Canadian insurer Fairfax Financial Holdings (PINK:FRFHF) recently reported second quarter results. Book value increased to $382.7 per share at quarter end. Two investment moves of note during the quarter are:
1) The company increased its equity hedges from 30% to 92.5% by initiating Russell 2000 shorts. From the company’s 2Q interim report:
“… Accordingly, the company added short positions in the Russell 2000 index ($3.3 billion notional amount at an average Russell 2000 index value of 646.5) to its short positions in the S&P 500 index ($1.5 billion notional amount at an average S&P 500 index value of 1,062.52) entered into during the third quarter of 2009. At June 30, 2010, equity hedges represented approximately 92.5%of the company’s equity and equity-related holdings.”
2) The company bought a substantial amount of deflation protection. From the company’s 2Q interim report:
“ … The company has purchased derivative contracts referenced to consumer price indices (“CPI”) in the geographic regions in which it operates, which serve as an economic hedge against the potential adverse financial impact on the company of decreasing price levels. These contracts have a remaining average life of 9.7 years (10.0 years at December 31, 2009) and a notional amount and fair value as shown in the table above. As the average remaining life of a contract declines, the fair value of the contract (excluding the impact of CPI changes) will generally decline. The initial premium paid for each contract is recorded as a derivative asset and is subsequently adjusted for changes in the unrealized fair value of the contract at each balance sheet date. Changes in the unrealized fair value of the contracts are recorded as net gains (losses) on investments in the company’s consolidated statements of earnings at each balance sheet date, with a corresponding adjustment to the carrying value of the derivative asset. In the event of a sale, expiration or early settlement of any of these contracts, the company would receive the fair value of that contract on the date of the transaction. The company’s maximum potential loss on any contract is limited to the original cost of that contract.
During the second quarter of 2010, the company purchased $10,256.6 (2009 – nil) notional amount of CPI-linked derivative contracts at a cost of $90.1 (2009 – nil) and recorded net mark-to-market gains of $69.9 (2009 – nil) in respect of positions remaining open at quarter end. During the first six months of 2010, the company purchased $21,539.1 (2009 – nil) notional amount of CPI-linked derivative contracts at a cost of $173.7 (2009 – nil) and recorded net mark-to-market gains of $58.8 (2009 – nil) in respect of positions remaining open at the end of the period.”
It appears Fairfax is really worried about equity market valuations and the likelihood of the economy taking the deflationary path.
Disclosure: Author holds shares of Fairfax Financial Holdings
1) The company increased its equity hedges from 30% to 92.5% by initiating Russell 2000 shorts. From the company’s 2Q interim report:
“… Accordingly, the company added short positions in the Russell 2000 index ($3.3 billion notional amount at an average Russell 2000 index value of 646.5) to its short positions in the S&P 500 index ($1.5 billion notional amount at an average S&P 500 index value of 1,062.52) entered into during the third quarter of 2009. At June 30, 2010, equity hedges represented approximately 92.5%of the company’s equity and equity-related holdings.”
2) The company bought a substantial amount of deflation protection. From the company’s 2Q interim report:
“ … The company has purchased derivative contracts referenced to consumer price indices (“CPI”) in the geographic regions in which it operates, which serve as an economic hedge against the potential adverse financial impact on the company of decreasing price levels. These contracts have a remaining average life of 9.7 years (10.0 years at December 31, 2009) and a notional amount and fair value as shown in the table above. As the average remaining life of a contract declines, the fair value of the contract (excluding the impact of CPI changes) will generally decline. The initial premium paid for each contract is recorded as a derivative asset and is subsequently adjusted for changes in the unrealized fair value of the contract at each balance sheet date. Changes in the unrealized fair value of the contracts are recorded as net gains (losses) on investments in the company’s consolidated statements of earnings at each balance sheet date, with a corresponding adjustment to the carrying value of the derivative asset. In the event of a sale, expiration or early settlement of any of these contracts, the company would receive the fair value of that contract on the date of the transaction. The company’s maximum potential loss on any contract is limited to the original cost of that contract.
During the second quarter of 2010, the company purchased $10,256.6 (2009 – nil) notional amount of CPI-linked derivative contracts at a cost of $90.1 (2009 – nil) and recorded net mark-to-market gains of $69.9 (2009 – nil) in respect of positions remaining open at quarter end. During the first six months of 2010, the company purchased $21,539.1 (2009 – nil) notional amount of CPI-linked derivative contracts at a cost of $173.7 (2009 – nil) and recorded net mark-to-market gains of $58.8 (2009 – nil) in respect of positions remaining open at the end of the period.”
It appears Fairfax is really worried about equity market valuations and the likelihood of the economy taking the deflationary path.
Disclosure: Author holds shares of Fairfax Financial Holdings
