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

[Uccmal]

Parsad says: Well, HW is hedged 100%+!  So either governments can pull off an equally stellar coordinated withdrawal of capital, as they did when injecting it...or the shit hits the fan.  Will be interesting to see how Berkshire handles the situation if the hard core guys are the ones who are correct.  Cheers!

 

 

 

 

The withdrawal is a highly anticipated event.  It will move markets down temporarily, and create some short term dislocation, and perhaps a reasonable buying opportunity.  But it is in essence a positive event and a nomalization of the relationship between states and the economies of western nations.

 

Buffett has been ploughing money into Mid-American which will be unaffected by this nonsense.  He is also building cash again so he will have lots to deploy if some deals surface.  There is no reason to suggest that P&G, KO, or Heinz will suffer as much as many others in a mild recession.  On the other hand Bank of Ireland, BBRY, and Resolute will get crushed like bugs. 

[Parsad]

Parsad says: Well, HW is hedged 100%+!  So either governments can pull off an equally stellar coordinated withdrawal of capital, as they did when injecting it...or the shit hits the fan.  Will be interesting to see how Berkshire handles the situation if the hard core guys are the ones who are correct.  Cheers!

 

 

 

 

The withdrawal is a highly anticipated event.  It will move markets down temporarily, and create some short term dislocation, and perhaps a reasonable buying opportunity.  But it is in essence a positive event and a nomalization of the relationship between states and the economies of western nations.

 

Buffett has been ploughing money into Mid-American which will be unaffected by this nonsense.  He is also building cash again so he will have lots to deploy if some deals surface.  There is no reason to suggest that P&G, KO, or Heinz will suffer as much as many others in a mild recession.  On the other hand Bank of Ireland, BBRY, and Resolute will get crushed like bugs.

 

You're talking about a very small portion of Fairfax's portfolio...about 10%. 

 

While the withdrawal is a highly anticipated event, the outlier effects are completely unknown when considering the enormity of the intervention.  I'm not sure either Buffett or Prem can accurately anticipate the fallout or success.  No one can!  Cheers!

[txlaw]

Taking into account that FFH is a leveraged investor, and assuming that FFH is more likely than not correct about the disconnect between financial markets and economic fundamentals, I'm still a little unclear on why a 100% equity hedge is necessary for "protection." 

 

What exactly are they protecting themselves from?  From going under?  From not being able to earn a certain amount of premiums?  Or solely from having their book value marked down in a manner correlated with the market? 

 

Let's say that FFH (treating FFH as one big insurer) simply wants to be able to maintain their net premiums earned at a Net Earned Premiums/Equity ratio of no more than 1:1.  FFH's shareholder equity is currently at $8.5 billion, and net earned premiums on an annualized basis is $5.8 billion.  The common plus preferred portfolio is at $5.3 billion.  Why couldn't they just hedge 50% of their common + preferred portfolio to meet their protection goals?  Why 100%?

 

At the annual meeting, I believe management -- I think it may have been Paul Rivett -- indicated that FFH was hedged so that they could write a substantial amount of insurance if/when the markets declined.  For those of you who went (Grenville?), am I right about that?  Or am I misremembering that?

 

I guess the theory is that after the market declines: (1) FFH would have a hard insurance market to underwrite in; (2) FFH's surplus would be at roughly the same place as it is now (or even greater); and, therefore, (3) FFH would be able to drastically increase net premiums earned while simultaneously having undervalued markets to invest in. 

 

This implies they are hoping to make a substantially more leveraged bet on equities after an anticipated market decline.  Which would really juice their returns if they are correct.  But this seems a bit more of a directional bet than protection, per se.

[txlaw]

So either governments can pull off an equally stellar coordinated withdrawal of capital, as they did when injecting it...or the shit hits the fan.

 

Why can't there be some middling scenario? 

 

A lot of people say that the injection of capital has juiced the capital markets, but economic growth remains tepid.  Okay, well, if capital is withdrawn in a less than stellar, non-coordinated manner, isn't it possible that the capital markets tank, but that economic growth continues at its tepid pace?

 

And if economic growth continues at the same pace, then won't real businesses (in aggregate) continue to generate wealth at the same rate they have been?  If that is the case, then doesn't it still make sense to own good businesses if you are valuing them based on economic fundamentals?

[Packer16]

My question is why do they have to withdraw until they see inflation? With all the deleveraging to go we may not see inflation for 5 years+?  If that is the case then how are these portfolios filled with cash going to do?  I would be concerned if I say reckless behavior in stock or lending markets (which I do not) or inflation (which I do not).  Am I missing something?  I am not finding 20 and 30 cent dollars (like I found a few years ago) but I am finding 50 to 60 cent ones with an occasional 20 center thrown in.

 

Packer

[Parsad]

That stage has passed. Berkshire won't blink even if hard core guys are correct, it cares if there is permanent damage to intrinsic value of the companies it owns.

 

You know this better, such comments of yours surprises me, may be the head is stuck in FFH bin. On macro level, I think, we should be watching if inflation crosses 2% level for the Fed to act.

 

Could be you are buying into the Berkshire hype a bit.  Investors were always told that Berkshire could not sink.  Then we are told by Buffett in 2008 that Berkshire was weeks away from sinking, if the Fed had not acted to stabilize the system...although they would be the last to sink. 

 

How many people had their entire life's savings in Berkshire Hathaway?  Foolish to think that corporations aren't susceptible to economic collapses...even the best of the best are susceptible when you have leverage, debt, counterparty liability, and in many cases regulatory requirements for statutory levels of capital!  Cheers! 

[rjstc]

That stage has passed. Berkshire won't blink even if hard core guys are correct, it cares if there is permanent damage to intrinsic value of the companies it owns.

 

You know this better, such comments of yours surprises me, may be the head is stuck in FFH bin. On macro level, I think, we should be watching if inflation crosses 2% level for the Fed to act.

 

Could be you are buying into the Berkshire hype a bit.  Investors were always told that Berkshire could not sink.  Then we are told by Buffett in 2008 that Berkshire was weeks away from sinking, if the Fed had not acted to stabilize the system...although they would be the last to sink. 

 

How many people had their entire life's savings in Berkshire Hathaway?  Foolish to think that corporations aren't susceptible to economic collapses...even the best of the best are susceptible when you have leverage, debt, counterparty liability, and in many cases regulatory requirements for statutory levels of capital!  Cheers!

 

What do you mean by sinking? They have obviously sunk off and on but have always come back.

 

[finetrader]

Don't have the crystal ball to say where the market is going.But with stock market going higher I've boosted my hedge to 25% of portfolio from 15%. And with about 20% in cash, I guess I have 45% portfolio protection.

 

I suspect the september return to office will not be to buy more stocks, but most probably to assess risk in the market and economy and act accordingly.

[Parsad]

That stage has passed. Berkshire won't blink even if hard core guys are correct, it cares if there is permanent damage to intrinsic value of the companies it owns.

 

You know this better, such comments of yours surprises me, may be the head is stuck in FFH bin. On macro level, I think, we should be watching if inflation crosses 2% level for the Fed to act.

 

Could be you are buying into the Berkshire hype a bit.  Investors were always told that Berkshire could not sink.  Then we are told by Buffett in 2008 that Berkshire was weeks away from sinking, if the Fed had not acted to stabilize the system...although they would be the last to sink. 

 

How many people had their entire life's savings in Berkshire Hathaway?  Foolish to think that corporations aren't susceptible to economic collapses...even the best of the best are susceptible when you have leverage, debt, counterparty liability, and in many cases regulatory requirements for statutory levels of capital!  Cheers!

 

What do you mean by sinking? They have obviously sunk off and on but have always come back.

 

Buffett said that Berkshire was weeks from going under if the Fed didn't step in.  That's how bad things had gotten at one point. 

 

Whether that was a bluff or not by Buffett, I don't know...but he would not make a statement about Berkshire like that if he didn't think it was possible.  He reiterated the comment in his open thank you letter to Uncle Sam on November 16, 2010.  Cheers!

 

http://www.nytimes.com/2010/11/17/opinion/17buffett.html?_r=0

[SharperDingaan]

The withdrawal is a highly anticipated event    It has already been going on for quite some time ....

 

Most yield curves are now relatively normal, & no longer flat or inverted; ie: re-established risk premiums.

Most 1 Yr T-Bill/Gilt/Canada rates less inflation are now either on the bubble, or only mildly negative.

Most major banks now have materially better capital ratios than they once had.... & they are getting better still

 

Most would argue that you do not start withdrawing support until you have actually have an economic take-off, & the infra-structure to support it.  That infra-structure has been getting rebuilt for quite some time, & it has been designed for resiliency. It has also been getting repeated real-time tests (Cyprus, Greece, Portugal, Spain), & each test has resulted in smaller shock waves.

 

Yes there will be the unintended goofs ... but the waves are now more likely to be moderate/heavy swells versus the all out tsunamis.

 

[Grenville]

 

At the annual meeting, I believe management -- I think it may have been Paul Rivett -- indicated that FFH was hedged so that they could write a substantial amount of insurance if/when the markets declined.  For those of you who went (Grenville?), am I right about that?  Or am I misremembering that?

 

 

Txlaw,

 

I don't remember if anyone said that at the meeting. I think others have talked about that on the board.

 

However, I am working under the assumption that the hedges are in place to protect their ability to write if equity markets take a dive.

 

I did a quick search on the last few quarterly transcripts for the word "hedges" and on the Q3 2012CC Prem's response doesn't connect the hedges to the ability to write, but more to just stay protected and conservative like here:

 

Tom MacKinnon - BMO Capital Markets Canada

Prem, what we're seeing here, we're starting to see underwriting results improve, both for you guys and for the industry, and but your -- to some extent, your investment portfolio was a conservative and cautious stance, doesn't really allow you to participate fully in any kind of earnings run-up associated with what could be potentially firming markets. I'm wondering what's your message to investors relative this? Is this just to continue to be patient? And what would it take to change your mind, vis-à-vis the equity hedges and the significant cash position?

 

V. Prem Watsa - Chairman and Chief Executive Officer

That's a very good question. That's a key question, Tom. The underwriting operations for our company -- all our companies is improving as you pointed out, improving quite significantly. But the investment side, we're very conservative. We've got 33%, $8 billion in cash, common stock positions are fully hedged. We have very little corporate bonds. Our muni bonds are predominantly guaranteed by Berkshire Hathaway, so it's a very conservative portfolio. And the reason for our conservative portfolio is very simply, the -- it seems to us that the disconnect between the fundamentals, in terms of companies and economies, and markets. So stock price -- stock and bond markets are high and the fundamentals we think, are quite different, meaning on the low side. And so you'll either have the fundamentals go up over time to catch up with stock prices, catch up with very low spreads, or you'll have the markets come down. And we've said for some time, this time period, we think of it as a 1 in 50, 1 in 100-year event. It's not a normal time period. And so we just think you have to be very, very careful. The fact that we've got cash in our portfolios, making no money today is a big advantage as and when opportunities come. Because of course, the only people who can take advantage of it is the people who have cash. In 2008, Tom -- 2008, 2009, you had a very significant -- 2 things happened, right? You had the stock market dropped almost 30% and the spreads widened significantly. And in that time period, we had 75% of our portfolios in cash and government bonds. So we could take advantage of the opportunities that presented themselves to us. And 2010, 2011, we've started hedging and in by 2011, we've hedged significant parts of our portfolio. But the other hand, we have realized very significant gains. So in the first 9 months, I think we have realized $730 million, but it's masked in a way, by the unrealized losses on the hedges. And we expect that to reduce, Tom, over time, and perhaps even become profits as it had in '08, '09.

 

So, and to summarize, Tom, we just said we've always been always long-term -- our long-term results are excellent. In any single year, in any single quarter, we can't tell you what we'll make. Our investment results have been lumpy. They're not smooth. We're not looking at providing 5%, 10%, 15% growth every quarter. We don't know how to do it -- we'd love to do it if we could but what we have focused our company from inception, 27 years ago, is on the long term. And that continues to be the case.

[JBird]

When in 2008 did Buffett say Berkshire was weeks away from going down? AGM?

[Guest wellmont]

Buffett never said he would go under. Some very smart people think we would have survived just fine without government intervention, after a massive, painful clean out of the system.

[ERICOPOLY]

The other way to look at things is the index has recorded more than $300 in earnings since they went to 100% hedged.  It has burned off, through earnings, more than 25% of the market valuation (the fat) since they hedged.

 

So does that make $900 the new $1,200?  Or is this the wrong way to think about it?  They went completely unhedged at $800, and when it came back up to $900 they didn't use that opportunity to go fully hedged.  Not until $1,200.  But there is a lot of earnings under the belt now -- so how do they view those accumulated earnings in relation to where they would un-hedge?

 

[merkhet]

Perhaps the full quote would be more instructive.

 

http://www.nytimes.com/2010/11/17/opinion/17buffett.html

 

My own company, Berkshire Hathaway, might have been the last to fall, but that distinction provided little solace.

 

If Mr. Buffett was using "might" in the way you guys are suggesting, then he would have written "would have provided" as opposed to just "provided."

[Guest longinvestor]

That stage has passed. Berkshire won't blink even if hard core guys are correct, it cares if there is permanent damage to intrinsic value of the companies it owns.

 

You know this better, such comments of yours surprises me, may be the head is stuck in FFH bin. On macro level, I think, we should be watching if inflation crosses 2% level for the Fed to act.

 

Could be you are buying into the Berkshire hype a bit.  Investors were always told that Berkshire could not sink.  Then we are told by Buffett in 2008 that Berkshire was weeks away from sinking, if the Fed had not acted to stabilize the system...although they would be the last to sink. 

 

How many people had their entire life's savings in Berkshire Hathaway?  Foolish to think that corporations aren't susceptible to economic collapses...even the best of the best are susceptible when you have leverage, debt, counterparty liability, and in many cases regulatory requirements for statutory levels of capital!  Cheers!

 

What do you mean by sinking? They have obviously sunk off and on but have always come back.

 

Buffett said that Berkshire was weeks from going under if the Fed didn't step in.  That's how bad things had gotten at one point. 

 

Whether that was a bluff or not by Buffett, I don't know...but he would not make a statement about Berkshire like that if he didn't think it was possible.  He reiterated the comment in his open thank you letter to Uncle Sam on November 16, 2010.  Cheers!

 

http://www.nytimes.com/2010/11/17/opinion/17buffett.html?_r=0

 

I want to challenge the twisted interpretation that "even" Berkshire is not safe, and therefore concentrated investment in one company is not a good idea.

 

Warren was talking in the context, once, of the 1-in-50/100 year event would have taken much more than one company down. Like his statement that if there is nuclear war we would not be worrying about our investment.

 

I'd like to stick with Warren and Charlie's repeated statements: Ignore macro, don't buy and sell, and when you like an idea CONCENTRATE

 

 

[txlaw]

However, I am working under the assumption that the hedges are in place to protect their ability to write if equity markets take a dive.

 

What are your thoughts on the notional value of the hedge?  The 100% versus some lesser percentage question.

 

 

Mr. Watsa said:

So, and to summarize, Tom, we just said we've always been always long-term -- our long-term results are excellent. In any single year, in any single quarter, we can't tell you what we'll make. Our investment results have been lumpy. They're not smooth. We're not looking at providing 5%, 10%, 15% growth every quarter. We don't know how to do it -- we'd love to do it if we could but what we have focused our company from inception, 27 years ago, is on the long term. And that continues to be the case.

 

So this is really the issue.  Are they really trying to maximize "total return" over the long run, or are they straying towards an "absolute return" strategy?

 

As I just posted on another thread, it's possible that FFH believes that the best thing to do for "total return" is to preserve the ability to underwrite as much business as possible because they believe a very hard market will ensue in the near future. 

 

That would make a lot of sense to me.  Instead, we tend to get these lines about "protection" and being "conservative."  It's sort of similar to the way Kyle Bass always "hedges" by saying, well, I may be wrong, but I have a fiduciary responsibility to construct my portfolio this way (putting money into gold, making asymmetric bets against Japan, etc.).  And anyone else who behaves differently is being reckless.

 

So here's the question I think a lot of us would like definitively answered:

Would HWIC be acting differently if they were not managing an insurance portfolio? 

[Parsad]

I personally would have reduced operational leverage of FFH so that they can be more like other insurance companies and don't need to live in fear of getting wiped out. On the other hand, FFH wouldnt have the returns they did without the kind of leverage they built up.

 

Not true.  I think if they had used the same sort of leverage as MKL, they would have had as good, if not better returns, than they have had since inception.  They are very good equity investors, and Brian is probably one of the best bond investors over the last 25 years.  Combine that with the likelihood they would not have suffered as badly over the "7 lean years", and they would be ahead of the game right now.  As well, they would not have had to hedge so completely and would have enjoyed investment returns as good, if not better, than anyone else.

 

FFH returned ~9% since 2000, without leverage it would have been 2-3% per year? Their float is twice book and investment assets are three times book. Without their investing acumen, they would probably be out of business by now...

 

Two things you've gotten wrong here.  If they had used less leverage, the significant issues they faced during the 7 lean years would not have been as pointed.  Second, if they had used less leverage, more of the portfolio would have been in equities like Markel and Berkshire.  Why do you think they've decreased leverage from historical levels?  Because they've learned that lesson.  I just wish they would reduce it a little more.  Cheers!

[JBird]

Foolish to think that corporations aren't susceptible to economic collapses...even the best of the best are susceptible when you have leverage, debt, counterparty liability, and in many cases regulatory requirements for statutory levels of capital!  Cheers!

 

So it's not necessarily the overvaluation of the general stock market that prompted Fairfax to hedge, but the possibility of major economic collapse?

[Parsad]

Foolish to think that corporations aren't susceptible to economic collapses...even the best of the best are susceptible when you have leverage, debt, counterparty liability, and in many cases regulatory requirements for statutory levels of capital!  Cheers!

 

So it's not necessarily the overvaluation of the general stock market that prompted Fairfax to hedge, but the possibility of major economic collapse?

 

Both.  They needed to protect their statutory capital levels to write business if markets tank, but I think they were also very worried about a major economic event...be it a run on U.S. currency, China real estate crash, Japan going bust, or Europe falling apart.  They have no clue what will happen, but I think the odds of something happening were high based on history, and they took an incredibly conservative stance.  We'll know if they were overly conservative only in hindsight.  Cheers! 

[Otsog]

This thread is amazing, I've learned so much.  Thanks everyone.

 

Sigh, now back to CFA study where I get to learn about technical analysis  :-\

[giofranchi]

Don't have the crystal ball to say where the market is going.But with stock market going higher I've boosted my hedge to 25% of portfolio from 15%. And with about 20% in cash, I guess I have 45% portfolio protection.

 

I suspect the september return to office will not be to buy more stocks, but most probably to assess risk in the market and economy and act accordingly.

 

finetrader,

I like this post of yours very much!

With all the talking about FFH equity hedges, one thing is clear to me: each one of us should always "assess risk in the market and economy and act accordingly."

All the rules and quotations won't be enough, if you don't have a very well defined strategic plan, and the discipline to always reassess it, and then follow it.

Just because the economy isn't important 95 times out of 100, doesn't mean it is prudent to overlook it the remaining 5 times...

Of course, to live by "fixed and immutable rules" (i.e. The economy doesn't matter) is easy and comforting... But I would rather think and come to a reasoned and justifiable conclusion in each different situation: the answer will almost always be the economy doesn't matter, but I won't be fooled the rare time when that rule doesn't apply.

And of course, to find rules that are ALWAYS true is very suspicious in engineering and science too, let alone investing!!

Btw Mr. Munger in recent years seems to be much more worried about the economy than he has ever been.

 

I am in Elba Island for some vacation! So, see you all back at the end of the month!

 

Cheers!

 

giofranchi

[Uccmal]

The recent events at Fairfax are not doing alot to convince me of their ability to invest privately. 

 

Cara operations is no where near a market dominant type of player.

 

And now RIM.  Thats a big set of chains to be dragging around for the "long term". 

 

There are so many mid size companies in the manufacturing/energy arena that Fairfax could monetize so much faster.  I have listed 3 that they have held, have board members on, or hold now, that are all better than either RIM or Cara. 

 

Mullen group, H&R Reit, and Russell Metals to start.  All would feed instant cash flow to FFH. 

 

At one time I held up to 1000 shares in FFH.  I am now at 100, and probably will go to none shortly. 

[Myth465]

....At one time I held up to 1000 shares in FFH.  I am now at 100, and probably will go to none shortly.

 

Smart. Very smart. A true value investor unlike several on this board who try to show "unconditional love" for Fairfax.

 

+1

[Parsad]

....At one time I held up to 1000 shares in FFH.  I am now at 100, and probably will go to none shortly.

 

Smart. Very smart. A true value investor unlike several on this board who try to show "unconditional love" for Fairfax.

 

I've bought and sold Fairfax many times since 2003.  In fact, we sold half our stake several months ago to buy other stuff while retaining our cash position.  But, now reading something like this after the BBRY acquisition and the amount markets have run up, I think the true contrarian would actually be buying Fairfax.  I think I may re-establish my position with more of this sentiment floating around.  Cheers!