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

[ERICOPOLY]

I feel like they could buy bonds instead of investing in equities via delta hedging. 

 

Well, GreenlightRe, with Mr. Einhorn managing a value long, short investment program, had a positive investment return in Q2 2013, while practically every bonds portfolio suffered losses due to increased rates.

 

giofranchi

 

Are there any quarters where Mr. Einhorn's strategy underperforms bonds?  I'm sure it's not such a slam dunk that one quarter of data suggests.

[txlaw]

It will be interesting to see MKL results this coming week.

 

In my mind, BRK and MKL have had the right strategy, and FFH has not.  FFH has been far too macro-focused.  WRB continues to roll along as well.

[giofranchi]

It will be interesting to see MKL results this coming week.

 

In my mind, BRK and MKL have had the right strategy, and FFH has not.  FFH has been far too macro-focused.  WRB continues to roll along as well.

 

We simply cannot know yet. As Mr. Watsa has said during the conference call, it took 5 years for deflation to set in in Japan... Likewise the New Deal policies worked for 5 years in the '30s, before they worked no more... So, probably we still must wait 2 more years, before knowing for sure.

What I am positive about is that, even if there were only a small chance to repeat the '30s experience, seriuos and reliable people should have looked for ways to protect themselves and their companies against such an outcome... Of course, you might argue that FFH's protections have been too extreme and not really justifiable... We will see!

 

giofranchi

[Parsad]

It will be interesting to see MKL results this coming week.

 

In my mind, BRK and MKL have had the right strategy, and FFH has not.  FFH has been far too macro-focused.  WRB continues to roll along as well.

 

We simply cannot know yet. As Mr. Watsa has said during the conference call, it took 5 years for deflation to set in in Japan... Likewise the New Deal policies worked for 5 years in the '30s, before they worked no more... So, probably we still must wait 2 more years, before knowing for sure.

What I am positive about is that, even if there were only a small chance to repeat the '30s experience, seriuos and reliable people should have looked for ways to protect themselves and their companies against such an outcome... Of course, you might argue that FFH's protections have been too extreme and not really justifiable... We will see!

 

giofranchi

 

I think the close calls a decade ago and the leverage forced them to make that decision.  If leverage was lower and they had not gone through a near-death experience, they would have been able to avoid some of the hedges.  Berkshire and Markel operate with less leverage, thus they were able to take advantage of markets, rather than worry about portfolio risk.  At the same time, IF Prem is correct on the hedges and the risks (which I think he is, but not quite the extreme they've taken) then they will make it up on the back-end like they did with the CDS investment.  It ain't over till the fat lady sings!  Cheers!

[giofranchi]

I feel like they could buy bonds instead of investing in equities via delta hedging. 

 

Well, GreenlightRe, with Mr. Einhorn managing a value long, short investment program, had a positive investment return in Q2 2013, while practically every bonds portfolio suffered losses due to increased rates.

 

giofranchi

 

Are there any quarters where Mr. Einhorn's strategy underperforms bonds?  I'm sure it's not such a slam dunk that one quarter of data suggests.

 

I have not said one strategy is better than the other, or vice versa. What I meant to show is that the two strategies are different and may lead to different results. Moreover, FFH already has a large bonds portfolio.

 

giofranchi

[txlaw]

It will be interesting to see MKL results this coming week.

 

In my mind, BRK and MKL have had the right strategy, and FFH has not.  FFH has been far too macro-focused.  WRB continues to roll along as well.

 

We simply cannot know yet. As Mr. Watsa has said during the conference call, it took 5 years for deflation to set in in Japan... Likewise the New Deal policies worked for 5 years in the '30s, before they worked no more... So, probably we still must wait 2 more years, before knowing for sure.

What I am positive about is that, even if there were only a small chance to repeat the '30s experience, seriuos and reliable people should have looked for ways to protect themselves and their companies against such an outcome... Of course, you might argue that FFH's protections have been too extreme and not really justifiable... We will see!

 

giofranchi

 

What we cannot know yet is whether or not FFH will be right on their macro call. 

 

However, what I am criticizing FFH for is rejecting the idea that if you focus on valuation (taking into account possible adverse economic scenarios), you can essentially ignore macro forecasts.  I adhere to the "don't spend too much time on macro when it comes to investing" school -- Munger style. 

 

So even if there is a risk of another deflationary period in the US, the only "risk" is the market pricing your companies at low valuations.  At which time you buy more of them!  Especially if you have cash coming in a la BRK and MKL.

 

(Incidentally, I don't agree that today is like the 30s -- I believe we learned from that period, and our policy makers have acted differently today to prevent such an occurrence.)

[giofranchi]

It will be interesting to see MKL results this coming week.

 

In my mind, BRK and MKL have had the right strategy, and FFH has not.  FFH has been far too macro-focused.  WRB continues to roll along as well.

 

We simply cannot know yet. As Mr. Watsa has said during the conference call, it took 5 years for deflation to set in in Japan... Likewise the New Deal policies worked for 5 years in the '30s, before they worked no more... So, probably we still must wait 2 more years, before knowing for sure.

What I am positive about is that, even if there were only a small chance to repeat the '30s experience, seriuos and reliable people should have looked for ways to protect themselves and their companies against such an outcome... Of course, you might argue that FFH's protections have been too extreme and not really justifiable... We will see!

 

giofranchi

 

What we cannot know yet is whether or not FFH will be right on their macro call. 

 

However, what I am criticizing FFH for is rejecting the idea that if you focus on valuation (taking into account possible adverse economic scenarios), you can essentially ignore macro forecasts.  I adhere to the "don't spend too much time on macro when it comes to investing" school -- Munger style. 

 

So even if there is a risk of another deflationary period in the US, the only "risk" is the market pricing your companies at low valuations.  At which time you buy more of them!  Especially if you have cash coming in a la BRK and MKL.

 

(Incidentally, I don't agree that today is like the 30s -- I believe we learned from that period, and our policy makers have acted differently today to prevent such an occurrence.)

 

Well, to have really learnt from the past would have meant not to get into so much debt anymore, living for two decades beyond our means, squandering precious resources.

Instead, we have already let our (US and Europe) debt out of control. We can do things differently, but we cannot assume there is an easy way out. At least not until there is enough evidence!

 

As far as how well value investing worked during the '30s, or in Japan during the last 15 years, the evidence is far from clear... Mr. Graham himself said that only 1 out of 100 managers survived the '30s, among those who weren't already bearish in 1925. Also Mr. Keynes saw his personal worth significantly reduced for many years after 1937. And we are talking about 2 of the most brilliant investment minds of last century!

 

That's why, although I generally agree with you, I don't like very much fixed rules... I want to always keep an open mind and adapt my thinking as circumstances dictate.

 

giofranchi

[berkshiremystery]

It will be interesting to see MKL results this coming week.

 

In my mind, BRK and MKL have had the right strategy, and FFH has not.  FFH has been far too macro-focused.  WRB continues to roll along as well.

 

We simply cannot know yet. As Mr. Watsa has said during the conference call, it took 5 years for deflation to set in in Japan... Likewise the New Deal policies worked for 5 years in the '30s, before they worked no more... So, probably we still must wait 2 more years, before knowing for sure.

What I am positive about is that, even if there were only a small chance to repeat the '30s experience, seriuos and reliable people should have looked for ways to protect themselves and their companies against such an outcome... Of course, you might argue that FFH's protections have been too extreme and not really justifiable... We will see!

 

giofranchi

 

What we cannot know yet is whether or not FFH will be right on their macro call. 

 

However, what I am criticizing FFH for is rejecting the idea that if you focus on valuation (taking into account possible adverse economic scenarios), you can essentially ignore macro forecasts.  I adhere to the "don't spend too much time on macro when it comes to investing" school -- Munger style. 

 

So even if there is a risk of another deflationary period in the US, the only "risk" is the market pricing your companies at low valuations.  At which time you buy more of them!  Especially if you have cash coming in a la BRK and MKL.

 

(Incidentally, I don't agree that today is like the 30s -- I believe we learned from that period, and our policy makers have acted differently today to prevent such an occurrence.)

 

Well, to have really learnt from the past would have meant not to get into so much debt anymore, living for two decades beyond our means, squandering precious resources.

Instead, we have already let our (US and Europe) debt out of control. We can do things differently, but we cannot assume there is an easy way out. At least not until there is enough evidence!

 

As far as how well value investing worked during the '30s, or in Japan during the last 15 years, the evidence is far from clear... Mr. Graham himself said that only 1 out of 100 managers survived the '30s, among those who weren't already bearish in 1925. Also Mr. Keynes saw his personal worth significantly reduced for many years after 1937. And we are talking about 2 of the most brilliant investment minds of last century!

 

That's why, although I generally agree with you, I don't like very much fixed rules... I want to always keep an open mind and adapt my thinking as circumstances dictate.

 

giofranchi

 

Gio,...

 

too bad you haven't been at this years AGM. At the start of Prem's speech, I felt for 2 minutes that he verbally spoke almost like a priest in a church,...a financial church,... barely remember the exact words,... not sure, I might recall in my mind hearing,... "have faith",... and "believe". Damn that there isn't a full transcript of his entire speech available. Somehow I felt he tried to teach the audience to have faith in HWIC's long term strategies and not to lust for short term gains. ::)

 

-----

 

I might repost Hoisington words...

 

http://www.hoisingtonmgt.com/hoisington_economic_overview.html

http://www.hoisingtonmgt.com/pdf/HIM2013Q2NP.pdf

 

The secular low in bond yields has yet to be recorded. This assessment for a continuing pattern of lower yields in the quarters ahead is clearly a minority view, as the recent selling of all types of bond products attest.

 

http://s12.postimg.org/o677lx471/image.jpg

 

[Grenville]

 

Gio,...

 

too bad you haven't been at this years AGM. At the start of Prem's speech, I felt for 2 minutes that he verbally spoke almost like a priest in a church,...a financial church,... barely remember the exact words,... not sure, I might recall in my mind hearing,... "have faith",... and "believe". Damn that there isn't a full transcript of his entire speech available. Somehow I felt he tried to teach the audience to have faith in HWIC's long term strategies and not to lust for short term gains. ::)

 

I think this is the quote he read that you are referring to: 

 

"It is generally recognized that faith is a great vital force in the conduct of human affairs. It plays an essential part in business, education, medicine, politics, science, and religion. Faith is the master key to great discovery, invention, and achievement. Faith is not blindness, supposition, credulity, or ordinary belief. Belief is of the intellect, faith is of the soul. Faith overleaps all visible horizons. Daily you act and walk by faith rather than by sight. You are constantly exercising faith whether you are conscious of it or not. Your life is built on faith. The antidote for worry, fear, anxiety, doubt, discontent, and other disturbing elements is a supreme faith in God, in men, and in yourself."

 

It comes from a John Marks Templeton book Prem recommended: "Riches for the Mind and Spirit." I  enjoyed it very much.

 

It's available online:

http://books.google.com/books?id=5YGmnjI96S0C&lpg=PA54&ots=ijapQz6t3v&dq=It%20is%20generally%20recognized%20that%20faith%20is%20a%20vital%20force&pg=PA54#v=onepage&q=It%20is%20generally%20recognized%20that%20faith%20is%20a%20vital%20force&f=false

[ERICOPOLY]

I find that not making 25% gain due to fear is numerically identical to losing 25% due to crash.  With Fairfax at 50% of book value equities weighting, this 25% loss is one arising from 50% decline in the markets.

 

Going back to 1060 on the S&P500 when they first put on the full hedge, you're talking about 530 on the S&P500.  Way lower than where they dropped their hedges in 2008, and quite a bit lower than the 2009 absolute bottom of 666.

 

You find yourself in the present with a given degree of capital that came from the past years of compounding.  Did you make mistakes that you are unaware of (errors of omission), that cost you 50% of your capital?  Or are you only counting losses that you are aware of, where it is obvious (errors of commission).

[ERICOPOLY]

So if you consider that they dropped their hedges at 800 in 2008, and then put them back on at 1060, were they merely stressing out over a 20% drop back down to 800?  That's only a 10% hit to their book value.  In saving themselves from that 10% hit, they've suffered an even large hit looking at where they would be today verses where they actually are today.

 

[ERICOPOLY]

Forgot to mention the role of taxes.  The hit to book value would have been only 7% at 30% tax rate.  Imagine... All this fuss over 7%.  Giofranci estimates of growth put that at just under 6 months of earnings.

[Liberty]

That's such a brilliant way to look at it, thanks for the insight Eric.

[ERICOPOLY]

I would like to qualify my statements by saying that HWIC are much better investors than me, and I make more mistakes than they do.  However they're out there in the public and I'm not, so they get the analysis :D

[LakesideB]

So if you consider that they dropped their hedges at 800 in 2008, and then put them back on at 1060, were they merely stressing out over a 20% drop back down to 800?  That's only a 10% hit to their book value.  In saving themselves from that 10% hit, they've suffered an even large hit looking at where they would be today verses where they actually are today.

 

They were worried about it going much much lower than 800. Prem has often mentioned the famous Ben Graham's saying about only 1 in 100 investors surviving 1929 if they weren't bearish in 1925. The Dow Jones went from 400 to 200 ... a 50% crash in the 1929  ... and if you weren't bearish u would seen the 200 level as a great opportunity to come right back in. The Dow reached 300 .. but what would have killed you is the the second leg of the crash which was a 90% drop !!

 

It is precisely this severe second leg they are worried about.

 

On a side note ... I have noted many think of FFH as someone who looks to profit from active macro bets. In my opinion this is completely false.

 

Prem and his team are good in picking stocks and protecting their downside. The macro bets are there to protect their downside so that they can create value to do what they do best - pick great stocks. The cds bet was to protect them from recoverable from reinsurers, while the equity hedge is to protect against a massive drop in equity markets so that they can live to see another day. The former was an asymmetric bet, while the latter is a bet on their skills to deliver value well and beyond the market will do over the long term.

 

[Liberty]

I would like to qualify my statements by saying that HWIC are much better investors than me, and I make more mistakes than they do.  However they're out there in the public and I'm not, so they get the analysis :D

 

This is unrelated to the current discussion, but the other day I was wondering if Fairfax/HWIC would have a better track record over the past 25 years if they had just bought Berkshire stock whenever it was selling close to a fair valuation (or better, of course) for the equity portion of their portfolio... They've had all these amazing investments and trades and deals, but in the end, was it better than buying Berkshire juiced with float leverage over 25 years?

 

As Munger was saying, there's no bonus points for difficulty in investing. If you Eric can compound at 70% by specializing in a handful of companies, I don't think that necessarily makes you a worse investor than someone with a much larger circle of competence but lower returns. The question is, how would HWIC do without the constraints of being in an insurance company/investing OPM...

[LakesideB]

I find that not making 25% gain due to fear is numerically identical to losing 25% due to crash. 

 

Hi Eric ... I am not sure how you could equate both to be the same .... If I loose 25% of my capital I need about 35% return to get back even... and if the loss is more than 25% the return required to break even gets exponentially higher. But surely you also know this .. so perhaps i am not getting what you meant to convey ..

[Parsad]

So if you consider that they dropped their hedges at 800 in 2008, and then put them back on at 1060, were they merely stressing out over a 20% drop back down to 800?  That's only a 10% hit to their book value.  In saving themselves from that 10% hit, they've suffered an even large hit looking at where they would be today verses where they actually are today.

 

They were worried about it going much much lower than 800. Prem has often mentioned the famous Ben Graham's saying about only 1 in 100 investors surviving 1929 if they weren't bearish in 1925. The Dow Jones went from 400 to 200 ... a 50% crash in the 1929  ... and if you weren't bearish u would seen the 200 level as a great opportunity to come right back in. The Dow reached 300 .. but what would have killed you is the the second leg of the crash which was a 90% drop !!

 

It is precisely this severe second leg they are worried about.

 

On a side note ... I have noted many think of FFH as someone who looks to profit from active macro bets. In my opinion this is completely false.

 

Prem and his team are good in picking stocks and protecting their downside. The macro bets are there to protect their downside so that they can create value to do what they do best - pick great stocks. The cds bet was to protect them from recoverable from reinsurers, while the equity hedge is to protect against a massive drop in equity markets so that they can live to see another day. The former was an asymmetric bet, while the latter is a bet on their skills to deliver value well and beyond the market will do over the long term.

 

Correct.  But they have to do this because of the leverage.  The 1 in 100 investor's not surviving "The Crash" is somewhat of a fallacy.  That number would be 1 in 100 if the investor used leverage or were on margin.  An investor who owned their stocks outright, or had the equivalent of a cash account, would have survived perfectly well as long as the underlying brokerage didn't go under because of fraudulent use of the investor's assets.  The same would have been true in 2008/2009. 

 

Even when Buffett said that everything would have gone under, including Berkshire, but they would have been the last to fall, is because of the use of debt, leverage and especially counterparty risk.  An investor who owned Coca-Cola outright would have no problem surviving a 1929 style crash.  Leverage is great when things work, but it can kill you when things go wrong.  Cheers! 

[ERICOPOLY]

So if you consider that they dropped their hedges at 800 in 2008, and then put them back on at 1060, were they merely stressing out over a 20% drop back down to 800?  That's only a 10% hit to their book value.  In saving themselves from that 10% hit, they've suffered an even large hit looking at where they would be today verses where they actually are today.

 

They were worried about it going much much lower than 800.

 

No they were completely unhedged at 800.  I forget where, but it was somewhere in the 800 range that they dropped ALL of their equity hedges.

 

And yes, they made all those "1in100 year storm" comments, and "very few survived the great depression" comments a long time beforehand.

 

Then the market rallies 25% and they go completely hedged again?  It's not like 20% is a terrifying amount of market swing.  That kind of decline can happen in any market.

 

And then if it happens, it's only a 7% loss to them due to their 50% exposure and the tax thing.  I mean, come on, I eat 7% losses for breakfast!  (happens at least a couple of times a year).

[LakesideB]

So if you consider that they dropped their hedges at 800 in 2008, and then put them back on at 1060, were they merely stressing out over a 20% drop back down to 800?  That's only a 10% hit to their book value.  In saving themselves from that 10% hit, they've suffered an even large hit looking at where they would be today verses where they actually are today.

 

They were worried about it going much much lower than 800. Prem has often mentioned the famous Ben Graham's saying about only 1 in 100 investors surviving 1929 if they weren't bearish in 1925. The Dow Jones went from 400 to 200 ... a 50% crash in the 1929  ... and if you weren't bearish u would seen the 200 level as a great opportunity to come right back in. The Dow reached 300 .. but what would have killed you is the the second leg of the crash which was a 90% drop !!

 

It is precisely this severe second leg they are worried about.

 

On a side note ... I have noted many think of FFH as someone who looks to profit from active macro bets. In my opinion this is completely false.

 

Prem and his team are good in picking stocks and protecting their downside. The macro bets are there to protect their downside so that they can create value to do what they do best - pick great stocks. The cds bet was to protect them from recoverable from reinsurers, while the equity hedge is to protect against a massive drop in equity markets so that they can live to see another day. The former was an asymmetric bet, while the latter is a bet on their skills to deliver value well and beyond the market will do over the long term.

 

Correct.  But they have to do this because of the leverage.  The 1 in 100 investor's not surviving "The Crash" is somewhat of a fallacy.  That number would be 1 in 100 if the investor used leverage or were on margin.  An investor who owned their stocks outright, or had the equivalent of a cash account, would have survived perfectly well as long as the underlying brokerage didn't go under because of fraudulent use of the investor's assets.  The same would have been true in 2008/2009. 

 

Even when Buffett said that everything would have gone under, including Berkshire, but they would have been the last to fall, is because of the use of debt, leverage and especially counterparty risk.  An investor who owned Coca-Cola outright would have no problem surviving a 1929 style crash.  Leverage is great when things work, but it can kill you when things go wrong.  Cheers!

 

True Ofcourse. But here I think the concern is not of leverage killing them but MTM. P&C leverage has its advantages over traditional leverage. With equity mkt dropping however, their equity base will be marked to market and AMBest and rating agencies will essentially make it impossible from them to do normal business... possibly wiping them out should you have a cat event at the same time.

[LakesideB]

 

It's not like 20% is a terrifying amount of market swing. 

 

Again .. they are not terrified of a 20% drop but of a massive 90% swing .. where they will effectively get wiped out.

[ERICOPOLY]

 

It's not like 20% is a terrifying amount of market swing. 

 

Again .. they are not terrified of a 20% drop but of a massive 90% swing .. where they will effectively get wiped out.

 

Again... they dropped all hedges at 800 -- that's a 20% drop.

[Guest wellmont]

 

It's not like 20% is a terrifying amount of market swing. 

 

Again .. they are not terrified of a 20% drop but of a massive 90% swing .. where they will effectively get wiped out.

 

it's interesting they are worried about a global collapse but then they bought a serious chunk of bbry? doesn't make a lot of sense.

[ERICOPOLY]

Let me put it to you differently...

 

They dropped all hedges at 800 because:

 

A)  They thought the market would continue to fall

B)  Margin of safety at 800 and time to make some big money

 

I'm worried if you answer "A".  ;)

[LakesideB]

 

It's not like 20% is a terrifying amount of market swing. 

 

Again .. they are not terrified of a 20% drop but of a massive 90% swing .. where they will effectively get wiped out.

 

it's interesting they are worried about a global collapse but then they bought a serious chunk of bbry? doesn't make a lot of sense.

 

BBry is about 3% or so of their portfolio so not that significant from their portfolio allocation prespective.  Its a balance sheet play .. you could perhaps arrive at a liquidation value that is closer to $18 to $20. This ancors the downside. There is a transformation in the business happening where handset business will be less relevant as they become focused on deploying QNX as a security toll road for the enterprise and charge a recurring fee to get on this toll road. If they are successful this think could be worth substantially more. Whether the global crises happens or not in the long run enterprise need for security is not doing to go down.