Let us do a little thought experiment: Suppose you would be able to give 1 Dollar of your money to an excellent capital allocator who manages 2 Dollars worth of assets for every 1 Dollar you give him. Further assumethis guy earns 15% after corporate taxes on these assets over a 10 year period.
Now what would your economic earnings be? Well 15% RoA then equals a stunning 30 cents on every Dollar you initially invested or 30% RoI. This example might actually sound too good to happen in reality but though it is “unreal” that’s what currently happens:
When Leucadia (LUK) recently hit its low around 12 USD it was trading at less than 50% of NAV. As they have to mark their big investments to market value NAV currently is rather understated than the opposite. Conclusion: Permanent loss of capital is hard to imagine and by investing one Dollar then getting two Dollars of well managed assets, the investor is practically leveraging up – without the use of debt!
The same can be observed with well managed insurance companies: At Fairfax (FFH) for example, the investor gets per invested Dollar more than 3 Dollars worth of securities because of the miraculous float. When used effectively this float can be nearly as valuable as equity and therefore compound shareholder returns at impressive speed.
Finally let me outline the idea of “leveraging up” once again: When you can buy 2 Dollars worth of assets for less than 1 Dollar and you can be sure that the managers of these assets are excellent capital allocators then:
1. Permanent capital loss is very unlikely.
2. Long term economic returns will be excellent.
Compare that to a managed investment fund where you get in at NAV but have to pay the general 2Â plus 20% fee, the huge benefits of the former option become very obvious:
1. Margin of Safety
2. Higher economic earnings
3. Shareholders aligned with management
4. No costs for allocating the investors capital
Okay giving away your capital to Buffett, Watsa or Steinberg might not be as much fun as allocating it yourself. The long term return however will likely be superior to what the private investor can achieve.
Now what would your economic earnings be? Well 15% RoA then equals a stunning 30 cents on every Dollar you initially invested or 30% RoI. This example might actually sound too good to happen in reality but though it is “unreal” that’s what currently happens:
When Leucadia (LUK) recently hit its low around 12 USD it was trading at less than 50% of NAV. As they have to mark their big investments to market value NAV currently is rather understated than the opposite. Conclusion: Permanent loss of capital is hard to imagine and by investing one Dollar then getting two Dollars of well managed assets, the investor is practically leveraging up – without the use of debt!
The same can be observed with well managed insurance companies: At Fairfax (FFH) for example, the investor gets per invested Dollar more than 3 Dollars worth of securities because of the miraculous float. When used effectively this float can be nearly as valuable as equity and therefore compound shareholder returns at impressive speed.
Finally let me outline the idea of “leveraging up” once again: When you can buy 2 Dollars worth of assets for less than 1 Dollar and you can be sure that the managers of these assets are excellent capital allocators then:
1. Permanent capital loss is very unlikely.
2. Long term economic returns will be excellent.
Compare that to a managed investment fund where you get in at NAV but have to pay the general 2Â plus 20% fee, the huge benefits of the former option become very obvious:
1. Margin of Safety
2. Higher economic earnings
3. Shareholders aligned with management
4. No costs for allocating the investors capital
Okay giving away your capital to Buffett, Watsa or Steinberg might not be as much fun as allocating it yourself. The long term return however will likely be superior to what the private investor can achieve.
