's investing prowess with the float of his Canadian insurance
company Fairfax Financial often draws comparisons to
, but the firm reported losses in its portfolio for the third
quarter. While stocks delivered positive returns, even with the
derelict Research In Motion (
) in the portfolio, early hedges ultimately outweighed gains. The
last time Watsa was early on hedging, he made billions.
According to Fairfax's financial results, in the third quarter
its net gains on common stocks were $151.3 million and on bonds
were $204 million. Combined with a small gain on preferred
stocks, its total net gains on investments were $355.6 million.
The company also reported net losses on common stock and equity
index short positions of $490.8 million, and on credit default
swaps of $10.7 million. Its combined net losses on financial
instruments were $477.6 million.
Combined with several small gains and losses on foreign currency,
Fairfax ended the third quarter with a net realized loss of
In the third quarter last year, hedging performed more handily:
Fairfax had net realized gains of several million dollars on
bonds and stocks, and almost a billion dollars on common stock
and equity index short positions. Its total net realized gains
that quarter were $1.14 billion.
Fairfax is a long-term-oriented company that has produced an
average of 10.6% over the past five years and 9.6% over its
26-year history. Its third-quarter fluctuation had to do with the
scenario Watsa expected for the year not playing out in the time
Watsa in his
2011 investor letter
said that he maintained a 100% equity hedge to protect against a
near-term economic downturn "given interest rates at close to
absolute zero and no fiscal stimulus bullets available in the
western world." Yet one more fiscal stimulus bullet was found
when the Federal Reserve in September announced a third round of
quantitative easing in which it will purchase $40 billion of
agency mortgage-backed securities per month and maintain low
rates not to conclude until mid-2015.
The stimulus and other factors boosted the S&P to return
6.35% in the third quarter and 16.44% in the first nine months of
the year, even though U.S. GDP has been lower than expected, the
deficit has expanded and analysts expect third quarter S&P
earnings to be lower than 2011 levels. Watsa hedged expecting the
biggest risk to lurk in the near term, seeing good performance
for stocks over the next decade.
From his 2011 letter
: "As for the United States, as we have discussed many times
before, if we thought the 2008/2009 great contraction was like
any other recession the U.S. has experienced in the past 50
years, we would not be hedging today. However, we continue to
worry that the North American economy may experience a time
period like the U.S. in the 1930s and Japan since 1990, during
which nominal GDP remains flat for ten plus years with many bouts
of deflation. To combat the great contraction of 2008/2009, the
U.S., as well as Europe and most countries in the world, went
'all in' with huge stimulus programs. They have no ammunition
left now and austerity is the slogan of the day, worldwide!"
The market's rally may have staved off or postponed his thesis
unfolding. As of the end of the third quarter, Fairfax maintains
short positions "against a potential decline in equity markets"
in individual equities, the Russell 2000 index, the S&P 500
index and the S&P/TSX 60 index, it said in its third quarter
Watsa has been in a similar hedging-loss situation before that
ended lucratively. In 2004, Fairfax held very conservative
investment positioning that included hedging a significant amount
of its common stock holdings to protect against an equity market
decline. It led to an $81.5 million hedging loss and 6.3% return,
but Watsa was wary of the environment.
The next year, the conservative investment position, combined
with the effects of several hurricans and runoff losses, resulted
in a record $498 million loss at Fairfax. Hedging resulted in a
$148 million unrealized loss.
"We expect the unrealized losses from our hedges to be just that
(i.e., unrealized) and at the end of the day we expect them to
protect our portfolios from a 1 in 50 or 1 in 100 year event in
the financial markets," Watsa said in his 2005 letter.
Watsa turned out to be spot-on. When that event happened in 2007,
Fairfax had the best year in its history.
"Our total investment portfolio had another excellent year in
2007 while we maintained and increased the protection we have
built against a 1 in 50 or 1 in 100 year storm in the financial
markets," he said in his 2007 letter.
In 2007, he made $1.64 billion in total net gains, including
unrealized gains and losses from his S&P 500 hedges and
credit default swaps. The return that year was 14.4%.
Hedging results were even better in 2008. When all major stock
markets had fallen about 50%, Fairfax reported a 16.4% return and
total interest and dividend and net investment gains of $3.3
"While we are pleased that our forecast of 'the seven lean years
are over' did come true, we much prefer the Noah principle,
'Forecasting doesn't count, building an ark does'!" Watsa said in
Time will tell if the markets have a downturn and his ark
building pays off again.
All of Watsa's top stock positions returned gains in the third
quarter: Johnson & Johnson (
) (up 2%), Level 3 Communications (
) (up 4%), Resolute Forest Products (up 12%), Research In Motion
) (up 1.5% and down 48% year to date), U.S. Bancorp (
) (up 7%) and USG Corp. (
) (up 15% and up 148% year to date).
See Prem Watsa's portfolio here. Also check out the
dervalued Stocks, top growth companies and high yield stocks of
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