Francis Chou who manages the Chou Funds is a true Benjamin Graham type investor. An uglier looking portfolio you will never find. Ugly, but successful:
15 Year Annual Compounded Rates of Return
Chou Associates ($CAN) 10.9% S&P 500 ($CAN) 4.1% Chou Associates ($US) 13.5% S&P 500 ($US) 6.5%
He just released his most recent semi-annual letter to investors with the following commentary:
Factors Influencing the First Six Months Results
THE CANADIAN DOLLAR AGAINST THE U.S. DOLLAR: The strength of the Canadian dollar against the U.S. dollar had a negative impact on the results of the Fund. The difference in performance results between the net asset value per unit (NAVPU) priced in Canadian dollars, versus U.S. dollars, is attributable to the fact that on December 31, 2010, one U.S. dollar was worth approximately $0.99 Cdn, whereas six months later, on June 30, 2011, one U.S. dollar was worth approximately $0.96 Cdn. Even if the price of an American security remained the same in the first half of 2011, it would have nonetheless shown a depreciation of roughly 3% on June 30, 2011 when priced in Canadian dollars. During the first six months of 2011, the stock market, as measured by the S&P 500, advanced despite numerous political and economic uncertainties. The second quarter ended with investors turning much more cautious as sovereign debt problems in Europe resurfaced, and concerns over runaway growth in China intensified. In the U.S., the end of the second phase of quantitative easing and the political stalemate over increasing the debt ceiling created further investor anxiety.
Positive contributors to the Fund's performance were equity securities of Sanofi, Watson Pharmaceuticals, Valeant Pharmaceuticals, Sprint Nextel, and debt securities of Level 3 Communications. Securities that declined the most in the first half of 2011 were equity securities of Flagstone Re, MannKind, Overstock.com, AbitibiBowater, and Class A warrants of Bank of America.
Was S&P's reduction of the United States' credit rating from AAA to AA+ a blessing in disguise?
In our opinion, it was a blessing in disguise. While the ratings of rating agencies are important, how investors' view and use these credit ratings is more important. We are diligent about doing our own homework on companies and countries and find that, while ratings may be useful to others, they are not that meaningful to us. In our opinion, the U.S. has not had triple-A credit for some time and the downgrade by S&P provided a much needed dose of reality. We believe that in the long run, the downgrade will not have a material effect on the economic prospects of the country, but in the short run, it may have to pay slightly higher interest rates. It is hard not to be amused at how ratings affect human behavior.
One would have expected that with the downgrade and the ensuing market turmoil, investors would flee almost all U.S. assets. Yet, precisely the opposite happened. When the Dow Jones Industrial Average tanked over 600 points in a day, investors flocked to U.S. treasuries. So much for the ratings. We think the stock market's adverse reaction to the downgrade is extreme, and as long term investors, expect the recent turmoil in financial markets to give us some attractive investment opportunities. Because our investment horizon is five years or longer, we are willing to buy into situations where the short term looks cloudy, but where the long term story is solid and valuations are attractive. We are now finding both debt and equity securities that are attractively priced and are continuing to add positions in the retail and financial sectors.
In summary, we are comfortable with the holdings we have in the portfolio. We believe they are cheap and undervalued and are optimistic about the future. To make a historical comparison, a major difference from the Great Depression of 1929 is that the money supply, as measured by M2, declined by more than 30% from 1929 to 1933. There was no quantitative easing. As we know, quantitative easing is a gentler term for flooding the system with money. While we cannot predict how the economy will fare in the future, our best guess is that there won't be a double dip recession, but if there is one, it will be mild.
Facing Economic Reality
Obviously, we are not a fan of quantitative easing and much prefer facing reality. We believe investors who make bad investments should suffer their losses and companies that bankrupt themselves should go bankrupt. Institutions, CEOs and investors should be held accountable for bad investments and inept decision making. Taxpayers should not be forced to prop up seriously troubled companies on a selective basis. We should stop thinking 'Too big to fail' and start thinking 'Too big to save'. It seems every time the government thinks the economy is slowing down or not growing fast enough, it talks of quantitative easing as if there are no consequences. We believe that quantitative easing tends to distort economic reality and to misallocate scarce resources. Facing economic reality is, in our opinion, the quickest way out of the economic doldrums we're now in. The current scenario gives all investors a new dimension regarding which stocks or bonds to purchase, namely, figuring out which companies might benefit from government intervention in the economy. This should not be a consideration when investing. Rather, we believe investments should be made solely on the merits of the companies and their valuation. Although it is important to understand the macroeconomic issues facing the companies we have invested in, or are thinking of purchasing, as value investors we focus on companies that are cheap relative to their intrinsic values. If macroeconomic issues make it difficult to understand companies' fundamentals, as was the case with financial companies in 2006 and 2007, we avoid those companies and sometimes the entire sector.
U.S. Banks
Even if the proposed Basel III capital requirement rules are adopted, we believe the big banks are attractively priced. With interest rates at artificially low levels, and the wide spreads between what the banks are paying for deposits and the FDIC-insured money they can borrow in the market, their earnings are enormous. In addition, lending criteria are tighter and, in general, the quality of loans is now quite high, which means the banks' earnings are high in terms of the risks they are taking. While they must still deal with some serious legacy issues, for most big banks, such as JPMorgan Chase (JPM, Financial), Wells Fargo (WFC, Financial) and Bank of America (BAC, Financial), their pre-interest and pre-provision earnings in the $30 to $40 billion range are high enough to absorb losses. We also think their common shares, and in some cases their TARP warrants, are attractive investments. The TARP warrants give the holder the right to buy the bank's stocks at a specific price. Most of these warrants are long dated, with most expiring in 2018 or 2019. This time frame of eight-plus years allows the banks to grow their intrinsic value to a high enough level to meet the strike price of the warrant. In addition, we believe the strike price is adjusted downward for any quarterly dividend paid that exceeds a set price. A more detailed discussion of the TARP warrants is included in the letter to the 2010 semi-annual report.
Canadian Real Estate
Among the G8 nations, Canada has done the best since the Great Recession of 2008 and has been widely lauded for its fiscal and economic performance. Its real estate prices have reflected that positive opinion. But therein lies the problem. In most countries, real estate prices have declined substantially, while in most of Canada, especially in the big cities, prices have actually increased. Based on ratios such as rent-to-house-price and disposable-income-to-house-price, Canadian house prices are out of line with historical standards. In addition, household debt as a percentage of disposable income is unprecedentedly high. This does not mean that Canadian real estate prices will decline soon, but it does indicate that valuations are stretched. We would be cautious in this environment. If there is a choice, it is better to rent rather than buy a house. However, if you are determined to buy a house, we would urge you to do so without borrowing too much money.
Here is the portfolio of the Chou Associates Fund as of June 30, 2011 excluding the $116mil of the fund that was in cash (roughly 20%):
SHARES*
AbitibiBowater Inc. - $ 26,552,826
Bank of America Corporation, warrants, Class A - $20,835,704
Berkshire Hathaway Inc., Class A - $33,542,243
Flagstone Reinsurance Holdings Ltd. - $12,179,716
Gannett Company Inc. - $4,464,055
Goldman Sachs Group Inc. - 14,750,812
Int'l Automotive Components Group North America - $105,589
JPMorgan Chase & Company, warrants - $10,113,756
MannKind Corporation - $8,937,730
Media General Inc., Class A - $3,459,628
Office Depot Inc. - $1,512,327
Olympus Re Holdings Ltd. - $2,454,620
Overstock.com Inc. - $22,077,843
Primus Telecommunications Group Inc. - $6,511,085
RadioShack Corporation - $12,989,768
Sanofi ADR** - $15,096,483
Sears Holdings Corporation - $27,138,468
Sprint Nextel Corporation - $31,768,340
The Gap Inc. - $2,332,404
USG Corporation - $5,523,786
Valeant Pharmaceuticals International Inc. - $11,345,374
Watson Pharmaceuticals Inc. - $42,095,704
Wells Fargo and Company, warrants - $8,907,538
XO Holdings Inc. - $1,350,889
Total Equity Holdings - $326,046,688
BONDS
Abitibi-Consolidated Inc., debt stubs - $300,529
Global Crossing (UK) Finance, 10.75%, Dec 15, 2014 - $5,042,099
Level 3 Comm. Inc., 15.0%, conv., Jan 15, 2013- $51,431,575
Primus Telecommunications, 14.25%, May 20, 2013 - $12,916,471
RH Donnelley Inc., term loan - $7,581,287
Total Bond Holdings - $77,271,961
15 Year Annual Compounded Rates of Return
Chou Associates ($CAN) 10.9% S&P 500 ($CAN) 4.1% Chou Associates ($US) 13.5% S&P 500 ($US) 6.5%
He just released his most recent semi-annual letter to investors with the following commentary:
Factors Influencing the First Six Months Results
THE CANADIAN DOLLAR AGAINST THE U.S. DOLLAR: The strength of the Canadian dollar against the U.S. dollar had a negative impact on the results of the Fund. The difference in performance results between the net asset value per unit (NAVPU) priced in Canadian dollars, versus U.S. dollars, is attributable to the fact that on December 31, 2010, one U.S. dollar was worth approximately $0.99 Cdn, whereas six months later, on June 30, 2011, one U.S. dollar was worth approximately $0.96 Cdn. Even if the price of an American security remained the same in the first half of 2011, it would have nonetheless shown a depreciation of roughly 3% on June 30, 2011 when priced in Canadian dollars. During the first six months of 2011, the stock market, as measured by the S&P 500, advanced despite numerous political and economic uncertainties. The second quarter ended with investors turning much more cautious as sovereign debt problems in Europe resurfaced, and concerns over runaway growth in China intensified. In the U.S., the end of the second phase of quantitative easing and the political stalemate over increasing the debt ceiling created further investor anxiety.
Positive contributors to the Fund's performance were equity securities of Sanofi, Watson Pharmaceuticals, Valeant Pharmaceuticals, Sprint Nextel, and debt securities of Level 3 Communications. Securities that declined the most in the first half of 2011 were equity securities of Flagstone Re, MannKind, Overstock.com, AbitibiBowater, and Class A warrants of Bank of America.
Was S&P's reduction of the United States' credit rating from AAA to AA+ a blessing in disguise?
In our opinion, it was a blessing in disguise. While the ratings of rating agencies are important, how investors' view and use these credit ratings is more important. We are diligent about doing our own homework on companies and countries and find that, while ratings may be useful to others, they are not that meaningful to us. In our opinion, the U.S. has not had triple-A credit for some time and the downgrade by S&P provided a much needed dose of reality. We believe that in the long run, the downgrade will not have a material effect on the economic prospects of the country, but in the short run, it may have to pay slightly higher interest rates. It is hard not to be amused at how ratings affect human behavior.
One would have expected that with the downgrade and the ensuing market turmoil, investors would flee almost all U.S. assets. Yet, precisely the opposite happened. When the Dow Jones Industrial Average tanked over 600 points in a day, investors flocked to U.S. treasuries. So much for the ratings. We think the stock market's adverse reaction to the downgrade is extreme, and as long term investors, expect the recent turmoil in financial markets to give us some attractive investment opportunities. Because our investment horizon is five years or longer, we are willing to buy into situations where the short term looks cloudy, but where the long term story is solid and valuations are attractive. We are now finding both debt and equity securities that are attractively priced and are continuing to add positions in the retail and financial sectors.
In summary, we are comfortable with the holdings we have in the portfolio. We believe they are cheap and undervalued and are optimistic about the future. To make a historical comparison, a major difference from the Great Depression of 1929 is that the money supply, as measured by M2, declined by more than 30% from 1929 to 1933. There was no quantitative easing. As we know, quantitative easing is a gentler term for flooding the system with money. While we cannot predict how the economy will fare in the future, our best guess is that there won't be a double dip recession, but if there is one, it will be mild.
Facing Economic Reality
Obviously, we are not a fan of quantitative easing and much prefer facing reality. We believe investors who make bad investments should suffer their losses and companies that bankrupt themselves should go bankrupt. Institutions, CEOs and investors should be held accountable for bad investments and inept decision making. Taxpayers should not be forced to prop up seriously troubled companies on a selective basis. We should stop thinking 'Too big to fail' and start thinking 'Too big to save'. It seems every time the government thinks the economy is slowing down or not growing fast enough, it talks of quantitative easing as if there are no consequences. We believe that quantitative easing tends to distort economic reality and to misallocate scarce resources. Facing economic reality is, in our opinion, the quickest way out of the economic doldrums we're now in. The current scenario gives all investors a new dimension regarding which stocks or bonds to purchase, namely, figuring out which companies might benefit from government intervention in the economy. This should not be a consideration when investing. Rather, we believe investments should be made solely on the merits of the companies and their valuation. Although it is important to understand the macroeconomic issues facing the companies we have invested in, or are thinking of purchasing, as value investors we focus on companies that are cheap relative to their intrinsic values. If macroeconomic issues make it difficult to understand companies' fundamentals, as was the case with financial companies in 2006 and 2007, we avoid those companies and sometimes the entire sector.
U.S. Banks
Even if the proposed Basel III capital requirement rules are adopted, we believe the big banks are attractively priced. With interest rates at artificially low levels, and the wide spreads between what the banks are paying for deposits and the FDIC-insured money they can borrow in the market, their earnings are enormous. In addition, lending criteria are tighter and, in general, the quality of loans is now quite high, which means the banks' earnings are high in terms of the risks they are taking. While they must still deal with some serious legacy issues, for most big banks, such as JPMorgan Chase (JPM, Financial), Wells Fargo (WFC, Financial) and Bank of America (BAC, Financial), their pre-interest and pre-provision earnings in the $30 to $40 billion range are high enough to absorb losses. We also think their common shares, and in some cases their TARP warrants, are attractive investments. The TARP warrants give the holder the right to buy the bank's stocks at a specific price. Most of these warrants are long dated, with most expiring in 2018 or 2019. This time frame of eight-plus years allows the banks to grow their intrinsic value to a high enough level to meet the strike price of the warrant. In addition, we believe the strike price is adjusted downward for any quarterly dividend paid that exceeds a set price. A more detailed discussion of the TARP warrants is included in the letter to the 2010 semi-annual report.
Canadian Real Estate
Among the G8 nations, Canada has done the best since the Great Recession of 2008 and has been widely lauded for its fiscal and economic performance. Its real estate prices have reflected that positive opinion. But therein lies the problem. In most countries, real estate prices have declined substantially, while in most of Canada, especially in the big cities, prices have actually increased. Based on ratios such as rent-to-house-price and disposable-income-to-house-price, Canadian house prices are out of line with historical standards. In addition, household debt as a percentage of disposable income is unprecedentedly high. This does not mean that Canadian real estate prices will decline soon, but it does indicate that valuations are stretched. We would be cautious in this environment. If there is a choice, it is better to rent rather than buy a house. However, if you are determined to buy a house, we would urge you to do so without borrowing too much money.
Here is the portfolio of the Chou Associates Fund as of June 30, 2011 excluding the $116mil of the fund that was in cash (roughly 20%):
SHARES*
AbitibiBowater Inc. - $ 26,552,826
Bank of America Corporation, warrants, Class A - $20,835,704
Berkshire Hathaway Inc., Class A - $33,542,243
Flagstone Reinsurance Holdings Ltd. - $12,179,716
Gannett Company Inc. - $4,464,055
Goldman Sachs Group Inc. - 14,750,812
Int'l Automotive Components Group North America - $105,589
JPMorgan Chase & Company, warrants - $10,113,756
MannKind Corporation - $8,937,730
Media General Inc., Class A - $3,459,628
Office Depot Inc. - $1,512,327
Olympus Re Holdings Ltd. - $2,454,620
Overstock.com Inc. - $22,077,843
Primus Telecommunications Group Inc. - $6,511,085
RadioShack Corporation - $12,989,768
Sanofi ADR** - $15,096,483
Sears Holdings Corporation - $27,138,468
Sprint Nextel Corporation - $31,768,340
The Gap Inc. - $2,332,404
USG Corporation - $5,523,786
Valeant Pharmaceuticals International Inc. - $11,345,374
Watson Pharmaceuticals Inc. - $42,095,704
Wells Fargo and Company, warrants - $8,907,538
XO Holdings Inc. - $1,350,889
Total Equity Holdings - $326,046,688
BONDS
Abitibi-Consolidated Inc., debt stubs - $300,529
Global Crossing (UK) Finance, 10.75%, Dec 15, 2014 - $5,042,099
Level 3 Comm. Inc., 15.0%, conv., Jan 15, 2013- $51,431,575
Primus Telecommunications, 14.25%, May 20, 2013 - $12,916,471
RH Donnelley Inc., term loan - $7,581,287
Total Bond Holdings - $77,271,961
