Good blog post on FFH

[racemize]

I think the situation that Watsa isn't adequately considering is that the stock market remains flat to slightly higher over say the next 5 years.  The hedges will continue to require cash, he'll continue to sell his equity positions, and book value will continue to decline. This would be a pretty big disaster from an investment return and opportunity cost perspective.

 

Don’t confuse the short-term with the long-term: in the long-term FFH equity portfolio has always outperformed the indices. In the long-term they will make money, not lose it! Even if nothing truly significant happens to make them change strategy. ;)

 

Gio

 

I generally agree, although in the last 5 years they have not, and in the last 10 years they barely did.  I don't consider 5 and 10 years to really be all that short-term.

[Liberty]

Your whole argument about “the long-term” is very misleading. If Mr. Watsa’s defensiveness today is proven right, those numbers will change dramatically in a matter of just a few years…

 

How do you know that, though? Someone could have written the same thing a couple years ago. What if the market goes up another 30% in the next few years and the real economy picks up a lot? That's the problem with trying to time macro. Over the past 100 years, there were always reasons to think the sky was about to fall, yet our economy mostly keeps driving forward. How many points was the dow jones 100 years ago?

 

Markel and Berkshire will participate fully in a good economy, but they'll also do well if things go to hell.

 

If things go well, FFH will create value more slowly than they would otherwise because the hedges are like a huge weight tied to their ankles, but if things go to hell, they'll just rewind the tape a bit and get back some of the money they lost in the past few years. On the long-term net, I don't think they'll come out ahead unless there's something just as bad or worse than 2008 that happens soon, in which case their other equity holdings would probably suffer more than the average company since they tend to be somewhat distressed situations (how would Blackberry do in a collapse? probably worse than Wells Fargo and Johnson & Johnson, I'd guess).

 

I would rather have seen them reduce their leverage or raise minimum cash to 2b at the holdco level or something like that. That reduces risk, but it's less directional, so that if things don't go the way you think, you still move in the right direction.

 

Don’t confuse the short-term with the long-term: in the long-term FFH equity portfolio has always outperformed the indices. In the long-term they will make money, not lose it!

 

Gio, what do you think of FFH's performance if you remove the first few years when they were really small? It looks like both BRK and MKL have done better for quite a long time despite not having successfully bet on CDS in the GFC and such. Again, I think FFH could just reduce its leverage a bit and it would make them have to be a lot less paranoid about macro, which is never a position you want to be in anywyay...

[Munger_Disciple]

I don't understand why Fairfax pays dividends to shareholders. They are issuing more stock at the same time they are declaring dividends. This part of capital allocation does not make any sense to me. Also, if they need cash to pay for the hedges, then why not use the cash for that instead of dividends?

[Liberty]

I don't understand why Fairfax pays dividends to shareholders. They are issuing more stock at the same time they are declaring dividends. This part of capital allocation does not make any sense to me. Also, if they need cash to pay for the hedges, then why not use the cash for that instead of dividends?

 

I believe Prem said that he does it instead of paying himself a higher salary, so that all shareholders are treated equally (and he doesn't have to sell shares).

[racemize]

Your whole argument about “the long-term” is very misleading. If Mr. Watsa’s defensiveness today is proven right, those numbers will change dramatically in a matter of just a few years… It is exactly like keeping cash for a very long time, and then investing in a truly outstanding opportunity: until that opportunity materializes, your track record seems very poor, than all of a sudden it becomes wonderful! Mr. Watsa at the AM has said the investment business is primarily characterized by how quickly things change. He simply has been waiting for three years now…

 

Gio

 

Good post. I think most people have stopped believing in large market declines after the bull market of the past 5 years. When valuations decline, and it inevitably will, the results will show a different story. I like what FFH is doing. They haven't forgotten the first rule of investing: never lose money.

 

This is a theme I've seen on the board recently.  It's as if the good times will never end and markets never decline.  Somehow 2008/2009 is viewed as a fairly harmless blip that we navigated through without issue.  I don't remember it like that at all.  I remember how the fear was so strong, not just for investors but everyone.  Friends who had never invested a dime were watching the news to see how bad the stock market was doing and wondering how things would survive.  Since that time I've kept cash on the sidelines.  In retrospect it's been stupid because I could have juiced my returns a little more for the past five years.  Yet no one knows when the next crash or downturn will happen, and the last one caught a lot of people off guard.  I'd rather be patient and be able to seize opportunity than miss out.

 

My issue with the cash argument is that I've not found any evidence that it works out.  For example, Sam Neil very confidently said that he thinks most money could be made by doing nothing until the opportunity arose and then stepping in.  While I think that is true on an individual stock basis, and perhaps that was what he was referring to, based on all the modeling an studying I've done, it is not true for the market as a whole (which is the context of his answer).  I was completely taken aback when he said that, as I've found absolutely no evidence that it is true and he seemed to be implying that it was for the market.  The opportunity cost of having cash is extremely high, on a market level basis.  For an individual stock picker, the opportunities have to be compared against what you have in front of you, so the opportunity cost is what you normally get, or would get in that period, which I still believe to be high.  It is much harder to model that though, so there's lots of variables. 

 

The problem with this argument is that it looks foolish.  I feel like value investors, because they are so contrarian, like to hold cash and call it being "prudent".  It feels good right?  People get to say they held cash when the market was high and redeployed it at the bottoms, but they very rarely test to see if they would have done better just investing it with the rest of their picks the whole way through.  Incidentally, this can be tested without too much effort:

 

1) Figure out your ex-cash returns on a per year basis:

2) model holding a percentage of cash and redeploying it at the bottom (assume you have excellent timing)

3) figure out what percentage of cash gives you the highest returns over your time period

 

For every investor I've done this for (except for Pabrai's second and third funds), the ideal cash percentage was 0, and that was over recent time periods, including the 2008 drop. 

 

Side note: I really wanted to find out that holding cash was prudent and the right thing to do.  It made sense in my head.  I wanted to be contrarian and hold cash as the market went up and deploy it on the bottom.  I've just not been able to confirm that it works better.  I really don't like the fact that if you are 100% invested, that crash is going to hurt, and you likely won't be able to buy at the bottom, but that's what everything I've tested has said, unless your portfolio volatility is very very high (like Pabrai's was in 2008, and even with that, it was better for him to be 100% invested for his longer run, first fund).

[Kraven]

Your whole argument about “the long-term” is very misleading. If Mr. Watsa’s defensiveness today is proven right, those numbers will change dramatically in a matter of just a few years… It is exactly like keeping cash for a very long time, and then investing in a truly outstanding opportunity: until that opportunity materializes, your track record seems very poor, than all of a sudden it becomes wonderful! Mr. Watsa at the AM has said the investment business is primarily characterized by how quickly things change. He simply has been waiting for three years now…

 

Gio

 

Good post. I think most people have stopped believing in large market declines after the bull market of the past 5 years. When valuations decline, and it inevitably will, the results will show a different story. I like what FFH is doing. They haven't forgotten the first rule of investing: never lose money.

 

This is a theme I've seen on the board recently.  It's as if the good times will never end and markets never decline.  Somehow 2008/2009 is viewed as a fairly harmless blip that we navigated through without issue.  I don't remember it like that at all.  I remember how the fear was so strong, not just for investors but everyone.  Friends who had never invested a dime were watching the news to see how bad the stock market was doing and wondering how things would survive.  Since that time I've kept cash on the sidelines.  In retrospect it's been stupid because I could have juiced my returns a little more for the past five years.  Yet no one knows when the next crash or downturn will happen, and the last one caught a lot of people off guard.  I'd rather be patient and be able to seize opportunity than miss out.

 

This is exactly right.  In hindsight things are always obvious.  It is clear now that 2008/9 was perhaps the buying opportunity of a generation.  I know that everyone wants to believe that regardless of what happens people will continue drinking Coke and getting mortgages from Wells Fargo, but that isn't manna from heaven.  There are other things that could have occurred.  The entire financial crisis is a series of events that of course happened as they did, but could have very likely have occurred in different ways.  Likewise, the "buying opportunity" and the tremendous return on CDS might not have occurred either.  What if instead of Lehman going under the Fed acquiesced and backstopped Barclays for a couple of days.  I think people forget that prior to Lehman the market was still in reasonably good shape all things considered.  Sure, it was down, but not that much.  So Barclays neatly takes over Lehman and perhaps there is no financial crisis in the way it occurred. 

[Munger_Disciple]

I believe Prem said that he does it instead of paying himself a higher salary, so that all shareholders are treated equally (and he doesn't have to sell shares).

 

This does not change the fact that paying dividends leads to sub-optimal capital allocation at Fairfax. Given his net worth, I figure Prem can sell a few shares every year to pay for his lifestyle and this should not change his control of the company. Buffett has been giving away 5% of his stock (he converts them to B shares first) to charities for several years now, without any effect on his ability to control Berkshire. I am sure Prem can do something similar w/o forcing a penalty of additional share issuance on all shareholders.

[Liberty]

I believe Prem said that he does it instead of paying himself a higher salary, so that all shareholders are treated equally (and he doesn't have to sell shares).

 

This does not change the fact that paying dividends leads to sub-optimal capital allocation at Fairfax. Given his net worth, I figure Prem can sell a few shares every year to pay for his lifestyle and this should not change his control of the company. Buffett has been giving away 5% of his stock (he converts them to B shares first) to charities for several years now, without any effect on his ability to control Berkshire. I am sure Prem can do something similar w/o forcing a penalty of additional share issuance on all shareholders.

 

Doesn't seem to be about control since he owns tons of multiple-vote shares iirc. I agree it seems very sub-optimal. I wouldn't want to see Berkshire or Markel pay such a high percentage of book in dividends.

[tiddman]

What matters is not book value, though, it's IV. If Fairfax considers that they are worth more than BV (in the same way that Buffett considers that BRK is worth substantially more than BV), then issuing new stock above BV could still be dilutive if it is below IV.

 

There is a table printed in every Fairfax annual report with one of the columns titled, "INTRINSIC VALUE % Change in US$ Book Value per Share", the context is comparing Fairfax's intrinsic value (in other words, book value) to its stock price.  First of all this clearly draws a parallel between book value and intrinsic value.  Second, the end result in these two columns is very similar (19% CAGR vs. 21% CAGR as of 2013).  Third, Fairfax stock has on average traded at 1.06 book value over the past 13 years.

 

This all strongly suggests that Fairfax's intrinsic value is equal to book value.  Berkshire's intrinsic value is higher because it derives most of its earnings from operating companies that generate steady earnings every year and are valued based on earnings rather than book value.  But Fairfax doesn't have any such businesses.

 

In 2013, Fairfax's book value went down by 10% while the stock went up by 18%, a difference of 28%.  Today it trades at around 1.25x book value.  The highest multiple it has ever traded is 1.44x (according to GuruFocus).  I think that Fairfax stock is significantly overvalued, which is both a good time for them to issue shares and a good time for Fairfax shareholders to be cautious.

[jay21]

Side note: I really wanted to find out that holding cash was prudent and the right thing to do.  It made sense in my head.  I wanted to be contrarian and hold cash as the market went up and deploy it on the bottom.  I've just not been able to confirm that it works better.  I really don't like the fact that if you are 100% invested, that crash is going to hurt, and you likely won't be able to buy at the bottom, but that's what everything I've tested has said, unless your portfolio volatility is very very high (like Pabrai's was in 2008, and even with that, it was better for him to be 100% invested for his longer run, first fund).

 

I think that you should consider the psychological costs as well.  Hypothetically, let's say I confidently identified a situation that would double by 2012 in 2007.  In 2009, the position was halved and I now expect a 4x.  Will I be able to move my money out of that idea and recognize a 50% loss to move it into an idea that would go up by 6x by 2012?

 

I think if you can easily handle the psychological effects of being fully invested than it might make sense.  I haven't been around long enough to test myself psychologically yet so IDK if I can.  I feel more comfortable holding cash as I think I will be more prepared for a decline and will deploy cash rather than panic sell.

[Liberty]

There is a table printed in every Fairfax annual report with one of the columns titled, "INTRINSIC VALUE % Change in US$ Book Value per Share", the context is comparing Fairfax's intrinsic value (in other words, book value) to its stock price.  First of all this clearly draws a parallel between book value and intrinsic value.  Second, the end result in these two columns is very similar (19% CAGR vs. 21% CAGR as of 2013).  Third, Fairfax stock has on average traded at 1.06 book value over the past 13 years.

 

This all strongly suggests that Fairfax's intrinsic value is equal to book value.  Berkshire's intrinsic value is higher because it derives most of its earnings from operating companies that generate steady earnings every year and are valued based on earnings rather than book value.  But Fairfax doesn't have any such businesses.

 

In 2013, Fairfax's book value went down by 10% while the stock went up by 18%, a difference of 28%.  Today it trades at around 1.25x book value.  The highest multiple it has ever traded is 1.44x (according to GuruFocus).  I think that Fairfax stock is significantly overvalued, which is both a good time for them to issue shares and a good time for Fairfax shareholders to be cautious.

 

My understanding is that they believe that IV parallels book more or less, so it's the most useful metric to use as a benchmark, but it doesn't mean that they think that Fairfax's IV is literally exactly 1.0x book (ie. if they really can compound at 15% or more while protecting the downside, it would be crazy to say that IV was 1.0x, especially in a low interest environment -- but these days, maybe it is...).

 

Before Berkshire had a significant portion of its earnings from operating businesses, its IV was significantly higher than book because of the quality of its insurance and investing. Like Markel now, despite Ventures still being small, Tom Gaynor says he thinks MKL is worth 1.5-2.0 book. It's also incorrect to say that Fairfax doesn't have "any such businesses" (operating), though they are still small.

 

I'm not saying that FFH's IV is much higher than book - I said I didn't know - just that it's incorrect to automatically assume that issuing stock above book is not dilutive for shareholders. For example, if you estimate that IV is 1.3 book, then issuing at 1.25 book reduces per share value slightly.

[tiddman]

(ie. if they really can compound at 15% or more while protecting the downside, it would be crazy to say that IV was 1.0x, especially in a low interest environment -- but these days, maybe it is...).

 

If there were a mutual fund that had returned 15% per year for the past 10 years and was currently trading at a NAV of 100, would you be willing to buy it for 125?

 

Also, AZ had a good table in the article that started this thread showing that this 15% number is more wishful thinking than reality:

 

http://3.bp.blogspot.com/-0VVAtecz12M/U0XnlAVQ-RI/AAAAAAAAAwk/M4eJ1fewwSk/s1600/Fairfax+BV+CAGR.JPG

[Liberty]

If there were a mutual fund that had returned 15% per year for the past 10 years and was currently trading at a NAV of 100, would you be willing to buy it for 125?

 

Maybe. It depends if I think NAV understates IV.

 

You don't think Berkshire was worth more than book value a few decades ago?

 

Also, AZ had a good table in the article that started this thread showing that this 15% number is more wishful thinking than reality:

 

http://3.bp.blogspot.com/-0VVAtecz12M/U0XnlAVQ-RI/AAAAAAAAAwk/M4eJ1fewwSk/s1600/Fairfax+BV+CAGR.JPG

 

I never disagreed with that. My main point is: "it's incorrect to automatically assume that issuing stock above book is not dilutive for shareholders."

 

 

[vinod1]

 

Also, AZ had a good table in the article that started this thread showing that this 15% number is more wishful thinking than reality:

 

http://3.bp.blogspot.com/-0VVAtecz12M/U0XnlAVQ-RI/AAAAAAAAAwk/M4eJ1fewwSk/s1600/Fairfax+BV+CAGR.JPG

 

This is one point I disagree with in the article. We should always evaluate performance over a complete cycle, preferably over multiple cycles. We are arguably closer to top of bull market. So the performance even very long term ending at this point would unfairly penalize Fairfax.

 

Vinod

[racemize]

 

Also, AZ had a good table in the article that started this thread showing that this 15% number is more wishful thinking than reality:

 

http://3.bp.blogspot.com/-0VVAtecz12M/U0XnlAVQ-RI/AAAAAAAAAwk/M4eJ1fewwSk/s1600/Fairfax+BV+CAGR.JPG

 

This is one point I disagree with in the article. We should always evaluate performance over a complete cycle, preferably over multiple cycles. We are arguably closer to top of bull market. So the performance even very long term ending at this point would unfairly penalize Fairfax.

 

Vinod

 

I think the fairest way to do these comparisons is to make rolling 3, 5, 10 year periods (perhaps quarterly) and show the distribution of those periods against the benchmark.  For good managers, I would expect something like: 65% outperformance for 3 years, 85% outperformance for 5 years, and 99% percent outperformance for 10 years, or something along those lines.

 

Anyone happen to have the data for that?

 

Edit: I'm also curious if anyone disagrees with measurement in that fashion or thinks there is a better way.  It seems to me to be the fairest since it is agnostic to particular time frames and the initial years.

[bluedevil]

What matters is not book value, though, it's IV. If Fairfax considers that they are worth more than BV (in the same way that Buffett considers that BRK is worth substantially more than BV), then issuing new stock above BV could still be dilutive if it is below IV.

 

There is a table printed in every Fairfax annual report with one of the columns titled, "INTRINSIC VALUE % Change in US$ Book Value per Share", the context is comparing Fairfax's intrinsic value (in other words, book value) to its stock price.  First of all this clearly draws a parallel between book value and intrinsic value.  Second, the end result in these two columns is very similar (19% CAGR vs. 21% CAGR as of 2013).  Third, Fairfax stock has on average traded at 1.06 book value over the past 13 years.

 

This all strongly suggests that Fairfax's intrinsic value is equal to book value.  Berkshire's intrinsic value is higher because it derives most of its earnings from operating companies that generate steady earnings every year and are valued based on earnings rather than book value.  But Fairfax doesn't have any such businesses.

 

In 2013, Fairfax's book value went down by 10% while the stock went up by 18%, a difference of 28%.  Today it trades at around 1.25x book value.  The highest multiple it has ever traded is 1.44x (according to GuruFocus).  I think that Fairfax stock is significantly overvalued, which is both a good time for them to issue shares and a good time for Fairfax shareholders to be cautious.

 

At times, FFH's stock price has been multiples of its book value.  In 1996, it surpassed 3x book value. 

 

In the 1996 AR, Prem stated:

 

We have mentioned in the past that we are very careful about issuing shares. In our 1986 Annual Report we said, "We consider our stock as good as cash. When we issue stock, we will ensure that we get as much value as we give." While we have been very clear about the "getting" part, we consider the "giving" part to be equally important. So, while we have raised money at higher and higher stock prices in 1996, we feel our new shareholders are getting excellent long term value - otherwise we would not issue shares at these prices. Remember we said long term. In the short term, we have no idea where our shares will trade.

[thepupil]

 

Also, AZ had a good table in the article that started this thread showing that this 15% number is more wishful thinking than reality:

 

http://3.bp.blogspot.com/-0VVAtecz12M/U0XnlAVQ-RI/AAAAAAAAAwk/M4eJ1fewwSk/s1600/Fairfax+BV+CAGR.JPG

 

This is one point I disagree with in the article. We should always evaluate performance over a complete cycle, preferably over multiple cycles. We are arguably closer to top of bull market. So the performance even very long term ending at this point would unfairly penalize Fairfax.

 

Vinod

 

I think the fairest way to do these comparisons is to make rolling 3, 5, 10 year periods (perhaps quarterly) and show the distribution of those periods against the benchmark.  For good managers, I would expect something like: 65% outperformance for 3 years, 85% outperformance for 5 years, and 99% percent outperformance for 10 years, or something along those lines.

 

Anyone happen to have the data for that?

 

Edit: I'm also curious if anyone disagrees with measurement in that fashion or thinks there is a better way.  It seems to me to be the fairest since it is agnostic to particular time frames and the initial years.

 

I have done this for Berkshire stock. Berkshire has outperformed the s&p (inclusive of dividends) in 85% of monthly 5 year rolling periods since 1988, and 83% of those over the last 10 years. If you purchased in the months in which he has underperformed on a trailing basis you outperformed dramatically. If one based his or her stock decisions on this data the choice of which to dollar cost average  into is quite clear.

 

I own Berkshire because it is a well managed collection of businesses at a price that is relatively cheap to the s+p (there are obviously higher upside things out there) and not because of some arbitrary stock price performance statistics that i came up with to try to disprove all this "buffett has lost its stuff", but it is interesting.

 

Also in the months that Buffett has underperformed the median trailing performance of the S+P is +117%.

[Liberty]

This is one point I disagree with in the article. We should always evaluate performance over a complete cycle, preferably over multiple cycles. We are arguably closer to top of bull market. So the performance even very long term ending at this point would unfairly penalize Fairfax.

 

Vinod

 

Can you elaborate on why you think it "unfairly penalizes Fairfax"?

 

You don't feel 15-20 years is multiple cycles? If they had not hedged and had done great for the past 5 years, I don't think people would say that right now is not representative, just like they weren't saying that after the CDS win, and just like nobody is saying that now is not a good time to evaluate the performance of BRK and MKL, whether we're at a top or not.

 

Another question we could ask is how fast book value would have to grow over the next few years to bring up the average BV growth when you include the past 15 years. They say they're aiming for 15%, and I know they say results will be lumpy, but you'd need many years of 30% growth to compensate for those who bought 15 years ago..

[vinod1]

This is one point I disagree with in the article. We should always evaluate performance over a complete cycle, preferably over multiple cycles. We are arguably closer to top of bull market. So the performance even very long term ending at this point would unfairly penalize Fairfax.

 

Vinod

 

Can you elaborate on why you think it "unfairly penalizes Fairfax"?

 

You don't feel 15-20 years is multiple cycles? If they had not hedged and had done great for the past 5 years, I don't think people would say that right now is not representative, just like they weren't saying that after the CDS win, and just like nobody is saying that now is not a good time to evaluate the performance of BRK and MKL, whether we're at a top or not.

 

Another question we could ask is how fast book value would have to grow over the next few years to bring up the average BV growth when you include the past 15 years. They say they're aiming for 15%, and I know they say results will be lumpy, but you'd need many years of 30% growth to compensate for those who bought 15 years ago..

 

By cycle I mean a complete bear and a complete bull market. So you can measure it from top of a bull market to the top of the next bull market or from bottom of one bear market to the bottom of another bear market. Due to the way people approach investments, some are more likely to outperform during the bear phase (most value investors including Prem), while some are more likely to do better over the bull phase (Bill Miller for example). So if you measure it only over 1.5 or 2.5 cycle, etc. you are not likely to capture their true performance. It is like taking a measure of who is ahead at the 40 meter, 60 meter and 80 meter line for a 100 M sprint. Possibly interesting but not likely to reflect true skill.

 

So if you measure the performance at the top a bull market, value investors like Prem would not look good. If you measure them at the bottom of a bear market they would look much better than warranted. The only way to normalize this is to look at the complete cycle.

 

Just remembered that Buffett has mentioned this in the AR:

 

Charlie Munger, Berkshire’s vice chairman and my partner, and I believe both Berkshire’s book value and

intrinsic value will outperform the S&P in years when the market is down or moderately up. We expect to fall

short, though, in years when the market is strong – as we did in 2013. We have underperformed in ten of our 49

years, with all but one of our shortfalls occurring when the S&P gain exceeded 15%.

Over the stock market cycle between yearends 2007 and 2013, we overperformed the S&P. Through full

cycles in future years, we expect to do that again.

 

Vinod

 

 

[vinod1]

Another question we could ask is how fast book value would have to grow over the next few years to bring up the average BV growth when you include the past 15 years. They say they're aiming for 15%, and I know they say results will be lumpy, but you'd need many years of 30% growth to compensate for those who bought 15 years ago..

 

Do not disagree at all. Looking at the way they are positioned and just looking at the returns that can be expected of stock and bond markets, I do not think Fairfax can compound at more than 10% unless there is a severe market dislocation. Bond yields in the 3-4% range would be too tough to overcome for P&C companies.

 

Alleghany has commented on this in their recent letter and said that going forward 7-10% returns are their target. Fairfax should do so likewise.

 

Vinod

[vinod1]

 

Also, AZ had a good table in the article that started this thread showing that this 15% number is more wishful thinking than reality:

 

http://3.bp.blogspot.com/-0VVAtecz12M/U0XnlAVQ-RI/AAAAAAAAAwk/M4eJ1fewwSk/s1600/Fairfax+BV+CAGR.JPG

 

This is one point I disagree with in the article. We should always evaluate performance over a complete cycle, preferably over multiple cycles. We are arguably closer to top of bull market. So the performance even very long term ending at this point would unfairly penalize Fairfax.

 

Vinod

 

I think the fairest way to do these comparisons is to make rolling 3, 5, 10 year periods (perhaps quarterly) and show the distribution of those periods against the benchmark.  For good managers, I would expect something like: 65% outperformance for 3 years, 85% outperformance for 5 years, and 99% percent outperformance for 10 years, or something along those lines.

 

Anyone happen to have the data for that?

 

Edit: I'm also curious if anyone disagrees with measurement in that fashion or thinks there is a better way.  It seems to me to be the fairest since it is agnostic to particular time frames and the initial years.

 

Take 1990 to 2002 period. I am guessing, that the worst of the tech stock funds would have had pretty high rolling outperformance but would have had very large permanent loss of capital in the end.

 

I understand you are trying to come up with a mathematical way but I do not think this is the solution.

 

Vinod

[racemize]

I think the fairest way to do these comparisons is to make rolling 3, 5, 10 year periods (perhaps quarterly) and show the distribution of those periods against the benchmark.  For good managers, I would expect something like: 65% outperformance for 3 years, 85% outperformance for 5 years, and 99% percent outperformance for 10 years, or something along those lines.

 

Anyone happen to have the data for that?

 

Edit: I'm also curious if anyone disagrees with measurement in that fashion or thinks there is a better way.  It seems to me to be the fairest since it is agnostic to particular time frames and the initial years.

 

Take 1990 to 2002 period. I am guessing, that the worst of the tech stock funds would have had pretty high rolling outperformance but would have had very large permanent loss of capital in the end.

 

I understand you are trying to come up with a mathematical way but I do not think this is the solution.

 

Vinod

 

Ah, good point, I think if we add a requirement that this is only done for long term outperformance company/investors, then it would remove the permanent loss issue.  (I would generally only want to do this for something I was interested in investing in, which would only include something that is outperforming).

[Liberty]

By cycle I mean a complete bear and a complete bull market. So you can measure it from top of a bull market to the top of the next bull market or from bottom of one bear market to the bottom of another bear market. Due to the way people approach investments, some are more likely to outperform during the bear phase (most value investors including Prem), while some are more likely to do better over the bull phase (Bill Miller for example). So if you measure it only over 1.5 or 2.5 cycle, etc. you are not likely to capture their true performance. It is like taking a measure of who is ahead at the 40 meter, 60 meter and 80 meter line for a 100 M sprint. Possibly interesting but not likely to reflect true skill.

 

So if you measure the performance at the top a bull market, value investors like Prem would not look good. If you measure them at the bottom of a bear market they would look much better than warranted. The only way to normalize this is to look at the complete cycle.

 

Just remembered that Buffett has mentioned this in the AR:

 

Charlie Munger, Berkshire’s vice chairman and my partner, and I believe both Berkshire’s book value and

intrinsic value will outperform the S&P in years when the market is down or moderately up. We expect to fall

short, though, in years when the market is strong – as we did in 2013. We have underperformed in ten of our 49

years, with all but one of our shortfalls occurring when the S&P gain exceeded 15%.

Over the stock market cycle between yearends 2007 and 2013, we overperformed the S&P. Through full

cycles in future years, we expect to do that again.

 

Vinod

 

Thanks, that makes sense. I just feel it would change my mind more if the reason for the underperformance was their value approach rather than their macro bets.

 

ie. Berkshire hasn't done as well as the SP500 in the past 5 years, but I forgive them because they also didn't go down as much 6 years ago and I understand the logic behind their decisions.

 

For Fairfax, a lot of their stock picks did well in the past 5 years (WFC, JNJ, USB, Bank of Ireland, etc), it's just that shareholders won't really see most of those gains, even if there's another huge crisis (in which case, as I said, a lot of their current holdings would also drop a lot, so it's kind of a symmetrical bet).

[Guest longinvestor]

Another question we could ask is how fast book value would have to grow over the next few years to bring up the average BV growth when you include the past 15 years. They say they're aiming for 15%, and I know they say results will be lumpy, but you'd need many years of 30% growth to compensate for those who bought 15 years ago..

 

Do not disagree at all. Looking at the way they are positioned and just looking at the returns that can be expected of stock and bond markets, I do not think Fairfax can compound at more than 10% unless there is a severe market dislocation. Bond yields in the 3-4% range would be too tough to overcome for P&C companies.

 

Alleghany has commented on this in their recent letter and said that going forward 7-10% returns are their target. Fairfax should do so likewise.

 

Vinod

 

+1.  Tough to see how Prem would say that 7 to 10% is their target. There is a big lesson here about the perils of putting out return expectations like 15% long term.

 

[loganc]

CPI Contracts:

What matters is only the asymmetrical bet. Nothing else. Macro, micro, bla, bla, bla… If you find a coin and you get the chance to gain 10 if heads comes out or lose 1 if tails comes out, will you flip it?

Nothing else to say.

 

I like the analogy.  However, as regard the CPI contracts, how do you know you are flipping a "fair coin" or even a "coin" that provides "10:1"?  Is anyone smart enough to be able to determine the probabilistic attributes of a "coin" representing inflation?