Watsa vs. Buffett

[frommi]

 

Packer, even Eric has put on hedges! ;)

 

In all seriousness, though, I really respect you opinions and wanted to get your thoughts on this. What do you think about this?

 

http://blogs.ft.com/andrew-smithers/2014/03/a-world-awash-with-debt/

 

"Claims are often made that today’s low investment is due to “deleveraging”. This is nonsense. The figures published on March 6 by the US Federal Reserve show that corporate debt has risen by 9 per cent over the past year."

 

Isn`t this what the FED was trying to do with low rates? And now we should cry because it has worked?

Isn`t it natural that margin debt usage goes up when the market rallies and interest rates are low?

Should value investing now stop working only because the overall market is slightly overvalued? (Has it in the past?)

Shorting has an expected negative real forward return, the only reason to do it is to lower volatility. But that always comes with a cost. (Except when you are lucky.)

The best hedges are uncorrelated assets with a positive expected real return, i did this by accident in december/january through my investment in REITs. But i think that was only a by-product of searching for good returns and mispricings everywhere.

 

ERIC found a very good way of hedging with a two sided bet on IWM, but he had to be a bit lucky to set this up with low cost. Had the market surged after he bought the puts he would have not been able to do this.

[stahleyp]

 

Packer, even Eric has put on hedges! ;)

 

In all seriousness, though, I really respect you opinions and wanted to get your thoughts on this. What do you think about this?

 

http://blogs.ft.com/andrew-smithers/2014/03/a-world-awash-with-debt/

 

"Claims are often made that today’s low investment is due to “deleveraging”. This is nonsense. The figures published on March 6 by the US Federal Reserve show that corporate debt has risen by 9 per cent over the past year."

 

Isn`t this what the FED was trying to do with low rates? And now we should cry because it has worked?

Isn`t it natural that margin debt usage goes up when the market rallies and interest rates are low?

Should value investing now stop working only because the overall market is slightly overvalued? (Has it in the past?)

Shorting has an expected negative real forward return, the only reason to do it is to lower volatility. But that always comes with a cost. (Except when you are lucky.)

The best hedges are uncorrelated assets with a positive expected real return, i did this by accident in december/january through my investment in REITs. But i think that was only a by-product of searching for good returns and mispricings everywhere.

 

ERIC found a very good way of hedging with a two sided bet on IWM, but he had to be a bit lucky to set this up with low cost. Had the market surged after he bought the puts he would have not been able to do this.

 

It is natural that margin debt usage goes up when the market rallies. However, that also increases risk - unquestionably. What does "deleveraging" even mean? Is it that  you have more debt but just at lower rates? Is that really safer than less debt at lower (or constant) rates? I don't know the answer to that. Like, if I had a ton of credit card debt and my rates drop and I pile on debt, does that mean I'm in a better position than if I had less debt at the old rate? I'd venture to guess that's I'm better off with less debt at a higher rate - it reduces moral hazard. If corporations on adding to their debt because rates are low, is that really deleveraging?

 

We could make the same argument back in 2007 that the market was only "slightly" overvalued. The Shiller P/E wasn't dramatically higher than it is now, Tobin's Q is higher now than it was then, market cap to GNP is higher now than it was then.  I'm not saying that a crash is imminent but when you play with the natural course of the economic engine (artificially low interest rates) it's wise to be prepared for unexpected outcomes.

[yadayada]

Buffett also said that if he had like 500k$ -10 million$ to invest he would be 100% invested almost all the time.

[stahleyp]

Buffett also said that if he had like 500k$ -10 million$ to invest he would be 100% invested almost all the time.

 

I'm not as nearly as smart as Buffett, nor I'm I as unemotional. Also, earlier in the thread, I made the point that Buffett isn't right all the time.

http://www.marketwatch.com/story/buffett-says-subprime-crisis-not-a-big-threat-to-us-economy

 

 

On that point, didn't Buffett go almost all to cash back in 1969? He was all in bonds back in 2007.

 

"I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities."

 

 

 

[Palantir]

What does "deleveraging" even mean? Is it that  you have more debt but just at lower rates?

 

I think this is indeed part of it, but I believe deleveraging referred to the early part of the recession, not our current state IMO.

[frommi]

Its simple. When you are able to call market tops do it!

 

I know that i can`t because i have tried this in 2006 and 2007 and lost a lot of money shorting. And guess what, i missed shorting the downmove in 2008 completly. And the perverse thing with shorting is that you hope that something bad happens on the weekend to be up on monday. I couldn`t count the weekends where i thought about nuclear attacks and all these shit, that makes your life really miserable.

 

I bought some stocks in the end of 2008 but much too early and sold near the low of the downmove in 2011. Missed the complete upmove in 2012 because of my german angst. I would have been better off if i just had stayed long since 2005 and that with the worst downmove we had in 30 years in between. But i am able to learn. My lesson was to stay invested no matter what happens, i just try to find the best opportunities available und move my funds there. And stay optimistic about the future, thats good for your mood. :)

 

And btw. I hear that debt argument ever since 1998, debt was always to high in the eyes of the observer. But thats not a reason that the market crashes tomorrow. (And 10-20% corrections are not crashes in my eyes, just opportunities to buy more.). Just look at Japan how long high debt rates can be carried into the future. And btw. value investing even worked there in one of the worst bear market we have ever seen. (source:http://greenbackd.com/2013/07/23/has-value-investing-worked-in-japans-long-bear-market-1990-to-2011/)

 

 

[stahleyp]

frommi,

 

I think that's where you and I differ. For one, I don't short. I've never shorted a stock. I'm a pretty simple guy and I think the market is fairly, but certainly not always, efficient. I almost never time. If I do, it's very, very small moves (I'll usually sell a tiny bit to reduce emotional anxiety, like in 2011 - it makes me feel like I've "done" something. And I do mean very, very small like $50 or $100 here and there). This has worked out well. I can calm the irrational, emotional side of myself while also thinking more rational about the larger dollars.  Additionally, when people much smarter than myself are saying to "watch out" I think it's prudent to listen.

 

I've been fully invested, or very, very close to it (I save a good amount of my paycheck so money is temporarily put into cash) and, with leverage at times I'm sure I had more than 100% equity exposure. Like I said, I'm a simple guy. I try to buy when others are fearful and be fearful when others are greedy. People are clearly more greedy now than they were a few years ago. That doesn't mean that greed can't go on for a while or become greedier though. For instance, my uncle, who got out of the market a while ago is thinking about getting back in. He's feeling like he's "missing out." Or, a friend on facebook who was bragging about the "100% he made on Facebook calls." I've had some pretty decent returns the past few years and I think it's prudent to take down aggressiveness a bit. I'm not hedging everything or completely going to cash, however. If the market continues to rally, I'll continue to save cash and pare down my existing holdings even more. Will I miss out? Maybe, but I've been at the dance for too long and I'm getting a bit tired. :P

[mcliu]

Just because Buffett invests in one way doesn't mean that other methods can't work. Who wouldn't be 100% invested if they were as talented and motivated as Buffett?

 

Soros, Icahn, Tepper, Dalio, Renaissance don't invest at all like Buffett, but they all seem to do fine. The same can be said of the team at FFH. The investment strategy is different, but it doesn't mean it's any less effective.

 

Some of these guys are just better macro investors..

[frommi]

@stahlehyp Thats the thing i probably don`t get. For me its a no brainer to sell things that have only a forward return of 10-15% and switch to things that have a 25-30% forward return. That belongs to my investment process. I would only switch to cash when there is no other asset class in the world where i get the returns i search for, or cash yields so much that an risky investment somewhere else is out of question. (I doubt that will ever happen but i can understand that its another story when you handle billions or are bound to invest in equities.)

 

And since i won`t use more than 10% leverage for me there is no more or less agressivity. Perhaps its a matter of each investment style if timing has to be a factor. But why should i make something really unreliable a part of my investment process? Even some of the brightest minds and best stock market timers of the past like Livermore have gone broke through leverage and were not able to time the market every time they tried.

[stahleyp]

frommi,

 

I'm of the opinion that things work in cycles. Bull markets usually last about 4-5 years. We're in the 5 year now (depending on how you measure it - 5 years from March of 2009 or 2.5 years from Sept 2011). Now, some bull markets last longer, around 1991-1999. Some are much shorter, 1935-1936. The longer ones tend to have some type of tailwind, technological breakthroughs, lowering of government, debt - something. The shorter ones tend to have a headwind (working through the great depression and it's aftermath). We're improving but what's the price we're paying for that? By most measures the market is overvalued (either slightly or significantly). How much value is left? Perhaps I'm misreading you (I apologize if that's the case) but the ease at which you're expecting the "10-15%" returns makes me all the more uneasy. Then again, you might be a vastly superior investor to myself (not a high hurdle to clear by the way!) and can do those returns without batting an eye. 

 

Sometime, the situation will reverse and we'll be in bad times again. Will it continue to rally before then? Quite possible. Like I said, people who missed out are now jumping back in. Could things be worse than many are expecting? Quite possible. With interest rates so low and people are hopping back on the bandwagon, that is artificially creating demand for risk assets. If demand is increasing due to artificial positioning, that creates extra risks. The Fed has messed around with interest rates a couple times over the past 20 years (around 1996 or so due to LTCM) which helped create the dot com bubble. Then again with the housing crisis to get us out of the mess with the dot com aftermath. Now, they're playing the song again trying to get us over the aftermath of the housing crisis. Perhaps this tune will end differently. But, like I said, I've been at the dance for a while and I'm getting tired.

[thepupil]

I think it's important to remember what exactly every investors role actually is and how they've positioned themselves. Whether it's Watsa, Buffett, Klarman, or whoever, they all do different things and are positioned accordingly.

 

WARNING: long rant with little coherent thought and many statements of the obvious

 

Buffett has positioned Berkshire to be a constant buyer of high quality businesses. He basically keeps insurance float in cash and fixed income for a rainy day and constantly buys something with every dollar that comes in from his wholly owned businesses and investment income. He basically has multiple years of insurance disaster in an "emergency fund" and then reinvests everything else. His time horizon is perpetual and he ALWAYS has a sizable portion of his overall firm's assets and equity in cash coming in. Berkshire, the corporation, is like a miser with a very stable job and 3 years of spending in the bank. Why wouldn't said miser plow all additional earnings back into assets withe the highest expected long term returns? Last year Berkshire had $28B of Pretax income, it invested 11BN in capex, 3B in bolt on acquisitions, 12BN on Heinz, added a little XOM to the mix and ended up with a similar amount of cash. The gun gets constantly reloaded so there's no worry about not having bullets for a more promising hunting environment.

 

Also, if there is anything I have taken away from Snowball and studying Buffett, it's that it is in his DNA to always want more, to keep continue compounding (in a safe way and for society's benefit) but he is in it for the journey, there is no destination. I remember being shocked when Buffett said he liked JPM and owned a million shares in his PA. Not because I thought JPM was a bad investment, but because of the window into his psyche that offered. Why on earth does Buffett need a PA? He owns tens of billions of Berkshire. In my opinion he is simply wired to seize every great opportunity and compound his net worth. I would have all cash and gold hidden under various mattresses, jurisdictions, fields etc. in my PA if I has 1/100th his wealth in a stake in a nicely diversified growing public corporation.

 

Klarman runs a value oriented gigantic hedge fund that makes the bulk of its money (from what i've read of him, which isn't very much besides his book which is dated) on distressed credit and equity opportunities. His investors have no tax considerations (he only takes non profit clients) are hopefully sophisticated and strong enough to give him money when the time comes and his opportunities increase. Imagine if Berkshire gave back large portions of its assets and then tried to raise money  quickly in the depths of the crisis. It would likely be very value destructive. Not so for Baupost. There is no insurance liability to offset, no mandate, AND no perpetual mindset or social obligation like a corporation with 300,000 employees that is also the nation's most important railroad and utility. According to wikipedia, Baupost has 42 employees. Running Baupost, the management company, is entirely different than running berkshire. Baupost can stop playing the game whenever it wished and then come back. Burlington Northern, GEICO, National Indemnity, MidAmerican cannot stop playing the game because the lights would go off, the oil would stop being delivered; their capital expenditures and purchases of investments must go on.

 

There is a difference in mandate. Baupost does not control most of the companies it has positions in so price is very important because returns come from rerating and changing prices. Baupost buys 50 cent dollars and sells them. Berkshire buys 80 cent dollars (and some 50 cent one's too) and then reaps perpetual equity coupons (the economic return of those dollars). Post purchase price and rerating are much less important to berkshire because it rarely sells. 

 

As for Watsa, I see him as somewhere in between the two. He is more levered than Berkshire (8/36 < 220/480), owns lower quality businesses and not as much in sheer dollar terms to have tons of non insurance cash pouring in, and is therefore more sensitive to drawdowns in market prices and economic conditions. He has to worry/care about the macro. Maybe he is going about it in the wrong way, maybe not. I like his Russell short (though obviously he was WAY early), his low downside high upside deflation bets, etc. But whether he is right or wrong, he is doing what he thinks is best for the organization he runs, and that's what the other two titans are doing as well.

 

I don't know if that really was coherent or added anything to the conversation, but its just my two cents.

 

You always need to consider what exactly the person does when he gives some sort of advice or opinion on positioning.

 

EDIT: Personally, I'd rather just buy way OTM puts on Berkshire to hedge the Watsa scenario. Imposing this hedging cost (which obviously compounds over time and is significant) allows me to stay more than fully invested with comfort. I've probably spent 3%  of my berkshire on berkshire hedges over the course of the past 3 years, but that's allowed me to be comfortable with a big position in it and never be tempted to sell. If i always have savings coming in and i can't lose more than 20%, then the depression/deflation scenario doesn't phase me too much

 

[frommi]

@stahleyp First i am surely one of the worst investors here. I made so much mistakes in my investing career that i can fill a book with it. But i am able to learn.

Your problem of the cycles etc. is only understandable for me when you buy something, hold onto it for 5 years and then come to the conclusion that the bull market is 5 years old and you sit on large gains. I avoid this situation completly because i always look for better values and i have found a way to compare all my investments with one simple number (my forward rate of return, i can even calculate that for my netnets and compare them with good compounders). Thats probably sometimes to easy but it makes my investment process easier and helps me to decide when i have to sell and buy something else (my current rule is when i find something with double the rate under some other conditions like max position size.).

 

I don`t know if these forward rate of return numbers get real but i know that Yachtman and some other value investors use something similar. When they get real in 75-80% of the cases after 5 years i should reach my goal of >15% returns easily.

 

@thepupil +1

[Guest wellmont]

ffx is set up to preserve capital. I don't see how the enterprising investor could not find things that have way more upside. And I don't view it as a a cash substitute. If the markets go higher, ffx will lag due to the counterweight of the institutionalized conservatism. if the markets go down ffx capital will be preserved but shareholders won't get a great result. ffx is a stock. stocks go down in bad markets. if you want to preserve capital and perhaps grow it at unexciting rates ffx is one you could look at. I still wonder what it was about 2008/2009 (and beyond) that left ffx ceo less than enthused about buying stocks (aside from risky Canadian mobile device companies) and covering shorts.

[stahleyp]

@stahleyp First i am surely one of the worst investors here. I made so much mistakes in my investing career that i can fill a book with it. But i am able to learn.

Your problem of the cycles etc. is only understandable for me when you buy something, hold onto it for 5 years and then come to the conclusion that the bull market is 5 years old and you sit on large gains. I avoid this situation completly because i always look for better values and i have found a way to compare all my investments with one simple number (my forward rate of return, i can even calculate that for my netnets and compare them with good compounders). Thats probably sometimes to easy but it makes my investment process easier and helps me to decide when i have to sell and buy something else (my current rule is when i find something with double the rate under some other conditions like max position size.).

 

I don`t know if these forward rate of return numbers get real but i know that Yachtman and some other value investors use something similar. When they get real in 75-80% of the cases after 5 years i should reach my goal of >15% returns easily.

 

@thepupil +1

 

I can agree with pupil's points, too.

 

Rest assured that I'm not selling just because I've had large gains. Indeed, I've had large gains for a while.  I'm selling because a) Valuations are stretched (being fully aware that they can stretch even more) B) super smart guys (even though their endgames are different (Watsa, Klarman, etc) are bearish - not just "expect 5% returns" bearish but significantly more so. C) This market is, probably, getting long in the tooth. Each day is making it more so D) The average guy is starting to get back in to the market (I'm also aware that can also last for a while). E) The Fed is undergoing a huge experiment. Indeed, most of the world is with them. Messing with economic nature can have very severe consequences. If the bears are right and one is positioned appropriately, one could make a killing in the environments these guys talk about. If that doesn't happen, I'd miss out on 10% a year or what have you. I think it was Davis that said "You make most of your money in bear markets - you just don't know it at the time." I find that's been the case for me in the past, as well.

 

You mentioned Yacktman. He was a huge underpeformer to middling performer for years and years. Since he's fund inception in 1992 through roughly Sept 2008 he underperformed the S&P500 overall.  I have the chart pulled up now and it doesn't look like at anytime during that period (since inception) he was beating the market. If so, it's so small that it's hard seeing outperformance on morningstar. 16 years he lagged. If one includes the cost of taxes, I wonder what the numbers would look like.

[frommi]

Yes because he plays it safe with stocks that have 10-15% forward rate of returns. It was only the process of calculating a rate of return that i was interest in. How do you decide which investment is better for your portfolio, gut feeling? :)

There was a poll some weeks ago where >80% of this forum polled that they make position sizing dependend on value. How is that possible without being able to compare the investments?

 

 

Sorry for derailing this threat.

[stahleyp]

Yes because he plays it safe with stocks that have 13% forward rate of returns. It was only the process of calculating a rate of return that i was interest in. How do you decide which investment is better for your portfolio, gut feeling? :)

There was a poll some weeks ago where >80% of this forum polled that they make position sizing dependend on value. How is that possible without being able to compare the investments?

 

 

Sorry for derailing this threat.

 

How have his investors performed? I wanna say that before 2008 he had like $70 million under management. How do we know it wasn't luck instead of skill? Shouldn't a skilled investor be able to beat the market by at least a little over 16 years?

 

Personally, I don't do forward rates of returns, ie (I think I should make 15% a year on this stock for 5 years). For me, the future is too unknown for that. I'll find a stock and then I tend to sell it when it reaches, what I feel , is fair value. If it does those returns in a year, I move on. If it takes longer, I hold on. If I find something with a bigger disconnect, then I might sell the existing position and move to that. It depends.

 

And yes, if I'm honest, part of it is on "gut" feeling, too - ie if something is too good to be true, it probably is. That's why I missed out on these Chinese related companies. I thought about buying CCME for a while but never did. This"gut feeling" also helped me avoid gold stocks for the most part in the past until June of last year (I had a small position I bought back in 2004 and sold it off along the way). The market usually isn't stupid. The gut feeling I had in 2007, while I got hurt, also stopped me from making stupid decisions back then (buying banks like the guys at Dodge and Cox did). It's stopped me from making some smart decisions occasionally, too, like not having big enough positions.

[Packer16]

I would not sell because the market has such and such valuation unless you are holding the market.  If you hold individual stocks I would look at what alternatives are available and as frommi has said at this point I have been able to find individual securities which have higher expected returns in comparison to bonds or money markets. 

 

I think part of how much you want to put in stocks is how comfortable are you with volatility. If you are risk averse keeping money in cash or bonds is not a bad idea to sleep well.  I find the biggest downside of large equity allocations is volatility.   

 

There still is alot of cash reserves held at the Fed.  These are a source of further liquidity in the market.  When I see these reserves decline and/or an increase in short-term rates then I will see where the stocks I own are valued.

 

As to debt, I think if you put debt into perspective it is not to bad.  The US has $17t GDP (income) vs. $13t personal debt and $19t corporate debt and $24t corporate and $60t personal net worth.

 

Packer

[stahleyp]

Packer,

 

Thanks for your thoughts. Do you recall Buffett's article from about 10 or 11 years ago that blasted us for having so much debt? He was pretty dire in the article from what I recall. I'd think things are much worse now than they were then. If you're not familiar with it, I'll try to dig it up.

 

On another note about Buffett's cash some of the other posts on this thread.

 

http://ca.finance.yahoo.com/news/berkshire-opposes-dividend-proposal-buffett-gates-pay-rises-164442830--sector.html

[Packer16]

I remember that he talked about selling part of the farm to someone else via debt but I think a better analogy is the farm is growing faster than other farms (which are smaller) so the effect is a decline in the growth in wealth.  If you look at the growth on personal net worth it is still increasing even though we have debt.  As of 2011, US personal net worth was $60t with debt of $13t on asset of $73t.  Here is a good site for some perspective:

 

http://en.wikipedia.org/wiki/Financial_position_of_the_United_States

 

 

Packer

[Liberty]

Those who are looking a Schiller's CAPE might want to have a look at this. I think it makes good points:

 

http://philosophicaleconomics.wordpress.com/2013/12/13/shiller/

 

This is an interesting follow up:

 

http://philosophicaleconomics.wordpress.com/2014/03/16/the-u-s-stock-market-is-expensive-and-it-should-be/

[racemize]

Has Racemize finished his study/paper on being fully invested/holding cash?

 

+1

 

I am interested in this too

 

me too, that guy really needs to stop being so lazy and... oh wait.

 

I'm in final revisions of my second essay on investing and taxes (mostly focused on the amount an active investor has to beat the index to have equivalent after-tax returns).  The next essay will be the cash one.  It will take me a while to put it into the right format and get it into shape, but in the mean time, here's the executive summary:

 

I've found almost no fund or individual that should not have been fully invested.  The only person that I think it made sense for is Pabrai's second and third funds (not his first one, with a longer track record).  I've studied hindsight bias S&P market timings, mechanical screens, various individual people's returns, and fund returns that I'm aware of.  Essentially, 95% of people would not have beaten the opportunity cost of having held cash.  The only time that it works out better is if you have an extremely volatile portfolio (much more volatile than the S&P).  When you are volatile, holding cash through the down turn is a bigger deal, and the corresponding upswing is also a big deal, which can lead to higher overall returns.

 

I am desperately in search of any evidence that contradicts the above.  If you are aware of any strategy where not being 100% invested all the time gives higher returns over the long term than being 100% invested, I want to hear about it.  It also needs to be reasonable/applicable (obviously).

[bennycx]

This makes sense because if over the long term equities yield a positive return and assuming you have little knowledge about market timing then it only makes sense to be fully invested

[racemize]

This makes sense because if over the long term equities yield a positive return and assuming you have little knowledge about market timing then it only makes sense to be fully invested

 

Does anyone have a good market timing record?  Can they show that it would have done better if than if they hadn't timed and that it wasn't luck?  Is there a good market timing system?  If so, how does it work? 

[stahleyp]

Packer,

 

Thanks for the link. Wouldn't the debt load be significant more if the market (both housing and stock) didn't recover? I just wonder what would have happened under a different scenario.

 

Liberty,

 

I've read the first one. It was certainly food for thought.

 

race,

 

Are you basing your returns on what the market has done in the past 10 years or some other assumption? What if, for example, the US were to go through a long deflationary period?

[racemize]

I used Shiller's data from 1871 to now, and made various hindsight bias assumptions (e.g., hold a certain amount of cash all the time until a significant drop occurred, having the insight to only invest at the bottom and invest for the next 1-3 years, and then go back to cash again, or similar).  I did similar studies from 1970 until now.  I did not come up with a scenario, assuming near-perfect timing (but holding cash until that timing was required), where holding cash made any sense.