Charles Mizrahi moved over to Angel Publishing a year or so ago, so we’re seeing a lot more ads for his Inevitable Wealth Portfolio. And the latest one pretty well bangs us over the head with the huge promises… including a “make 109 times your money” in the next decade headline, which is a dramatic promise to make even if you’re willing to be patient and let your investment work for that long.
And a real long-term focus is, of course, a challenge for most folks — trading and leverage and daily and monthly and quarterly returns overwhelm our imagination, and immediate gratification is the hallmark of modern culture, so investors seem to consider 18 months to be “long term” now. Ten or 20 years is beyond the comprehension of many investors… which is a shame, because for must of us who are terrible at predicting the short term vacillations of the market (yes, that probably includes you… and it definitely includes me), getting fantastic compounded returns on our hard-earned savings generally requires us to have the patience to sit through terrible years without overreacting.
But I’m getting ahead of myself — what is that stock being pitched in the ads for Charles Mizrahi’s Insider Alert? (It’s also still sometimes called the Inevitable Wealth Portfolio, which I think was the old name with his previous publisher but could still be active… subscription prices have ranged from about $1,000 to $2,500 in the years we’ve covered this publication, this latest ad was at $1,499.)
This excerpt will make it pretty clear:
“… it all starts today with one company that EVERY investor needs to own.
“It’s beaten Berkshire… and the gains that come rolling in could amount to 109 times your money.
“Let me explain…
“This ONE STOCK is the ‘Next Berkshire’
“It’s a story straight from a Horatio Alger novel…
“In the ’70s, a then-unknown man immigrated to Canada with $8 in his pocket.Are you getting our free Daily Update
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“Today, he heads a multinational holding company that pays out insane profits, makes piles of cash on companies no one else cares about, and has outperformed just about everyone else in the stock market since 1985.
“Oh, and he’s also a multibillionaire.
“So it’s no surprise many call him the ‘Warren Buffett of Canada.’
“The man even named his son after Buffett’s mentor, Benjamin Graham.
“Though for all of his success, he’s remained largely out of the public eye.
“As the Toronto Star puts it, he’s “the richest, savviest guy you’ve never heard of.”
“So who is this guy? And how could investing with him today mean you could earn up to 109 times your money over the next decade?”
And he makes the point that this “Warren Buffett of Canada” made a huge bet that paid off during the financial crisis:
“His intake when the house of cards tumbled down? More than $2 billion.”
So who is this?
Yes, Mizrahi is (again) hinting at Fairfax Financial (FFH in Toronto, FRFHF OTC in the US), which is a large Canadian insurance conglomerate. And yes, Fairfax and Markel (MKL) probably share the title for “most times being compared to Berkshire Hathaway.”
Mizrahi has been pitching this particular pick in his ads since at least the Fall of 2013, and the stock has disappointed for most of that time (it’s up about 5% since I covered that first teaser pitch for the stock, compared to 82% gains for Markel, 40% gains for Berkshire, and 33% gains for the S&P 500 during that same time period)… but it’s also a stock that I’ve moved into fairly aggressively over the past six months, adding first as a hedge against economic calamity in the weeks before the election and then, as the story changed fairly substantially this year (with both a huge shift in Fairfax’s bearish positioning and a major acquisition that brought the share price down), as a long-term bet on Prem Watsa’s ability to generate another wave of growth.
Fairfax has never been a “slow and steady” performer — their fantastic long-term returns have come because of some major acquisitions, and because of Watsa’s macro positioning of the investment portfolio… most famously when he bet big against housing during the bubble and did indeed book that profit for Fairfax of ~$2 billion when things collapsed (Fairfax’s market cap was only about $3.5 billion at the time, so that was a huge boost).
And it’s been a hugely successful company, thanks both to Prem Watsa’s ability to acquire insurance companies at decent prices and, recently, improve their operations… and to Watsa’s investing strategy, which is very aggressive and targeted compared to most insurance companies.
That positioning has worked against Fairfax’s investment returns over the past six or seven years, most of the derivatives and the net short positioning of the portfolio has been a drag on their performance for a long time. That positioning was my initial reason to buy in to the shares back in October, because it was an easy way to buy a good company and also get exposure to some big picture bets and deflation and a short hedge against the market. Watsa is an active value investor who might provide market-beating returns some of the time even if he’s wrong about the big picture, and he has been quite wrong about the big picture for the past several years — but he also reacted fairly quickly after the election to close out Fairfax’s negative bets on the market because of the changes in prospects under Republican leadership (and, probably more importantly, because of the massive shift in market sentiment).
So that’s not a new and exciting name for you, but yes, it’s still being recommended by Inevitable Wealth Portfolio, and this happens to also be a stock I’ve been buying. Here’s a little excerpt of what I wrote to the Irregulars a little over a month ago when I last added to my position:
Fairfax Financial, the big Canadian insurance/investment conglomerate, had the weak end to the year that should have been expected given the hugely bearish positioning Prem Watsa had going into the second half of 2016 — following the election, and with the obvious and dramatic change in the market with the Republican takeover in DC that spurred so much investor optimism and rekindled inflation expectations, Watsa reacted quickly and closed much of that hedge book, but the cost of closing those short positions and deflation bets meant they booked two billion dollars in realized investment losses in 2016 (the net drop was only $1.2 billion, but that’s because of unrealized gains for positions that were still on the books as of December).
So that meant Fairfax, which has a market cap of only about $11 billion today, had a big drop in book value when most insurers would have seen roughly flat book value (since most of them had to write down the value of their bond portfolios due to the sharp rise in interest rates in the second half of 2016, but would have seen equity gains for their “risk” portfolios). Operating performance remained excellent, with good underwriting, the fall in book value was solely due to investment losses (overall, the reported loss for the holding company was a bit over $500 million — profits from insurance operations covered more than half of the investment losses).
Fairfax’s book value per share as of the end of December was US$367, which means that at a $465 share price the company is trading at about 1.25X book value. That’s roughly average for Fairfax over the past decade, the shares have generally bottomed out around book value and maxed out around 1.4X book most of the time. I think it’s worth being in partnership with Prem Watsa during what is likely to be a very volatile year — he was certainly wrong about his expectations of deflation and stock market collapse over the past year, but we can see that even being that wrong had a fairly muted impact, with book value per share dropping only 9% on the year (almost all of that in the fourth quarter), and he’s been prescient and nimble enough in the past to garner extraordinary gains during tumultuous periods like the 2008-9 crash.
So I’m again increasing my allocation to Fairfax, as I did in December on the initial dip, with an increase of my position by about 25%. That’s partly just because I like being exposed to Prem Watsa’s investment strategy and his extraordinary long-term success rate (volatile though the stock has sometimes been, with the gains coming in chunks), but the more immediate reason is because, as I noted in December when it was announced, I think the pending acquisition of Allied World has the potential to give Fairfax a nice boost over the next year or two (similar to the benefit Markel saw from their acquisition of Alterra in 2013).
That possible boost comes mostly because it will boost Watsa’s portfolio more dramatically than it increases the book value of the combined company — and I expect Fairfax to earn more on that investment portfolio than Allied World did. Whether or not it actually leads to a better valuation for Fairfax is unknown, for sure, but it’s certainly possible. That Markel/Alterra deal, which was an unusually good and well-timed acquisition, to be fair (even though Markel investors were terrified by it at the time), set the stage for Markel to boost its book value per share by about 50% over the course of four years… and with that growth they also got a higher price/book valuation (going from roughly 1X book on the dip when the Alterra deal was announced, to about 1.6X book today) — 50% over four years doesn’t sound so dramatic, but when you both increase the earnings or book value and increase the multiple you’re willing to pay on that book value (or earnings, or whatever), a stock can soar (Markel shares have risen 125% during that 50% increase in book value per share).
Part of the reason that Fairfax looks appealing now is simply that other high-quality insurers that have good long-term investment track records are generally too expensive — the ones in my portfolio, Markel and Berkshire Hathaway, are both well-loved in the heart of your friendly neighborhood Gumshoe, but they’re also too well-loved elsewhere, so they’re not likely to spur aggressive buying interest from me at their current lofty valuations. Fairfax, in contrast is not getting as much love at the moment, partly because of that bad quarter and because of worries about this latest acquisition — but has a similarly fantastic long-term record.
My expectation, based on the presentation detailing the deal (which used third quarter numbers, not December numbers, so I’ve adjusted for the big investment loss Fairfax reported in the fourth quarter), is that the fourth quarter book value per share for the combined company, after the new shares are issued to complete the deal, would be roughly $380 — based on the September numbers it would have been estimated at about $420, but Allied World had a small drop in book value per share in the fourth quarter, too, (on the order of 1-2%, much smaller than Fairfax’s)… so it will be somewhat accretive to book, but not in a big way. That doesn’t change the valuation much — it gets us closer to 1.2X book instead of 1.25X, but given the wild changes in the market over the first two months of this year that could all be washed away by whatever the March 31 number might be.
Prem Watsa writes an annual letter to shareholders, in the style of a somewhat less folksy Warren Buffett (Watsa intentionally emulates Buffett in many ways, which seems wise to me), and those are worth reading if you’d like to spend a little time getting used to his world view and investment and management strategies — they’re all collected here and the 2017 letter (about 2016 results), released about a month ago, is here.
The main risk that concerns me with Fairfax, beyond the risks that apply to all insurers (they could screw up underwriting or we could have cataclysmic catastrophes that hurt all insurers, or investors could revalue the whole sector), is that they may well languish for a while if Watsa’s investments don’t bear fruit in the near term.
This is what Prem noted in his latest annual letter in regards to their portfolio positioning after roughly seven years of the investment portfolio just breaking even (with bonds supplying some return, but bearish hedges eating up all of the potential equity return) — though the bearish hedges have been removed, they are certainly still taking big macro positions, particularly when it comes to interest rates:
“Since we fully hedged our common stock portfolio in 2010, we have been frequently asked, as we have constantly
asked ourselves, under what circumstances would we remove the hedges. Obviously, a huge sell-off in the financial
markets, such as that of 2008/2009, would have led to that result, as the hedges would have performed the purpose
for which they were established. What actually happened with the U.S. presidential election on November 8 was the
arrival of a new administration focused on dramatically reducing corporate taxes (35% to 15% – 20%), rolling back a myriad of regulations large and small which unnecessarily impede business, and very significantly increasing much needed infrastructure spending. In our view, this should light up ‘‘animal spirits’’ in America and result in much higher economic growth than what has prevailed in the last eight years. This would mean, over time, that long rates will rise – thus our decision to reduce the duration of our fixed income portfolios to about one year. Higher economic growth would result, we think, in higher profits for many companies, so that even though the indices may not go up significantly, we think a value investor like us can ply our trade again with less of a concern of economic collapse. When the U.S., a $19 trillion economy, does well, the world tends to do well!
“While many risks to global economic growth remain, such as protectionism, China unraveling and the euro
disintegrating, we believe the chances for robust growth have significantly increased. We will remain vigilant to
these and other risks, and will retain protections in place, such as the $110 billion notional amount of deflation
swaps we hold, which have five and a half years yet to run. We also hold $10 billion of cash in our insurance
companies, due to the liquidation of our long bond portfolio.”
The stock has done very well over a very long period of time… but it has also had extended periods when the basic value of the company has not really grown. In the six or seven years leading up to the 2008 financial crisis, the book value per share did not really grow at all — partly because underwriting performance was bad during much of that time, partly because of some investments that didn’t work out, partly, particularly in the later years, because Watsa was betting on the 2008 housing crash well before it happened, and those bets did not look good until they looked really good.
So Fairfax Financial does indeed require some patience — but over time, it has certainly rewarded that patience. For the sake of my portfolio, I hope it continues to do so… and I think the chances are good, particularly with Fairfax’s continued focus on acquisitions in both insurance and operating businesses, both in Canada and overseas (I particularly like their growing businesses in India and Brazil)…
… but no, I certainly don’t expect my Fairfax investments of the last six months to generate 109X returns (and so far, they’re in negative territory, my position is down about 9%). My expectation is much more muted than Mizrahi’s and I’d be delighted to see gains of a few hundred percent when I look back on these initial investments in ten or twenty years. Hopefully Watsa will remain at the helm (he’s 20 years younger than Warren Buffett, in case you’re wondering), and we’ll see a few crashes along the way that provide more advantageous buying opportunities.
Sound like the kind of investment you’d like to make? Think the valuation or the story is appealing right now, or are you sick of Watsa’s recent years of underperformance on the investing side? Let us know with a comment below.
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