Watsa from his 2014 annual letter

[original mungerville]

I am going to include myself with this comment: "I would not get too cute trying to time things perfectly here." We are all going to be wrong on our timing, so a phased plan makes the most sense to me. This correction has been forming for some time, it became increasingly obvious a couple weeks ago around time of the Yuan devaluation, and then last week, well, I guess it started.

 

I hear Dazel say he has time for Gold, or others say they have time for FFH, etc. maybe. People are stunned now and just selling, we will get a rebound at some point, then things will settle for a few days, people will start to realize where to put their money...its not necessarily the case you have more than a fews days / week or two until people start adjusting to this.

[Partner24]

You should not focus on what the price of FFH will be before taking your decision. What matters most is the gain in intrinsic value. The scoreboard will sooner or later take into account what happens on the field.

 

If it is later than sooner, you'll get the chance to buy FFH at a cheaper price along the way.

 

Cheers!

[tombgrt]

I think my computer is broken, Nasdaq down 8%? Lol!

 

 

GM down 15% to $25. Yihaaa.

[Alekbaylee]

It would be a good idea for Fairfax to release an update on their hedging portfolio with the vote for the Watsa family voting structure results today to let their investors know how the hedges are performing.

 

Or buy back some of their shares before they rebound.  ;)

[Partner24]

Terrific. 

 

It's on days like this that value investors can put into pratice what WEB have teached us.  :)

 

 

 

 

 

 

[rb]

I don't think your computer is broken. Mine says the same thing. Plus DOW is down 4%. BRK down 4%, WFC down 5%

 

Oh and it looks that the market is recognizing the FFH hedges. They're only down 1%. Or it could be just Dazel buying stock  ;)

[tombgrt]

I don't think your computer is broken. Mine says the same thing. Plus DOW is down 4%. BRK down 4%, WFC down 5%

 

Oh and it looks that the market is recognizing the FFH hedges. They're only down 1%. Or it could be just Dazel buying stock  ;)

 

I bought some Fairfax as well following Dazel. I guess it makes sense. After all Gio is out as well, great contra-indicator!

 

 

VXO at 45 btw.

 

I'm stuck at work trying to get some orders filled through the ib smartphone app. Fun.  >:( Damn, both GM and JPM warrants were down some 25%. CSU down 15%+ or something briefly. Efficient market my ass.

[ap1234]

Dazel,

 

As always, thank you for your contributions to the board! I always enjoy our posts.

 

Similar to you, I am long FFH. I like the fact that the company acts as a unique diversifier/uncorrelated bet within my portfolio. Today’s valuation is not particularly expensive and there is a lot of embedded optionality given their defensive positioning.

 

That said, you made a few interesting comments about Fairfax making a killing on their bond portfolio/equity hedges right now and suggested we could potentially see a 10% up day in the stock at some point.

 

Can you provide some more color on why you think Fairfax is currently making a killing in this environment? Based upon their disclosed positions, I don’t see Fairfax’s BV growing meaningfully since Q2.  I’d be interested to know whether I am missing anything? My thoughts are below:

 

1. Equities: Prem has said in the past that during a market downturn, Fairfax’s equity portfolio will hold up better than the market (i.e. they will make a profit on their equity hedges).

 

Based upon their disclosed equity holdings (US holdings in 13F + Bank of Ireland + Greek equities), it doesn’t appear that Fairfax is outperforming the market on the way down (i.e. their disclosed equity positions have dropped more than the Russell 2000 in Q3). Without knowing the exact nature of the individual equity hedges, it's hard to know how it is has performed over the past few months.

 

2. China: Fairfax has been publicly warning about the risks in China for many years. They have discussed at length the property bubble, the super cycle in commodities, etc. However, their equity hedges aren’t directly correlated to their views on China.

 

Based upon previous conversations with management (unless anything has changed over the past few months), my understanding is that they didn’t use equity hedges to directly profit from a Chinese slowdown. Instead, their view was that if China slows down there will be contagion around the world and the most expensive stock markets (ex. Russell 2000) will be impacted. They have some smaller individual equity hedges that are more direct bets on a China slowdown but these are reasonably small in relation to their overall hedges and the size of their investment portfolio. 

 

3. Fixed income: The majority of their bond portfolio is in US muni bonds. Less than 20% is in US Treasuries. Based upon QTD moves in US Treasuries + the performance of the muni bond index (as a rough proxy), I don’t see a significant gain. They also have some corporate bonds as well as acquired fixed income portfolio from Brit but it still doesn’t make a huge dent based upon my back of the envelope math (i.e. not significant in relation to the company's BV).

 

While I would love to wake up and see Fairfax up 10% in a day, nothing as of yet leads me to believe it will happen.

 

Of course if the market collapses from here (a very real possibility) and Fairfax covers the hedges and puts their cash to work, the company’s BV/share will grow materially. Some investors may begin to pay up for this optionality in advance but QTD returns on their investment portfolio don’t suggest to me that they have grown BV materially.

 

If I am missing anything, I'd love to hear your analysis.

 

[Jurgis]

Good post ap1234. :)

[bluedevil]

ap1234,

 

In the second quarter, the fixed income portfolio lost $660 million due to rising treasury yields.  That loss should be reversed completely based on yield declines this quarter.  This alone should result in $30 per share book value increase.  Any reason to doubt this MTM loss has reversed based on interest rates?

 

Deflation hedges should be up given declining inflation expectations, though those are hard to price quarter to quarter.

 

Hard to say what is happening with equity hedges vs. equity holdings b/c of limited disclosures, but my read of the statements is that they have $6.8 billion in hedges.  With stock markets down about 10% this quarter so far, that's about a $680 million gain on hedges.  At least $250 million will be offset by losses on Eurobank and BBRY alone, but hopefully they come out ahead on equities + hedges this quarter.

 

 

[TwoCitiesCapital]

ap1234,

 

In the second quarter, the fixed income portfolio lost $660 million due to rising treasury yields.  That loss should be reversed completely based on yield declines this quarter.  This alone should result in $30 per share book value increase.  Any reason to doubt this MTM loss has reversed based on interest rates?

 

Deflation hedges should be up given declining inflation expectations, though those are hard to price quarter to quarter.

 

Hard to say what is happening with equity hedges vs. equity holdings b/c of limited disclosures, but my read of the statements is that they have $6.8 billion in hedges.  With stock markets down about 10% this quarter so far, that's about a $680 million gain on hedges.  At least $250 million will be offset by losses on Eurobank and BBRY alone, but hopefully they come out ahead on equities + hedges this quarter.

 

Muni spreads have widened, but it's hard for me to know that impact versus the gain from generally falling rates. There's no doubt that the portfolio will have underperformed Treasuries, but we also have a higher yield which may make up for it. I am fully expecting a reversal of the losses, but there are reasons why it may not. Also, I know what Fairfax's exposure is the explosion in China, but that could be a one-off impact too that gives us a chance to dig in at better prices.