As the market advances and BlackBerry (
) tumbles, Fairfax Financial chairman and CEO
has taken the reverse position from the majority of investors: He
has hedged his portfolio against a market meltdown even at the cost
of tempered returns and committed sizable capital toward the
tattered smartphone maker. This all continued in the third quarter,
with some new developments.
Third Quarter Market Hedging
According to Fairfax Financial's third quarter financial results
released Oct. 31, Watsa's investment side of the business returned
around 6% for the third quarter, short of the Russell 2000 index's
10% but beating the S&P 500's 5%. But these gains from his
expert positioning were mitigated by two things: mark-to-market
losses from bonds due to rising interest rates, and hedging.
Watsa never hedged his portfolio before the past six or seven
years. Why is he doing it now? Because short-term underperformance
is worth it to avoid permanent losses, which are a real possibility
ahead, according to Watsa, whose gloomy outlook he has held for the
past several years for the markets did not change in the third
We are maintaining our defensive equity hedges due to our concern
about the financial markets and the economic outlook," he repeated
again in his latest third quarter release. The release adds later
that it has hedged investments "In response to the significant
appreciate in equity market valuations and uncertainty in the
Watsa also told GuruFocus in an interview last year: "We are
hedging not for 5-10% declines, we are hedging big market risk.
We're worried about the markets coming down significantly. It might
not happen, but we are just very downside protection oriented. We
look at downside protection, we worry about that, and we have to
live within our means."
At Sept. 30, 2013, Fairfax's equity and equity-related holdings are
hedged 100.1%, valued at $7.813 billion compared to the company's
total equity and equity-related holdings of $7.809 billion, from
100.6% at Dec. 31, 2012. Watsa believes so strongly in the
necessity of the hedges that Fairfax took a loss of $477.9 million
and $301.7 million in its equity and equity-related holdings after
equity hedges in the third quarter and first nine months of 2013,
Watsa had his portfolio fully hedged in 2008, helping him evade the
worth of the crash of that year. He removed the hedges in November
2008, after the market dropped 50% from its high, gaining 16.4% for
The current full hedging of Fairfax's portfolio has persisted since
at least 2010. Watsa began the year just 30% hedged, increasing to
100% in May and June. He delineated in his 2010 and 2011 annual
letters his reasons for distrusting the market's rise, saying most
recently in his 2012 letter:
"We continue to fully hedge our common stock portfolios because of
the reasons first discussed in our 2010 and 2011 Annual Reports.
Those reasons have not changed! Total debt (private and government)
as a percentage of GDP in the U.S., Europe and the U.K. are at very
high levels, thus limiting the options available to governments.
Deleveraging in the private sector has only just begun. In spite of
the significant deficit spending in the U.S. and Europe, high
levels of unemployment prevail in both areas and economic growth
continues to be very tepid..."
(Read more of Watsa's market views
in his 2012 investor letter here
As BlackBerry announced today, Fairfax has lost in its effort to
outright buy the technology company after controlling more than 10%
of its shares since a year ago, but is still going for a larger
stake. Instead, Watsa and other institutional investors will inject
$1 billion worth of convertible debentures into the company within
the next two weeks, of which Fairfax's part will be $250 million.
The 6% convertible debentures are each convertible into a common
share of BlackBerry at a price of U.S. $10.00, a 28.7% premium to
their Nov. 1 closing price, with a term of seven years. Conversion
of all of the shares would give the group 16% ownership of the
Management changes coming as part of the agreement include the
replacement of the company's CEO, Thorsten Heins, with John S. Chen
as interim CEO until a permanent executive can be found. Watsa will
likely play a major role in the selection of a new chief as he
becomes the lead director and chair of the Compensation, Nomination
and Governance Committee.
"Fairfax is a long-time supporter, investor and partner to
BlackBerry and, with this investment, reinforces its deep
commitment to the future success of this company," said
. "I look forward to rejoining the BlackBerry Board and to working
with the other directors and management team, under John Chen's
leadership, to shape the next stage of BlackBerry's strategy and
The market responded negatively to the news, with shares tumbling
16.4% on Monday, to $6.49 per share.
BlackBerry on Oct. 2 reported to the SEC that it sold only roughly
2 million of its recently launched BlackBerry 10 smartphones in the
second quarter, a hopeful turnaround product for the company. It
also reported a $965 million net loss due largely to a $934 million
charge for unsold BlackBerry 10 units.
Over the past five years, BlackBerry has seen its EBITDA per share
decline at a rate of 25.6%, while book value increased at a rate of
15.6%. The infusion from the group of investors will boost its cash
position from its current $2.34 billion as of second quarter end,
while management engages in turnaround or sell plans. The company
has no debt.
Most of Watsa's other top positions were flat or advanced for the
third quarter, with Johnson & Johnson (
) up 1.2%, Resolute Forest Products (
) flat, Level 3 Communications (
) up 26.6% and SandRidge (
) up 23%.
See the rest of
's equity portfolio here.
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