Hey, Mr. Market! Do I really have to make FFH 50% of my portfolio?

[peterism]

Giofranchi, be carefull BV will likely do down in Q2 because of their bond portfolio. FFH marks most of their bonds to market (held for trading bonds are MTM). I can foresee some repricing of FFH this quarter.

 

BeerBaron

 

C’mon, beerbaron! That’s exactly Mr. Market’s thesis… There is always a reason why Mr. Market gives you an opportunity!

And a repricing is never easy to foresee… What you can and do know with FFH is the price you pay and the value you get!

Let a repricing unfold: I will average down gladly! ;)

 

giofranchi

 

It's not a thesis, the actual value of FFH went down with the bond portfolio. I like to anchor myself at a specific price/BV not a dollar value. I'll gladly buy a shipload at 90% of Q2 BV tough!

 

BeerBaron

 

The actual value of FFH will fluctuate a lot... Will go up and down... But I don't really care. What I care about is very simple: a company, that has increased BVPS at 20% annual for 26 years, has almost gone nowhere for 3 years now. And in the meantime it has done everything right. Someone believes they have made mistakes... But I disagree. I would have done exactely the same! And I don't think we will have to wait a lot more, to see BVPS increase very fast again. That's why I have no doubt that any price below $380 is great value!

 

giofranchi

 

 

Can you tell why as a yardstick for performance you are using 26 year result? If I look at last 15 years CAGR of BVPS is 12% and for last 10 years CAGR of BVPS is 11% (including dividends paid).

[giofranchi]

Can you tell why as a yardstick for performance you are using 26 year result? If I look at last 15 years CAGR of BVPS is 12% and for last 10 years CAGR of BVPS is 11% (including dividends paid).

 

Well, I guess any comparison with the past might only take you that far, right? What is really needed in investing is a strong conviction about future possible returns. There is really no substitute for due diligence and all the hours spent studying and trying to deeply comprehend a business. :)

 

giofranchi

 

[tombgrt]

Can you tell why as a yardstick for performance you are using 26 year result? If I look at last 15 years CAGR of BVPS is 12% and for last 10 years CAGR of BVPS is 11% (including dividends paid).

 

Well, I guess any comparison with the past might only take you that far, right? What is really needed in investing is a strong conviction about future possible returns. There is really no substitute for due diligence and all the hours spent studying and trying to deeply comprehend a business. :)

 

giofranchi

 

 

After doing your DD, what would you say are the possibilities for FFH? Other than Prem's track record of course. In the past, BV growth was helped by an amazing bull market in bonds, extraordinary CDS gains, the first years (? first year 180% BV growth if I remember correctly) of operations, ...

 

I'm just curious because just a few posts ago you said this:

 

Hi longinvestor!

I know and agree with all those true things about BRK... Yet, still I am not convinced... I just don't understand a business on autopilot... A business without a strong person at the helm... Just one man or woman... Not a team or a board of directors... But I know that's me, and only me!

 

Vice versa, I am not worried at all about Mr. Watsa's succession plan. When, 20 years from now, he steps down, FFH will simply be what BRK is today. And I will sell my investment.

 

giofranchi

 

 

The case for Berkshire is actually very simple (even after WEB is gone) with it's decentralized group of very high ROE companies, great insurance companies underwriting at a great CR and long-term equity investments. It's likely that it remains a stable powerhouse with satisfactory returns.

 

Considering that you said yourself that there is no alternative to doing your DD; why do you view Fairfax as more attractive?

 

[giofranchi]

Can you tell why as a yardstick for performance you are using 26 year result? If I look at last 15 years CAGR of BVPS is 12% and for last 10 years CAGR of BVPS is 11% (including dividends paid).

 

Well, I guess any comparison with the past might only take you that far, right? What is really needed in investing is a strong conviction about future possible returns. There is really no substitute for due diligence and all the hours spent studying and trying to deeply comprehend a business. :)

 

giofranchi

 

 

After doing your DD, what would you say are the possibilities for FFH? Other than Prem's track record of course. In the past, BV growth was helped by an amazing bull market in bonds, extraordinary CDS gains, the first years (? first year 180% BV growth if I remember correctly) of operations, ...

 

I'm just curious because just a few posts ago you said this:

 

Hi longinvestor!

I know and agree with all those true things about BRK... Yet, still I am not convinced... I just don't understand a business on autopilot... A business without a strong person at the helm... Just one man or woman... Not a team or a board of directors... But I know that's me, and only me!

 

Vice versa, I am not worried at all about Mr. Watsa's succession plan. When, 20 years from now, he steps down, FFH will simply be what BRK is today. And I will sell my investment.

 

giofranchi

 

 

The case for Berkshire is actually very simple (even after WEB is gone) with it's decentralized group of very high ROE companies, great insurance companies underwriting at a great CR and long-term equity investments. It's likely that it remains a stable powerhouse with satisfactory returns.

 

Considering that you said yourself that there is no alternative to doing your DD; why do you view Fairfax as more attractive?

 

For FFH I see a very safe 15% CAGR in BVPS for the next 10 to 15 years.

 

To know and accept what I still don’t understand, and therefore cannot judge, and therefore cannot put a valuation to, is imo an integral part of DD. I repeat what I said a few posts ago: I just don’t understand a business on autopilot.

 

But I am sure everybody else will do just fine with BRK! :)

 

giofranchi

 

[Packer16]

I wonder if Fairfax realizes the huge opportunity cost the hedges have been.  I also wonder if they think their excellent timing of the last crash (hedges going in and removing near the bottom) can be repeated?  Fairfax's sweet spot is in investments so the hedges have wiped out a majority of their advantage.  I read a good quote from Howard Marks that you can't structure your portfolio to live through another 2008 because it was worse than worse case and you won't have much of a portfolio.  I think this is what Fairfax has done and I hope that upon careful reflection they will change.  I think the analogy to the 1930s or Japan in the 1990s is a stretch to say the least as the evidence since 2008 shows that this is a different situation.

 

Isn't the historical growth due in a large part to a growing investment portfolio that has reasonable returns?  With the hedges you have removed a large portion of the returns and thus the historical BV growth as FFH's underwriting results are not the best.  To quantify this over the past 3 years that the hedges have been on it has reduced investment returns by 1% per year.  To get to a 15% BV growth, FFH will have to earn $1.6 billion (.15 * BV /(1-tax rate)) or 6.2% pre-tax return on investments assuming they can generate a 100% combined ratio.  Over the past 3 years they have earned 4.9% on their investments implying a BV growth of 11.4%.  If you don't have the hedges you are at 14.3%.  The other potential upside asset they have is the deflation hedges.  Although they purchased at a great price and they have nice option characteristics, I think unless a major economic collapse happens they will expire worthless as the world governments will not let deflation happen (see the Fed and even the current ECB actions).

 

Packer

 

[tombgrt]

Can you tell why as a yardstick for performance you are using 26 year result? If I look at last 15 years CAGR of BVPS is 12% and for last 10 years CAGR of BVPS is 11% (including dividends paid).

 

Well, I guess any comparison with the past might only take you that far, right? What is really needed in investing is a strong conviction about future possible returns. There is really no substitute for due diligence and all the hours spent studying and trying to deeply comprehend a business. :)

 

giofranchi

 

 

After doing your DD, what would you say are the possibilities for FFH? Other than Prem's track record of course. In the past, BV growth was helped by an amazing bull market in bonds, extraordinary CDS gains, the first years (? first year 180% BV growth if I remember correctly) of operations, ...

 

I'm just curious because just a few posts ago you said this:

 

Hi longinvestor!

I know and agree with all those true things about BRK... Yet, still I am not convinced... I just don't understand a business on autopilot... A business without a strong person at the helm... Just one man or woman... Not a team or a board of directors... But I know that's me, and only me!

 

Vice versa, I am not worried at all about Mr. Watsa's succession plan. When, 20 years from now, he steps down, FFH will simply be what BRK is today. And I will sell my investment.

 

giofranchi

 

 

The case for Berkshire is actually very simple (even after WEB is gone) with it's decentralized group of very high ROE companies, great insurance companies underwriting at a great CR and long-term equity investments. It's likely that it remains a stable powerhouse with satisfactory returns.

 

Considering that you said yourself that there is no alternative to doing your DD; why do you view Fairfax as more attractive?

 

For FFH I see a very safe 15% CAGR in BVPS for the next 10 to 15 years.

 

To know and accept what I still don’t understand, and therefore cannot judge, and therefore cannot put a valuation to, is imo an integral part of DD. I repeat what I said a few posts ago: I just don’t understand a business on autopilot.

 

But I am sure everybody else will do just fine with BRK! :)

 

giofranchi

 

 

But how do you come at that very safe 15% CAGR? I know Prem has stated it some 3 years ago but why do you believe it will occur business wise? To make up for the last 3 years of almost status quo after dividends, the BV has to double. I of course know that returns will be lumpy but I'm just showing what the hedges (mostly) are currently doing.

 

BRK is much safer. I bet a 10% return from BRK might even have a better risk-reward profile than 15% from FFH.

 

 

I wonder if Fairfax realizes the huge opportunity cost the hedges have been.  I also wonder if they think their excellent timing of the last crash (hedges going in and removing near the bottom) can be repeated?  Fairfax's sweet spot is in investments so the hedges have wiped out a majority of their advantage.  I read a good quote from Howard Marks that you can't structure your portfolio to live through another 2008 because it was worse than worse case and you won't have much of a portfolio.  I think this is what Fairfax has done and I hope that upon careful reflection they will change.  I think the analogy to the 1930s or Japan in the 1990s is a stretch to say the least as the evidence since 2008 shows that this is a different situation.

 

Isn't the historical growth due in a large part to a growing investment portfolio that has reasonable returns?  With the hedges you have removed a large portion of the returns and thus the historical BV growth as FFH's underwriting results are not the best.

 

Packer

 

I agree. Part of the reason is that they are quite vulnerable without if the market would indeed crash.

[giofranchi]

I wonder if Fairfax realizes the huge opportunity cost the hedges have been.  I also wonder if they think their excellent timing of the last crash (hedges going in and removing near the bottom) can be repeated?  Fairfax's sweet spot is in investments so the hedges have wiped out a majority of their advantage.  I read a good quote from Howard Marks that you can't structure your portfolio to live through another 2008 because it was worse than worse case and you won't have much of a portfolio.  I think this is what Fairfax has done and I hope that upon careful reflection they will change.  I think the analogy to the 1930s or Japan in the 1990s is a stretch to say the least as the evidence since 2008 shows that this is a different situation.

 

Isn't the historical growth due in a large part to a growing investment portfolio that has reasonable returns?  With the hedges you have removed a large portion of the returns and thus the historical BV growth as FFH's underwriting results are not the best.  To quantify this over the past 3 years that the hedges have been on it has reduced investment returns by 1% per year.  To get to a 15% BV growth, FFH will have to earn $1.6 billion (.15 * BV /(1-tax rate)) or 6.2% pre-tax return on investments assuming they can generate a 100% combined ratio.  Over the past 3 years they have earned 4.9% on their investments implying a BV growth of 11.4%.  If you don't have the hedges you are at 14.3%.  The other potential upside asset they have is the deflation hedges.  Although they purchased at a great price and they have nice option characteristics, I think unless a major economic collapse happens they will expire worthless as the world governments will not let deflation happen (see the Fed and even the current ECB actions).

 

Packer

 

Well, as I have said a few posts ago, last decade economic growth has been the second slowest after the ‘30s in American history (1.7% y-o-y vs. 1.4% y-o-y… sorry, cannot see all that difference!), despite monetary stimulus has been the most extreme in American history, much larger than what had ever been attempted even from 1933 to 1937 by the Roosevelt administration!

You must at least admit that the jury is still out…

To reflate bubbles, after they have burst, is not synonymous with prosperity, it is just prosperity in disguise!

But I guess in a couple of years we will have the final verdict, as “the great disconnect” of Mr. Shilling, will finally be resolved, one way or the other!

Until that time, whoever reaches for yield imo is not right, but just reckless and, if finally proven right, lucky. I repeat: FFH has made no major strategic blunder that I know of till now. They are great strategic thinkers and I would have done exactly the same. No, wait, actually I have done exactly the same!

 

If in a two years time the real economy finally does what policy-makers wish it for, then I would like to see FFH stop its hedging strategy. Vive versa, if it keeps going on even then, I will admit they are making their first serious mistake, and I will reformulate my thesis on FFH.

 

But then, anyhow, a lot of things will be very different… think of how wonderful it would be: we will have finally find the way to live beyond our means for decades and getting away without paying the consequences! A brand new fantastic world! Hmmm… I don’t think so!

 

giofranchi

[giofranchi]

To make up for the last 3 years of almost status quo after dividends, the BV has to double.

 

Fortunately, whoever buys today at BVPS doesn’t have to worry about that, right?

Think of it this way: I believe the today investor is buying at the bottom of the cycle! :)

 

giofranchi

 

[Packer16]

I think there is a tremendous difference between the 1930s and today.  In the 1930s you had mass of people in developed world poor as could be.  Now even our poor were middle class by the 1930s standards and have access to medicines and products only the rich had or could even dream of in the 1930s.  I think focusing on GDP growth is misleading.  It is metric economic progress not economic standing.  I agree that economic growth may be equivalent to the 1930s but overall health of the economy is much better.  The overall economic health is what is reflected in stock prices and to think there is a disconnect based upon GDP growth doesn't make sense.  The other question I have is where is the money going to go?  The wealth is accumulated where is it going to go?  Into mattresses?  gold?  bonds? 

 

In the 1920s there was alot of wealth created through leveraged structures that collapsed in the early 1930s.  Many of the large US enterprises were levered via holding companies (utilities are an example).  There are many example in "The Crash and its Aftermath".  Are there such leveraged structures today?  I have not seen many.  Much of decline in the early 1930s was due to the collapse of leveraged structures.  Also remember that you could buy stocks on 5 to 10% margin. 

 

Lets look at the 1930s in terms of stock prices.  Once prices hit bottom 1932 (and many of the leveraged structures were wiped out) prices increased from 50 to 175 in 1937 (up 250%) then fell back to 125-150 (still up over 200% from bottom in 1932).  Today the S&P has rallied by about 130% from the bottom in 2009.  Also look at the record and approach of an investor that did well in the 1930s John Maynard Keynes:

 

http://www.lsgifund.com/LSGIRMK/Keynes.pdf

 

Even with slow GDP growth I don't think the gains are excessive due to the relative cheapness of equities.  The one upside we have versus the 1930s is as the 30s progressed you had facsist regimes in Italy and Germany and WWII which destroyed tons of wealth.  Given you don't have that today, the question is if we don't have high leverage and there are no destroyers of wealth (wars), where will the money go?  I think stocks and if that is the case then FFH has hedged away its greatest competitive advantage.

 

Packer       

[giofranchi]

Packer,

maybe it is just me that don’t get it right… but I really don’t understand how it is possible to say there is no high leverage today… Just look at the balance sheet of Deutsche Bank (see the file in attachment)! The whole world is over indebted, even China! Where corporate debt alone is almost 200% of GDP! Do you think Japan is sustainable? Then I really don’t know what sustainable means! And southern Europe?! Can you imagine what it means for a nation, like Italy for instance, to live without a currency that makes economic sense? As long as policy makers don’t admit it, the Euro will continue to be a major distortion and will continue to cause dangerous misallocations of capital. And, if you don’t like GDP, what about personal incomes in the US, which have gone back to the ‘80s level? And the personal saving rate?! At little more than 2% it is way too low, and cannot be reconciled with a nation on its way to create true and lasting wealth. In the ‘30s also, the personal saving rate fluctuated in between 0% and 5%, until it spiked to 25%… and that was what ended the depression! A renewed culture of thriftiness and accumulation of wealth on a nationwide scale. Now think about what will happen to net margins, when the personal saving rate will get back to, let’s say, 10% from 2.4% today…

Yet, the stock market is at its all time high… But don’t you dare hinting at the fact the economy might be slowly improving, like Mr. Bernanke so naively did a few days ago, because that will trigger chaos… C’mon… Isn’t that ridiculous?!

In the last century wars have only been the consequences of dealing with the social unrest, that sprang from misconceived economic policies. They were not the true causes. Maybe, we will find other means to deal with our own over indebtedness, not necessary new wars… at least by their classic definition, but why do you assume those new means will be painless? I don’t see any reason why they should be!

 

giofranchi

Deutsche-Bank-Horribly-Undercapitalized.pdf

[shalab]

Hi Gio - I generally like your posts but I am not sure where you get the 2% savings rate from. The government statistics dont indicate anything of the type - here is the one for May.

 

http://content.govdelivery.com/attachments/USESAEI/2013/06/27/file_attachments/221663/Personal%2BIncome%2Band%2BOutlays%2B%2528May%2B2013%2529.pdf

 

 

I own FRFHF and am in awe of what Prem has achieved. However, I think FRFHF is not going to return you 15% a year for 10-20 years. These folks have returned ~9% a year from 2000 and have also increased the outstanding shares significantly. I am certain they are going to face more competition in insurance with the entry of the hedge funds and the re-energized former giants.

 

What I see in the U.S is rapid innovation and fierce market competition. In the last couple of years, we have seen the emergence of Tesla, 3D printing which likely will change the way we live for the better. I think Warren got it right when he said he is bullish about the future of America.

[Packer16]

I am primarily referring the corporate sector primarily in US which has more cash then ever and this is the sector where we invest (equities).  I don't trust China and wouldn't invest there.  I would not be an investor in governments at this point and individuals appear to be able to service their debts so I think they will be OK.  I agree that there will be subdued inflation so the there is no spark for interest rates to rise and thus increase personal debt service ability.  Just look at the write-offs for credit card companies, mortgages and auto finance.  These have been coming down and are within historic ranges.  If were in such dire straights we would see these continue to remain high but they are not.  I  think personal income growth again is growth measure and not a standard of living measure (which I think has increased significantly due to technology pushing prices down for the same product).  As to the personal savings rate, do we need to save 10% or higher like the Japanese?  I think not.  Much of the growth is obtained via IP which is not capital intensive.  The additional savings just sits around earning nothing so the market says we have too much savings worldwide.  If we did not have enough, interest rates would surely be higher and the capital would flow that way. 

 

I think market is at an all time high due to it being the best alternative for capital.  Is there a better place with lots of excess cash in the corporate sector, reasonable valuations and the alternatives providing no return.  The returns may be less than we have seen in the past but we have to invest today not yesterday.  I agree that expected returns have declined but they have declined more in the equity alternatives than in equities.  I think the debt over the long term will be monetized via financial repression just like after WWII in the US.  Under this scenario, real assets with cash flows will be priced higher in deflating currency.  In essence when you are holding cash you are holding currency so I would rather hold asset than currency.  Just my 2 cents.  BTW I am investing in cheap stocks just like Keynes and have not let the macro change my approach.

 

Packer     

[PlanMaestro]

The whole world is over indebted

 

Gio, that phrase should tell you instantly that there is something wrong in the argument. For every debtor there is a creditor … and we still have only one world. ;)

 

BTW I am investing in cheap stocks just like Keynes and have not let the macro change my approach.

 

Hero.

[mcliu]

Hi Packer, when you refer to record cash, is that net of the amount of debt that's on corporate balance sheets? Corporations seem to be issuing large amounts of debt to take advantage of low interest rates.

[tombgrt]

To make up for the last 3 years of almost status quo after dividends, the BV has to double.

 

Fortunately, whoever buys today at BVPS doesn’t have to worry about that, right?

Think of it this way: I believe the today investor is buying at the bottom of the cycle! :)

 

giofranchi

 

 

Unfortunately however, it is the real past. The bullish case was exactly what you are saying 3 years ago and Prem did make those remarks on 15% CAGR back then. While it has little impact on you as a new shareholder, it's still true history. You can't use the LT track record from year zero as a bullish point for owning the stock and ignore the lousy performance of the last 3 years both at the same time.

 

While I'm confident in Fairfax' future under Prem Watsa and believe you are right to be a buyer of the stock, I haven't heard convincing reasoning on the business side of the matter other than the fact that they are well-protected and the macro doom scenario. If that is your main point for owning Fairfax, why don't you prefer cash or better combination of both? Surely Fairfax would initially tank with the market if it crashes. The price action the last few weeks show that this likely would occur for FFH shares.. Although most of that price action is purely rational considering how bonds have done. FFH's stock valuation has barely changed, although the stock dropped 10%.

 

 

What I've learned from holding this stock on and off the past few years is that you can easily trade in and out and make the same or better return as you would by holding. If the market tanks or general economic disaster strikes, I'm sure I will be able to pick some up at a great price!

[Packer16]

An interesting paper that describes Keynes philosophy and returns:

 

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2023011

 

Packer

[giofranchi]

tombgrt,

probably, I didn’t express myself well enough… My idea is basically that it will take only a 7.5% annual return from their portfolio of investments, for FFH to increase BVPS at a CAGR of 15%. Given that, contrary to what happened during the last decade, I expect insurance operations to get better and better, and finally to achieve an underwriting profit, the annual return needed from their portfolio of investments might actually be only around 7%. Historically, instead, they have achieved a 9.4% annual return. If they perform 25.5% worse than they did in the past, buying at book today will assure you a 15% compounded return on your investment.

To say they returned just 9% during the last 10 years clearly doesn’t make sense… it is enough to read Mr. Watsa’s 2012 AL to understand it very clearly… They thought they should be particularly careful with their portfolio of investments during the last 10 years, and probably during the next 5 years, and therefore they embarked FFH on a “defensive – aggressive – defensive again – aggressive again trip”. In 2003 – 2006: defensive, in 2007 – 2009: aggressive, in 2010 – 2013: defensive again… Well, but it should be evident to everyone it is an unfinished trip!! To judge their future possible performance, based on the last 10 years, makes no sense to me.

 

As far as trading is concerned, to jump in and out FFH, it might be a good idea… But I don’t do that. I have two businesses to look for each single day, and don’t have the time to get comfortable with trading. As Mr. Harriman said:

I want something that will grow

And I stick with it.

 

 

Packer,

I love Mr. Keynes and I think he has been one of the great minds of last century. And I love the way he invested his capital. Anyway, as you can see from the file in attachment, his net worth in 1936 was £506.522, while in 1945 is was just £411.238, after declining to as low as £171.090 in 1940… think of it: in just 4 years he saw his net worth declining –66.2%… According to maynardkeynes.org, also the Chest Fund suffered a –40.1% decline in 1938, then again a –15.6% in 1940, for a cumulative decline of –43% from 1937 to 1940…

Sorry, but I cannot conceive investing like the world were always the same… Studying all the great “wealth accumulators” of the past, they have one thing in common: they knew when to be aggressive, and when to be defensive… ah! And, of course, they were also right!

To have cash in a recession is divine

WEB, and, if you look at BRK’s balance sheet, at the end of 2012 they had 18% of Total Assets (or 41% of Equity) in Cash + Bonds, with $1.2 billion of free cash coming in every month. BRK will never suffer from a lack of cash: we better make sure we will neither!

 

 

Shalab,

My source of information is The Gary Shilling Insight, whose source in turn is The Bureau Of Economic Analysis. Its last point was Feb.2013 and it was 2.6%. If in the meantime it has gone up to 3.2%, it is good news. But, please consider that it is a very volatile figure, so a +0.3% in April followed by a +0.4% in May might not make a positive trend yet…

 

 

PlanMaestro,

You surely know better than that! When there is too much debt, everyone is on the hook. No one is spared. Too much debt basically means two things: 1) too much capital chasing too few ideas, huge misallocations of capital and bubbles follow; 2) capital spent recklessly to live beyond our means.

In either case capital will be destroyed. It follows that both borrowers and lenders will suffer almost the same. And for good reasons! Because lenders behaved foolishly and acted imprudently. Now they won’t have their money back. So, it really doesn’t matter who is the lender and who is the borrower. Once there is too much debt, compared to the net worth or to the income capability of an individual, a family, a business, a nation, or the world, 1) and 2) will make sure borrowers and lenders will suffer alike.

 

giofranchi

John_Maynard_Keynes_Part2-October_2010.pdf

[Packer16]

Thanks for your assumptions.  I just do not see how they get a 7% return with the hedges and the only enhancer is the deflation swaps.  Over the past 3 years (returns excluding the CDS), the investment portfolio grew by only 4.9% (losing a whole point to hedging).  Over 5 years it was 6.5%.  How do you think they will get to a 7% return again with the hedges and high current bond prices?  A good part of the 5 and 10-yr investment growth is due to CDS.  They really need insurance to step up to the plate and/or remove the hedges to reach the 7% target.

 

The other issue that I think is at odds with Marks is was 2008 a once in 50-year event or will reoccur in the near future.  FFH appears to think it will re-occur while Marks does not and thinks putting a portfolio together to withstand a 2008 event does not make sense.

 

Packer 

[giofranchi]

Thanks for your assumptions.  I just do not see how they get a 7% return with the hedges and the only enhancer is the deflation swaps.  Over the past 3 years (returns excluding the CDS), the investment portfolio grew by only 4.9% (losing a whole point to hedging).  Over 5 years it was 6.5%.  How do you think they will get to a 7% return again with the hedges and high current bond prices?  A good part of the 5 and 10-yr investment growth is due to CDS.  They really need insurance to step up to the plate and/or remove the hedges to reach the 7% target.

 

The other issue that I think is at odds with Marks is was 2008 a once in 50-year event or will reoccur in the near future.  FFH appears to think it will re-occur while Marks does not and thinks putting a portfolio together to withstand a 2008 event does not make sense.

 

Packer

 

1) I think we should not forget that the hedges, both if proven useful and if otherwise proven a waste of resources, are a matter of 2 more years, 3 at the maximum! If after that they should happen to be still in place, as I have already said, I will be the first to change my view on FFH.

2) At year end 2012 BRK had only 7% of its total assets in bonds. In what probably is going to be a secular bear for bonds, Mr. Watsa will shape FFH to resemble BRK structure more and more. If bonds are no longer an attractive vehicle for investments, Mr. Watsa will choose other asset classes to get a decent return on FFH’s total assets.

 

I want to find someone who is a good strategist, who stays flexible, and doesn’t have too many investing rules. Because too many investing rules and opportunism rarely go along together well. Instead, I want someone who constantly reassesses the situation and takes decisions accordingly. At the same time, I want to see a basic “philosophy”, that provides the solid bedrock on which everything else will be built. Opportunism and Value are a philosophy, not rules. Both Mr. Watsa and Mr. Marks fit my idea of great business partners. And, as strange as it might sound, I am positive they both will ultimately do very fine, even if today they have different views and have structured very different portfolios of investments.

 

giofranchi

 

[Packer16]

I hope you are right about the hedges.  I guess because I am a glass half full guy, I have a hard time buying into apocolyptic scenarios and it looks like today FFH's portfolio is structured for this type of scenario.  Once they change this bias I will feel more comfortable with a 15% BV growth number.  HWIC are great investors, I just think it is a shame they are hedging away their advantage.  However, if it is only for a few years, they should do fine in the long-term.

 

Packer

[giofranchi]

This gap must somehow be closed: either the blue line goes up to meet the red one, or vice versa. In any case I don’t think we will have to wait much longer to know. And, when we finally know, hedges will make sense no more!

 

giofranchi

[Packer16]

My question is why given you are measuring an change variable (GDP growth, % workforce participation) versus a non-change variable (stock prices)?  Couldn't money flow from what most consider overvalued bonds (esp, with financial repression) or commodities to stocks?  This is an allocation issue.  Over the past few years we have seen huge outflows of stock funds into bond funds and over the LT I would expect that change.  This would cause an increase in the value of stocks with no increase in GDP or workforce participation required.  If the GDP grows at a slower rate then it will add to the increase in stock prices.  I see the biggest danger to higher stock prices as the end of financial repression or inflation (as either would increase interest rates and suck funds from stocks).  I see neither of these two playing out over the next few years. 

 

Packer

[giofranchi]

Well, I think it is not just me! Mr. Bernanke’s stated goal is to reduce unemployment, right? And I guess we all agree on the fact that a cost of money that makes no sense has always led to misallocations of capital and bubbles… So, the question is: will the UCBOTW (United Central Banks of The World) succeed in engineering growth and in lowering unemployment with their monetary tools? Or not? If they are successful, I guess they will be able to gradually take the cost of money back to more sensible levels, without any major disruption. I know everybody is worried about interest rate hikes… But I don’t fully agree… In 2009 the UCBOTW saved us… And we have proceeded since then on the assumption they know what they are doing and will ultimately be successful… If they are successful, I don’t see confidence really broken by a rise in interest rates… Sure, there will be adjustments, but nothing dramatic… A more sensible cost of money might even be seen as a positive adjustment! On the other hand, as soon as we lose faith in the UCBOTW, chaos will ensue, no matter how low interest rates are, or how much money will be printed… Imo, it is really as simple as this: if the UCBOTW are successful, FFH’s hedges will prove to be a waste of resources; if, on the contrary, the UCBOTW ultimately fail, FFH’s hedges will prove to be very useful.

 

giofranchi

 

[mcliu]

I don't think anyone can predict how the stock market will perform over the next two or three years. To invest on the definitive prediction that it will rise is close to speculation. Given the amount of external factors affecting markets today, there's possibly a higher probability of markets experiencing a shock in the near future.

 

No one knows how the future will play out for sure, but if you have a slightly negative view, it doesn't seem to be a terrible time to be hedged.

 

Obviously, you'll experience a couple years of poor returns, especially if the hedged event does not occur, but the benefit is a peace of mind and protection of capital. And if the hedged event does occur, the firm will be at a huge advantage.

[rjstc]

I don't think anyone can predict how the stock market will perform over the next two or three years. To invest on the definitive prediction that it will rise is close to speculation. Given the amount of external factors affecting markets today, there's possibly a higher probability of markets experiencing a shock in the near future.

 

No one knows how the future will play out for sure, but if you have a slightly negative view, it doesn't seem to be a terrible time to be hedged.

 

Obviously, you'll experience a couple years of poor returns, especially if the hedged event does not occur, but the benefit is a peace of mind and protection of capital. And if the hedged event does occur, the firm will be at a huge advantage.

 

Does it maybe seem a little better to just concentrate on growing the business ie; Berkshire, Markel, etc rather than hopping around trying to guess the next macro trend?