumbered". A lot of people have liquidity (cash) today but it is not absolute liqudity. They have taken on more debt in their business or have bought a more expensive house with a mortgage reflecting artificially depressed i-rates. Same goes for corporations, even Buffett's cash situation isn't what it used to be when viewing it through the prism of future encumbrances. I will use 2013 as the year to pile up unencumbered cash which I will use to purchase short duration fixed income assets (less than 90 days). They could start by throwing out property taxes once you reach the age of 65 or something (or better, entirely on your primary residence). It's like you can't even buy a house as security that you'll always have somewhere to live. Maybe somebody has a fantasy that once they own a home, they will be secure. Well, that's only until you refuse/can't pay your perpetual "lease" (oh, I mean property tax) and they come with their guns and take you from your home. It's nice that in California tax payments on property can't rise more than 2% a year, but in other parts of the country how do you save up risk-free money to pay a property tax that could rise at 7% annually where you might live to 110 unexpectedly?

Regarding interest rates... I've asked this before but nobody really knows/knew the answer, so maybe some newer board members know: How can we compare interest rates of today versus 120 years ago when back then the dollar was backed by gold? Shouldn't a 2% government rate be considered a higher yield back then, when backed by gold, versus today when the underlying dollars devalue at a faster pace? I totally don't get these arguments about rates today versus history that goes way back. What seems unprecedented to me about low rates today, versus say 1890s, is that back then your low yield actually beat inflation. And your yield wasn't even taxable back in 1890 -- they brought the income tax in somewhere around 1913 or so. How do you make any money at all with a 2% 10 yr yield and you only keep maybe 1.3% yield after taxes? Surely there is higher risk involved here with making a real return, whereas if it were backed by gold it might be more of a fighting chance. So I can't figure out how comparing rates today versus far back in history is any kind of fair comparison whatsoever. A 2% rate today is vastly inferior to a 2% rate in 1890 -- that's my theory and I'm sticking to it.

I guess the Shiller P/E10 is now about 15x where they put on the hedges initially (at around 1030 on the S&P500). Not that it matters much to you given that what really counts is where the markets are today (not where they starting hedging), but just a venture down the hindsight 20/20 road for fun. I thought they'd gone fully hedged in late 2009, but I went back and looked it up and it was only 25% as it turns out: From the conf call in Oct 2009: While we like our common stock positions for the long term, a very significant increase in stock prices since March 2009 has prompted us to hedge approximately 25% of our portfolios by shorting the S&P 500 to total return swap contracts. We did this at an average level of 1,062 for the S&P 500. Then the next transcript I could find is the Q2 2010 transcript, but they've garbled the message in the transcript. It sounds like they are trying to say that 93% of the portfolio was hedged at 646.5 on the Russell2000, but I don't trust the quality of this transcript (notice the number of times it says "technical difficulty"): http://seekingalpha.com/article/217810-fairfax-financial-holdings-ltd-q2-2010-earnings-call-transcript?page=2 Yes, I’m sorry. So, in response to the (technical difficulty) in equity markets in 2009, and early 2010, the economic uncertainty in the U.S. (technical difficulty) our equity hedge ratio to approximately 93% of our equity exposure. The effect of this increase by entering into Russell 2000 and (technical difficulty) total return swap contracts, average index level of 646.5. This was in addition to the S&P 500. Russell’s total return swap contracts we had done in September 2009 at an S&P 500 (technical difficulty). Now, I’ll (technical difficulty) give you some information on the line financials, (technical difficulty). Thank you. EDIT: I guess it sounds more like they added to the prior hedges, and the new Russell 2000 hedges had average level of 646.5.

I guess the Shiller P/E10 is now about 15x where they put on the hedges initially (at around 1030 on the S&P500). Not that it matters much to you given that what really counts is where the markets are today (not where they starting hedging), but just a venture down the hindsight 20/20 road for fun.

How did you manage to buy BAC shares back around "10.30s" ? Did you get puts assigned?

I suppose the value of that $1.60 number is less than I implied -- it's just what they are doing right now, I had thought, but perhaps it is overvalued by assuming expenses would vanish without any decline in revenue. On the more bright side of things... The terminal value has more to do with earnings in a couple of years and beyond, not right this moment. So back to that 13% to 15% ROTE guidance by management -- in the current rate environment. That is probably related to that hiker/backpack analogy that Moynihan talked about where he implies he is now going to move the pace up more in line with rivals.

They are presently at about 8% ROE if you back out the expenses that are meant to be runoff (according to management) within 2.5 years. Here is the extent of my reasoning, from when the Q4 earnings were posted. Critique and revise please if you think the earnings are actually lower or higher:

They are presently at about 8% ROE if you back out the expenses that are meant to be runoff (according to management) within 2.5 years.

That was a good summary of the specific situations Cardboard. And I think you are right, it was that TIG insurance filing which is where they tipped their hand (but I got that tidbit from you, and you put together the thesis to the board). That was the bit of insider information that wasn't insider information. And ORH was beautiful because being 100% long was nothing to worry about. I remember Mungerville (now Original_Mungerville) being long 100% or more in ORH all throughout the crisis and hedging against the index making money both ways. What a stallion! ORH was cheaper and better than FFH so swapping from FFH to ORH in speculation of a buyout was hardly risky whatsoever! It had that subsidiary discount from being the 20% minority interest that FFH didn't already control.

IMO that "free put" is going to support the stock in times like these, but in a severe crash I think it's going down just like it did in the last severe crash. So I like the strategy in terms of using the "free put strike" as a lower bound of a volatility range to trade around, but if I was going to lever up substantially I'd be using real puts. Just me though. I am pretty scarred by that 2009 experience and Berkshire was no safe haven for a highly leveraged BRK position.

Keep in mind that I've only made the bets on situations that were to the best of my knowledge "inevitables". Then the only risk is duration risk and I've tried to manage that. You talked about 2 yr options but as UCCMAL would point out, you roll them once the next option series comes out. You don't ride them into the ground at expiry. So the 100% risk of loss is sort of a fiction as long as the underlying security is truly solid. Still added risk though -- mitigated by choosing low risk underlying foundation upon which to gamble on it's long-term direction (not short term!).

And 1y and 2y options are not very patient either. The non-recourse is nice, but if you cannot see how this can go wrong you are not being imaginative enough. I know that you are not just about leverage. Maybe those calls were cheap for specific reasons (crowded short) or prices were bowed to have a jump (like in March 2009), but that's not the technical discussion that this thread is having. I'm glad for your success, and it looks like you are mature guy that on several posts has showed that he understands than there is a difference between building wealth and keeping it. So you in that spirit I'm sure you can appreciate these examples: (1) General Growth GGP: I know several people that stroke big on this one, and others that envied those that stroke big. … only to lose most of it investing in Tronox, Chemtura, and other "sure thing" bankruptcy bets where they went big. (2) Chinese Stocks CCME: I know several smart guys that made lots of money on those Chinese Stocks in 2009, quantitative guys that did not read 10Ks or did due diligence. Many of those, and several that followed Hank Greenberg, invested later even bigger in CCME (I even forgot the real name of the company). Many lost huge on that sure thing. I have to say I don't like returns discussions, but maybe that's just me. But I'm old enough to see how reasonable smart people do unreasonable unsmart things when a pot of gold is shown to them and suggested they can do it too. Envy and greed, man. Then there’s the chasing of the investment return rabbit. What if you had an investment that you were confident would return 12% per annum. A lot of you wouldn’t like that -especially if you’ve done better- but many would say, “I don’t care if someone else makes money faster.” The idea of caring that someone is making money faster is one of the deadly sins. Envy is a really stupid sin because it’s the only one you could never possibly have any fun at. There’s a lot of pain and no fun. Why would you want to get on that trolley? This is why I have "only" 10% in 2 yr options, and less than 1% in 1 yr options. Then I have BAC warrants (6 yr options) and AIG warrants (8 yr options). Still a risk of total wipeout to be sure, but am free to admit that I am making gambles. Everything else you said I agree with -- everywhere I try, I tell people that I don't know very much but for a few things and I have done well through a form of gambling, not a form of investing. I'm not trying to explain what I've done in any other framework.

Well, I wouldn't do this in California because of the tax situation, but I have often wondered how a person could do going forward purchasing 10-year TIPS bonds with 100% of your cash and writing deep-in-the-money Berkshire puts for upside (this doesn't require any cash). Should we get the kind of 7% inflation that some pundits keep talking about due to all this "money printing", what a tailwind! And it doesn't add much downside risk (minimal), you get incredible margin allowance for US Govt Bonds.

Margin isn't available in a RothIRA account, which bodes well for my future financial survival. I currently have a margin loan in my taxable account which is fully hedged with puts that match the underlying. The account is levered 1.3x with margin but it's not nearly as bad as it looks (put option strikes are close to current stock price). Rick Guerin could have done that, but Berkshire stock likely didn't have put options back in those days.

And compare that 20% possible total loss to other strategies, like Mohnish's. I think he had 10% in Lear Corporation, 10% in Delta Financial, and 10% in Pinnacle, though perhaps not all at the same time. These companies it turned out had no intrinsic value (although he thought they did at the time). I think he made money trading volatility on Lear Corp -- and I think I saw him tell and interviewer (online clip) that he had just captured intrinsic value and that he would pick it up again if it dropped back down somewhere near $20 (but I think he later decided not too as the future became clearer). The point I am making is that perhaps a set % of the portfolio can be in levered calls as long as the rest of it is very solid (like Berkshire). Compared to other strategies... I don't know, but Mohnish's strategy has also turned up risk of 20% permanent loss here and there (in 10% increments). I once picked up a tracking position in Delta Financial Corporation in my RothIRA because I saw he owned it: [/img] DFC.tiff

"What happened to Rick?" And then Warren went a step further. He said that if you're even a slightly above-average investor who spends less than they earn, over a lifetime you cannot help but get rich if you are patient. And so the lesson. My question was, what happened to Rick? The lesson was, don't use leverage, right? And be patient. These are attributes he's talked about plenty, but I would say that it got seared in pretty solidly after hearing the format in which he put it. Margin has that problem too it. To survive a downturn your broker also has to remain patient. Had he been playing that game today, he could have put 80% into Berkshire "B" common and the other 20% into the at-the-money calls. Collectively that should give me roughly 180% long notional position. Then he would only have suffered a permanent loss of 20% at worst.

That has been my plan, but it's hard to keep myself on a plan. I would like to keep maybe 10% for myself to play with. I plan to pay for a house fully in cash. Then there shouldn't be any worries.

Probably mid-high teens maybe? Low 20s? Thanks, that's interesting. The leverage is actually making a bigger difference than I expected; I thought that the heavy concentration into your very best ideas was in itself a big part of the return. Though I suppose that it still is, just in a different way: You need to be extremely confident to lever things up, and you probably can't get to that point with a diversified portfolio. Did you start out investing like that, passing on anything that wasn't sure enough and then going very concentrated and levered? Or did you start with a more conventional approach to investing and over time you evolved that style because it suits your strenghts? I usually haven't held cash in the account. So during the short selling ban, for example, I was fully invested all the way down to the stock going to near $220 when I levered it and then there was the big pop and I sold off the leverage again. So I've made money by being fully invested in the account almost all of the time, but then conjuring excess reserves out of options land when the odds got really good.

We're still in this recession that started back in July. http://money.cnn.com/2013/03/08/news/economy/recession-forecast/index.html?iid=HP_LN Notably, we might be out of it before people realize we're in it.

It's +12.35% since the end of January. Unfortunately Fidelity only calculates these return statistics on a monthly basis, and then doesn't publish them to my account for another 15 days after that. And then hopefully Sanjeev will be right and it will be up a lot more a week from now.

Related story. A friend of mine runs a non-profit that prepares veterans for careers on wall street, like training for Series 7 exams and teaching valuation and trading techniques. He recently trained a young helicopter pilot who had finished three tours, two in Afghanistan and one in Iraq. On one of his tours he was shot out down and was lucky enough to not only survive but to avoid falling into enemy hands. The vet completed the training and went on an interview with a well know investment bank. After waiting for 15 minutes in a conference room in comes this pompous, suspender-wearing banker who proceed to grill the vet in a dismissive tone: "Do you have any idea what it is like to go home at night with a trading position that is going against you?"..."What makes you think you can handle the ups and downs of a trader?"...."Do you have any idea of the stress level involved here?" The young vet paused, and simply responded: "Does anybody shoot at you here? Thank you! I've been trying to make that point for a hell of a long time. My strategy might have (okay, it has) caused me to lose sleep, it has been stressful, but it's only money after all.

Oh those figures exclude the epic month . . . that explains the sub-par performance! ;D Sorry, I meant to say the 1 year figure does -- the rest of the figures include January 2012. I misphrased it. They all include January 2013, which was a down month. So the 1 yr number isn't the 300% that I previously stated.

My grandfather did pilot a B-24 Liberator across the Pacific from Australia to assault the Japanese (who put many holes in his plane). What I've done here is nothing like that. He risked my very existence! If I've put my family's financial lives at risk, that's a bit less reckless.

I also want them to get rejected/discouraged from returning much capital (it was a change of heart). I have so much in BAC that I want them to be a safer ride until their earnings power is restored (which will bring up and keep up the stock price). As I said earlier in the week, a little capital return today versus in a year or two matters little to the intrinsic value. Maybe the market would also like them to be safer -- these banks never actually lost that much in the financial crisis... what hurt shares (more than losses) was the dilution at low prices. Market should be afraid of dilution above all else if they've learned anything.