Fairfax Financials (FFH) is an insurance company specializing in the property, life, casualty, and reinsurance sectors. Its performance can be described as nothing less then accomplished, with compounded book value and stock price growths at 24.7% and 21% respectively over the last 25 years. With operations in over 100 countries and in conjunction with a very active mergers and acquisition team, Fairfax has positioned itself for future growth and profitability.
Many attribute the success of Fairfax Financials in no small part to Prem Watsa, dubbed by many as the “Canadian Warren Buffett”. His distinguished performance can be seen in his returns in equities and debt securities. The following table and charts demonstrates the performance of both Fairfax’s equities and bonds when compared against their standard benchmark:
Recent Performance
In stark contrast to their earlier performances, Fairfax’s investment returns declined by 80% from $944.5 million to $188.5 million between 2009 and 2010. In terms of the actual break up of their returns, their fixed income portfolio yielded $569.4 million, and their composite equity portfolio yielded $735.2 million. The cause of subpar performance was primarily attributed to a $936.6 million loss among others, due to their positions in both equity short and equity index total swaps.
Fairfax’s portfolio initially at the beginning of 2010 was hedged at 30%. However, between May and June, approximately 100% of the portfolio was hedged in order to protect and preserve their existing portfolio, and as a measure against what they felt was an excess glut of debt worldwide. An excerpt from their 2010 annual shareholder letter, ( http://www.fairfax.ca/Assets/Downloads/110304ceo.pdf) yields their thoughts regarding the market:
“If the 2008/2009 recession was like any other recession that the U.S. has experienced in the past 50 years, we would not be hedging today. However, we worry, as we have mentioned to you many times in the past, that the North American economy may experience a time period like the U.S. in the 1930s and Japan since 1990, during which nominal GNP remains flat for 10 to 20 years with many bouts of deflation.”
This analysis was derived from their view that both Europe and the United States attempted to solve their fiscal problems by reducing spending and raising taxes. This, in conjunction with what they perceived as a parabolic curve in terms of commodity prices, caused Fairfax to both maintain and increase their equity hedges.
At this point, could one argue that Fairfax’s hedging have failed to live up to his expectations? Historically, a similar situation occur, when at the end of 2006, Fairfax held CDS’s that were down 75%. Instead of cutting their losses immediately, Fairfax purchased more CDSs to hold an aggregate position of $341 million. In 2008, as the financial crisis was in full swing, Prem Watsa made headline news their position was worth $2.1 billion, a 515% increase in value.
The Risks of Deflation
Deflation, however, is one of the most cited concerns for Prem Watsa. At its very core, deflation is the general decrease of prices in both goods and services. As prices decrease, people as a whole tend to sit on their cash and spend less, as they anticipate future prices to be lower and lower. Unfortunately, this deflationary spiral continues, and businesses experience lower revenues, and must reduce operational capacity. As people are laid off, they will spend less, and thus, the cycle repeats itself. This has a negative effect upon stock prices as investors become more pessimistic in general.
As such, when 10-year CPI-linked derivative contracts were offered on the market place, Fairfax Financials invested $302.3 million into these contracts. Essentially, the concept behind these instruments is based upon the CPI reading 10 years from the date of the contract purchase. If in a hypothetical scenario, the CPI is 1000 today, and in ten years from now, it measured at 900, the percent difference (10%) would be multiplied by the nominal value of the contract. In this case, the nominal values of his contracts are valued at $22 billion.
So what does current data say about Fairfax’s analysis? According to the US producer price report ( http://www.bls.gov/ppi/home.htm), the fear of deflation seems for the moment, inconsequential, as the overall index rose 1.6% in February, double that of January. In the same time period, the price level of commodities increased by 1.7% with a 5.7% increase in gasoline prices. This is directly in line with their analysis of the commodity market. Although at the moment, their deflationary bet may seem to have failed, one must keep in mind their contract is for the span of 10 years, and as such, a repeat of their CDS bet may still occur.
Looking Forward
Economic conditions have been shaky and uncertain for the last two years. As such, as is in life, insurance exists to reduce risk and protect one’s assets. At the moment, Prem Watsta has positioned Fairfax in an advantageous position if deflation or a correction in the market were to occur. In the 2010 Q4 Earnings Call, Prem Watsa reiterated “…we're focused on protecting our capital from worst case events”, which remains in line with his philosophy of developing long-term value for Fairfax. The future outlook for Fairfax is cautious as he “...expects that our results will continue to be lumpy”, due to deflationary and equity risks. That being said, his positions in his hedges will be maintained in response to what he perceives as an overvalued and risky market. However, like all successful investors, Prem Watsa remains flexible to changing conditions in the market as he so eloquently stated, “Things change…and they will again!!!”
Gurufocus’s overall analysis of the market is Modestly Overvalued ( http://www.gurufocus.com/stock-market-valuations.php). For more information regarding Prem Watsa and his activities, please visit:
http://www.gurufocus.com/ListGuru.php?GuruName=Prem+Watsa
Many attribute the success of Fairfax Financials in no small part to Prem Watsa, dubbed by many as the “Canadian Warren Buffett”. His distinguished performance can be seen in his returns in equities and debt securities. The following table and charts demonstrates the performance of both Fairfax’s equities and bonds when compared against their standard benchmark:
Years | Fairfax Equities | S&P500 | Fairfax Bonds | Merrill Lynch Index |
5 | 14.20% | 2.30% | 12.60% | 5.90% |
10 | 17.90% | 1.40% | 11.90% | 6.30% |
15 | 17.20% | 6.80% | 10.00% | 6.20% |
Recent Performance
In stark contrast to their earlier performances, Fairfax’s investment returns declined by 80% from $944.5 million to $188.5 million between 2009 and 2010. In terms of the actual break up of their returns, their fixed income portfolio yielded $569.4 million, and their composite equity portfolio yielded $735.2 million. The cause of subpar performance was primarily attributed to a $936.6 million loss among others, due to their positions in both equity short and equity index total swaps.
Fairfax’s portfolio initially at the beginning of 2010 was hedged at 30%. However, between May and June, approximately 100% of the portfolio was hedged in order to protect and preserve their existing portfolio, and as a measure against what they felt was an excess glut of debt worldwide. An excerpt from their 2010 annual shareholder letter, ( http://www.fairfax.ca/Assets/Downloads/110304ceo.pdf) yields their thoughts regarding the market:
“If the 2008/2009 recession was like any other recession that the U.S. has experienced in the past 50 years, we would not be hedging today. However, we worry, as we have mentioned to you many times in the past, that the North American economy may experience a time period like the U.S. in the 1930s and Japan since 1990, during which nominal GNP remains flat for 10 to 20 years with many bouts of deflation.”
This analysis was derived from their view that both Europe and the United States attempted to solve their fiscal problems by reducing spending and raising taxes. This, in conjunction with what they perceived as a parabolic curve in terms of commodity prices, caused Fairfax to both maintain and increase their equity hedges.
At this point, could one argue that Fairfax’s hedging have failed to live up to his expectations? Historically, a similar situation occur, when at the end of 2006, Fairfax held CDS’s that were down 75%. Instead of cutting their losses immediately, Fairfax purchased more CDSs to hold an aggregate position of $341 million. In 2008, as the financial crisis was in full swing, Prem Watsa made headline news their position was worth $2.1 billion, a 515% increase in value.
The Risks of Deflation
Deflation, however, is one of the most cited concerns for Prem Watsa. At its very core, deflation is the general decrease of prices in both goods and services. As prices decrease, people as a whole tend to sit on their cash and spend less, as they anticipate future prices to be lower and lower. Unfortunately, this deflationary spiral continues, and businesses experience lower revenues, and must reduce operational capacity. As people are laid off, they will spend less, and thus, the cycle repeats itself. This has a negative effect upon stock prices as investors become more pessimistic in general.
As such, when 10-year CPI-linked derivative contracts were offered on the market place, Fairfax Financials invested $302.3 million into these contracts. Essentially, the concept behind these instruments is based upon the CPI reading 10 years from the date of the contract purchase. If in a hypothetical scenario, the CPI is 1000 today, and in ten years from now, it measured at 900, the percent difference (10%) would be multiplied by the nominal value of the contract. In this case, the nominal values of his contracts are valued at $22 billion.
So what does current data say about Fairfax’s analysis? According to the US producer price report ( http://www.bls.gov/ppi/home.htm), the fear of deflation seems for the moment, inconsequential, as the overall index rose 1.6% in February, double that of January. In the same time period, the price level of commodities increased by 1.7% with a 5.7% increase in gasoline prices. This is directly in line with their analysis of the commodity market. Although at the moment, their deflationary bet may seem to have failed, one must keep in mind their contract is for the span of 10 years, and as such, a repeat of their CDS bet may still occur.
Looking Forward
Economic conditions have been shaky and uncertain for the last two years. As such, as is in life, insurance exists to reduce risk and protect one’s assets. At the moment, Prem Watsta has positioned Fairfax in an advantageous position if deflation or a correction in the market were to occur. In the 2010 Q4 Earnings Call, Prem Watsa reiterated “…we're focused on protecting our capital from worst case events”, which remains in line with his philosophy of developing long-term value for Fairfax. The future outlook for Fairfax is cautious as he “...expects that our results will continue to be lumpy”, due to deflationary and equity risks. That being said, his positions in his hedges will be maintained in response to what he perceives as an overvalued and risky market. However, like all successful investors, Prem Watsa remains flexible to changing conditions in the market as he so eloquently stated, “Things change…and they will again!!!”
Gurufocus’s overall analysis of the market is Modestly Overvalued ( http://www.gurufocus.com/stock-market-valuations.php). For more information regarding Prem Watsa and his activities, please visit:
http://www.gurufocus.com/ListGuru.php?GuruName=Prem+Watsa
