Proven wrong for last 5 years, ace investor remains unfazed


Prem Watsa, Fairfax Financial Holdings, Canada

Die-hard value investor and avid follower of Warren Buffet and Benjamin Graham, Prem Watsa moved to Canada from India with just $600 in his pocket and built a fortune worth over $ 40 Bn in Fairfax - an insurance and investment management behemoth he created on the lines of Buffett's Berkshire Hathway. Until 2010, Fairfax delivered a 15 year average return of 18.3% p.a against 0.4% p.a. for the US S&P 500. Little wonder that he is popularly known as Canada's Warren Buffett. From 2010, owing to his discomfort with the growing disconnect between markets and the real economy, he started fully hedging his portfolio to guard investors against the many problems he sees. That strategy has not paid off yet - in the 5 years since, his portfolio has lost 4.9% p.a. on average against a 12.6% average increase in S&P 500. Watsa remains unfazed and continues his fully hedged stance - convinced that the world's asset markets are headed for a hard landing. As he says, its better to be wrong, wrong, wrong, wrong, wrong and then right - rather than the other way around. The wrongs have happened in recent years -what the world will keenly track is whether his strategy is going to come good soon, and more than make up for the last 5 years of "unnecessary" caution. He reminds his investors that it took 89 years for AIG to build $ 90 Bn in shareholder capital - and then they lost it all in just one year. Watsa believes we will see similar hard landings as asset bubbles stretch far beyond fundamentally justified valuations - and that protecting the portfolio rather than squeezing out the last dollar of returns from the bull market - is what will finally be in investors' best interests. Interestingly though from an Indian perspective, Watsa is very bullish on India and has a growing portfolio of companies in his billion dollar specialist India vehicle - Fairfax India Holdings.


From Hyderabad to Canada - with only $ 600 in his pocket

Prem Watsa, called the Warren Buffet of Canada, was born in Hyderabad, India, in 1950. After graduating in chemical engineering from the Indian institute of Technology, Madras, he moved to Canada in 1972. He completed MBA from the Ivey School of Business at the University of Western Ontario. It is noteworthy that for a person who would later make billions of dollars, he arrived in Canada with $600, just enough for the first semester's tuition fees, and a few days living expenses.

His first job was at Confederation Life as a security analyst. On joining, his boss gave him 'Security Analysis' by Warren Buffet. This book proved to be a deep and permanent influence in his life. Indeed his investment philosophies and strategies are closely aligned to the strategies followed by Warren Buffet. After nearly a decade gathering rich experience in various companies, he branched out on his own.

This came about when a friend of his pointed out that Buffet's secret was the insurance float, basically the amount garnered from insurance premiums paid by the public that formed the financial strength of Buffet.Looking around he identified Markel Financial, an insurance company, which he bought for $ 5.00 million, mainly with borrowed money.

He renamed the company Fairfax Financial, to indicate that his dealings would be fair with the investing public, while acquisitions of corporate entities would be friendly. The company's book value grew from $1.50 1985 to a high of $10.50 in 1989, which further boomed to $39 in 1995. Watsa listed the company on the NYSE in 2002. As he reported in the 2017 letter, "Since we began 31 years ago, our book value per share has compounded by 19.4% (20.2% including dividends) per year, and our stock price has followed suit at 18.6% per year. (Gurufocus Robert Abbott, April 21, 2017)

Investment Philosophy

Watsa is a value investor. There is really no need for further elaboration here, when you realise that Watsa is a great fan of not only Warren Buffet, but also Sir John Templeton and Benjamin Graham. In fact Templeton owns a chunk of Fairfax's stock. Like many successful investors, Watsa is a contrarian. Watsa invests in shares and bonds but not in commodities. Most of his shares are held in well-known blue chip companies.

His vision is actually fixed on the long-term. He wrote in 2014, "In the short term, there is no correlation between growth in book value and increase in stock price. You will note periods when our book value grew substantially faster than our stock price and vice versa. More recently, we think the intrinsic value of our company has grown much more than its underlying book value. In 2013, our book value dropped by 10% for the reasons discussed earlier while our stock price increased 18%, some of it due to the declining Canadian dollar. However, it is only in the long term that book values and stock prices compound at similar rates."

Investment Strategy

Like his mentor Warren Buffet, Watsa believes in buying businesses for the long term, and often takes significant to majority stakes in businesses he has conviction in. As regards the market investments part of his portfolios, he has been following a fully hedged strategy since 2010, owing to his growing disquiet in the disconnect he sees between financial markets and the real economy in the developed world.

What really differentiates Watsa from other investment managers is his uncanny ability to double down on 'black swan' events and gain from them.

Black Swan moment

One of his biggest moments in investing occurred when he went on a buying spree acquiring Credit Default Swaps mirroring his dim view on the housing bubble that was building up in the US market. "We bought our first (CDS) contract in 2003 and our last ones in December 2007. We just keep buying more and more, first five-year, then sever-year, because they were so cheap..." At one investment committee meeting where Prem asked, "What's the best idea we've got?" Francis Chou, who is a pretty shy guy, piped up. "Buy more credit default insurance." In the fall of 2008, Fairfax started to sell its CDS. The company made about $2 billion from those sales. (Gurufocus)

Another more controversial decision is his continuing investment in BlackBerry. This Canadian mobile manufacturer was once the gold standard for smartphones. It has now been eclipsed by Apple iPhone, Samsung and a host of other manufacturers. But Watsa has continued to back BlackBerry. The company is now exiting the phone business to concentrate on the Internet of Things. Will this bet be ultimately proven right? Only time will tell.

Letters to Shareholders

Watsa is an intensely private person and hardly interacts with the public. The one exception is his shareholder letters. Below are some excerpts from those letters which give valuable insights into his thinking and future plans.

Few investors focus as much on risks as Watsa, who worries about everything from tech bubbles to consumer spending. Writing in 2016's letter, he says:

"I have purposely given you a quick summary of all the problems/challenges that the world faces right now. The potential for unintended consequences, and therefore of pain, is huge. This is why Ben Graham said if you were not bearish in 1925 - yes, 1925 - you had a 1 in 100 chance of surviving the depression - really the 1930 to 1932 crash in the stock market that resulted in an 86% loss from the high in 1930. We continue to protect you, our shareholders - and our company - as best we can from the potential problems that we see. As we have said, it is better to be wrong, wrong, wrong, wrong, wrong and then right, than the other way around! We remember it took 89 years for AIG (AIG) to build $90 billion of shareholders' capital, and only one year to lose it all!"

In the 2017 Letter, Watsa wrote:

"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 selloff 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."

He has hedged Fairfax Financial's stock holdings for years, often with negative results. But, every so often he is vindicated, and Watsa said in the 2014 letter that he planned to continue with safety first:

"We had to endure years of pain before harvesting the gains of 2007 and 2008. While we hope the world economy muddles through, we continue to protect our company from the significant unintended consequences that prevail today." (Gurufocus Robert Abbott, April 21, 2017)

There are many lessons that one can learn from Prem Watsa. This quote reveals that Watsa regards himself as a trustee of shareholders' money He has managed to be both aggressive and cautious in his investments. Clear thinking has led him to hedge even the most outrageous of bets, so that he is not surprised by the downside. Many a time this strategy meant that he had to suffer short term losses, but this strategy of hedging has allowed him to outperform most of his peers in a big way.


Content is prepared by Wealth Forum and should not be construed as an opinion of HDFC Mutual Fund.

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