Fairfax Lollapalooza

I just got back from a two week trip to Toronto. The first week was spent exploring Toronto with my family. The second week of the trip was spent attending various investment events and I want to use this newsletter to share my insights. The events are based around the Fairfax Financial Annual General Meeting (AGM). Over time Fairfax has developed a following of investors and numerous events have spun-off from the AGM. There are conferences, stock picking competitions, dinners and plenty of opportunities for new investment ideas. When you spend most of your time reading company filing and looking at financial statements, these events are a welcome change. But first here are some thoughts on Toronto.

Toronto 2.0

I took some time to visit my brother, Torontonian Hugh Langis, co-founder and co-owner of Half Hunter (design studio) and The Station (best co-working office space in Toronto), which I shamelessly just plug in. By the time of my visit it was already spring time in Toronto and it was just warm enough to walk around. There’s only so much you can do with a two and a half year old but if you get the chance, the Royal Ontario Museum is a good spot to take your family. There are plenty of dinosaur skeletons among other artifacts. I have to say that the city of Toronto got a lot better over the last ten years. When I first stepped in the city in 2002, I wasn’t that impress. Toronto is often described as “la ville reine” (the Queen City). When your nickname is linked to Queen Victoria’s reign, entertaining is not what comes to mind. “Banks and malls” is how I had described Toronto. But that has changed. Millennials and hipsters took over the suits and royalists and transformed the city for a better place. Now Toronto is populated with cool indie coffee shops, trendy restaurants and great pubs for happy hour. The places are jammed packed in the middle of the day. I’m not sure if anybody works in Toronto. While it’s fun to see the city alive, I never fully understood how they manage to pay rent considering the booming prices of real estate (more on that later). Toronto is certainly closing the gap with Montreal. Today Toronto can say they have decent smoked meat, poutine, and bagels, all trademarks of Montreal. I also found Toronto to be cleaner than Montreal. Right now, Montreal is going through a rough time with all the constructions and its orange cones scenery.  Corruption and a lack of leadership have set the city behind but Montreal will be vastly improved in five years once the mess is cleaned up.  When I was in Toronto there was a pulse in the city. The Maple Leafs was in the playoffs (that’s a very rare thing) so were the Raptors. It was also the beginning of the MLB season and the Blue Jays were playing in Toronto. The city felt alive!

Toronto Real Estate

The Toronto real estate situation was the topic du jour while I was in Toronto. Toronto stole the crown from Vancouver for the most ridiculous real estate prices in the nation, and maybe in the world.  Owners and sellers are a very happy camp and while potential buyers are very frustrated. Toronto real estate has been considered expensive for at least the last seven years. Now the prices just shot up 33% year over year. What was considered “bubble price” a year ago now looked like a steal. Why did prices shot up 33% in one year? No reason. The fundamentals didn’t change. The economy didn’t boom. Population is modestly growing. Speculation is responsible for the booming prices. Sometimes higher prices are responsible for higher prices. There’s a pure disconnect between price and value. Housing basically should only rise by the extent of inflation, which is very low, and the extent of the productivity of the country, which in Canada is also very low. Real estate agents in Toronto like to cite the “strong demand” for the rise in price. But this runs against simple economic theory. Demand doesn’t increase the more you increase prices. In other words, the more expensive the real estate gets, the less demand there should be, not more. Need more signs that speculation is behind the rise in prices? A month ago Toronto held its real estate conference. The place was crowded with subprime lenders, third party lenders, and exhibits on how to get a second mortgage on your house.  That’s should be enough red flags.

The most plausible running theory is that following the implementation of the Vancouver foreign-buyer tax, foreigners decided to park their cash elsewhere, like in a big metropolitan like Toronto. These foreign buyers have no problem putting 50% cash down or more on a property. They see it as a safe haven for cash. We might not “get it”, but if your money is in China, buying property in Toronto is considered safer than leaving it in China.

When I was there the Ontario government took steps to cool down the market by slapping a 15% tax on foreign buyers.  While this might sound like a good idea, it will have unintended consequences over the long run. Whether or not Toronto housing prices fall – or their increase moderates – as a result of this tax depends on a host of factors. It might not have the desired effect at all. Toronto already has its own land transfer tax (Torontonians are double taxed when they buy a property) and that hasn’t stop buyers. Maybe foreigners will adjust and spend more on a lower value part of the housing market. This will boost prices and cause an affordable market into an unaffordable one. Foreigners have many other options for investment and might just invest in another country. Maybe none of these things will happen. At the end of the day, the impact of the tax on foreign housing purchases in Vancouver and Toronto remains to be seen. Perhaps it will work out exactly as planned in that city but I highly doubt it. Politicians looking for a quick fix by applying a bandage to a complex problem usually results in bigger problems. What is playing out in Vancouver and Toronto could well have unintended consequences across the country, not all of them happy.

Here’s an interesting article on the Toronto real estate. What an average priced house looks like in Toronto right now. The average price for a detached house in Toronto is more than $1.5 million. The Toronto Real Estate Board says that across the Greater Toronto Area, housing prices increased from $688,011 to $916,567 compared to March 2016.

Here’s what a $1.5 million dollar looks like in Toronto. According to the BlogTO article, the house went $500,000 over asking price.

Toronto house for 1.5 million
$1.55m Source: BlogTO

How is this going to end? People have been calling for a crash or a long time now. Short-sellers have been losing a lot of money trying to time a market crash. Canada dodged the global housing bust a decade ago, escaping without bank failures. The last real estate crash in Canada was in the early 1990s. People’s memory doesn’t go that far. What about raising the interest rates? I don’t think raising interest rate a couple points will change anything. A lot of people will be hurt by this. You need to look at is fueling the boom. The source: foreign money buying real estate in big Canadian cities. Higher interest rate won’t affect them because of the cash nature of the transaction and they are probably not financed by Canadian banks (well I hope not). Once the foreign money stops coming in, we might see a cool down/crash/correction.

Fairfax YYx Toronto Value

I was fortunate enough to attend the Fairfax YYx Toronto Value conference. The event was organized by some members of the Corner of Berkshire & Fairfax message board. These are great folks and I might have to become a member. They also organized other events and I will try to check them out in the future. The Ben Graham Centre’s Student Stock Picking Competition was happening at the same time but I think the YYx conference was a better use of my time. YYX is a smaller setting to talk/pitch value investing and share ideas. I found smaller settings better conducive to the flow and sharing of ideas. The name of the event is a play on the ValueX conferences. The organizer used the Toronto airport code and borrowed the superscript ‘x’. That’s how you get YYx. YYx is an event where like-minded people who are truly passionate about investing get together and share ideas. This is not a marketing or sales event but for investors willing to share ideas. The presentations are usually done under 15 minutes and are followed by a short Q&A session. The model is loosely based on TED talks. I left the conference with about ten new investing ideas of companies I never heard. I can call that a productive day. Just think about the amount of time it takes to get a decent idea. I might post the name of the companies with a short resume in another post if I get the time.

Fairfax Value YYx was followed by the Ben Graham Dinner. Instead of being identified by your name, you had stock sticker for your name tag. Obviously you have to be a stock nerd like me to think that’s a cool idea. The dinner is usually followed by a couple dessert speakers and long discussions about stocks, the markets, and of course Toronto real estate.

Figuring out BAM
Trying to figure out Brookfield Asset Management on the table paper cloth.

The Ben Graham Centre’s 2017 Value Investing Conference

The Ben Graham Centre, part of the Ivey Business School at the University of Western Ontario, runs a value investing conference geared to professional and other well-heeled investors. Value Investing was developed in the early 20th century by Benjamin Graham and has been popularised in recent decades by the success of many investors who follow the approach, most notably Warren Buffett. The centre brought in some of the brightest minds in the field to mull the question of where value lies in a market that doesn’t appear to give a care about valuation. Some speakers include well-known value investors Thomas A. Russo and Arnold Van Den Berg. Unfortunately Mohnish Pabrai couldn’t make it because he was sick, or a upper-body injury if we used hockey speak like they did at the event. The conference is also a showcase for less well known and smaller firm and companies. The speakers provided valuable insights into the methods and approaches that have made them successful, comment on the current investment climate and offer specific investment ideas

The conference opened with a message from the director on the importance of active management. These are tough times for bargain-hunting investors. Ever since the financial crisis, most value-oriented portfolios of stocks have lagged the broad market. Indexing and robo-advisors are the flavor of the day. But George Athanassakos, the director, made the case that good active managers will survive and will still make a good living out of active management.

ETFs

Like I mentioned above, it’s been a tough couple years for professional money managers. The growth of indexing is a significant developments that have impacted the market. Vanguard, with $4.2 trillion in asset under management, is a magnet that is attracting a lot of money. In the last three calendar years, investors sank $823 billion into Vanguard funds, 8.5 times as much as the net $97 billion added to every other mutual fund combined!  Vanguard is currently managing $4.2 trillion! (Source: NYT/Morningstar/Vanguard). Indexing creates a cycle in which money pours into the biggest mega-cap stocks, driving them (and the indices) higher. This causes active money managers, who tend to own smaller stocks to underperform, causing their investors to redeem, thereby forcing the active managers to sell their stocks, driving them down, further widening the gap with the indices, leading even more people to throw in the towel and embrace indexing. ETFs and robo-advisor are distorting the market and financial assets are severely mispriced. There’s definitely a social detriment to have capital in the hands of people who are just seeking average performance but on the other hand, you can make a case that a certain portion of active money manager are not contributing anything positive to society and a good portion of them are not earning their fees. That’s why in the long run only the superior ones will make it in the business.

Indexing is good thing. I recommended ETFs to many people. But we all know that too much of a good thing is not the solution. The doctor said that a glass of red wine is good for you, but that doesn’t mean you should drink the whole bottle.  Charlie Munger, the vice-chairman of Berkshire Hathaway, said that “If you pushed indexation to the very logical extreme you would get preposterous results.” And he’s right (Who am I to argue with him?). The more capital that is indexed, the more it inflates the prices in the index and leads to poor capital allocation. If you mutual funds are closet indexers (most of them are), you are better off with ETFs.

I think you need to find the right balance.  You still need active managers. However active managers need to lower their fees much lower to justify their existence and to be able to compete. You can’t control the market but you can control the amount of fees you pay.  Indexing is trendy right now but it has become too trendy and it will end badly. The only thing that will reverse the trend is a bear market. This was the opening of the conference.

Keynote Speakers:

There were many great speakers and I can’t do a resume of all of them. But Will Danoff is worth highlighting.

Will Danoff

Will Danoff, manager of Fidelity Investments’ $108 billion Contrafund, the largest actively managed equity mutual fund.  Danoff is currently the mascot for the active management industry. He’s literally living proof that despite all the technological advances in attempts to beat the market in a march toward artificial intelligence, nothing can really beat the human mind. But despite the achievement, Danoff is not a household name.

You probably saw Fidelity’s ad campaign around in Canada. “The $108 billion man who beat the market” (WSJ).  Since he took over on Sept. 17, 1990, Contrafund has averaged a 12.7% return annually, according to Morningstar, outperforming the S&P 500 index by 2.9 percentage points a year. If you’d invested $10,000 in the fund then, you’d have had $231,207 at the end of last month; the same amount in the S&P 500 would have grown to $118,18, the Wall Street Journal reported. But like most active managers, the last few years have been tough. The big returns were in the past when Danoff crushed it in the early days. Recently, the Contrafund has been struggling. For the past five years, the fund has trailed the market by just over half a percentage point annually on average, although it outperformed in 2015 by more than five points. Anyway this hasn’t stopped Fidelity from a massive marketing campaign to try sell their funds.

Danoff was an excellent speaker and he’s a growth investor. His talk was about a growth investor’s perspective on value. Why have a growth investor at a value investing conference? Well it’s good to have a different perspective. Plus, like I said, he’s a human who have beaten the market. The term “value investing” is very vague these days. Value investors a la Ben Graham are rare these days. Good luck finding a quality “net-net” investments, a company trading for less than its net current assets that won’t hurt your portfolio. The idea rest on finding “a dollar for fifty cent”. While the concept sounds good, what usually happens is that “dollar” you found starts to shrink to 90 cent, then 80 cent…you see where I’m going with this. What’s more interesting is that “dollar” increase in value over time. The idea that a company’s business value “reality” is measurable and evolves gradually (hopefully upward) over time, while its stock price may fluctuate widely based on investors’ hopes and fears about the future. Danoff seeks companies poised for sustained, above-average earnings growth that isn’t reflected in the valuation of their shares.

Danoff is in a tough spot now because of his size. He can’t make an investment under $2 billion and that limits potential investments. He also can’t move quicker than the smaller funds. You want to know what Danoff is investing in today? Here’s a sample of his biggest positions.

Fidelity Contrafund holdings
Source: Fidelity

I’m not sure if you would call that a “stock picker’s” portfolio. Danoff crushed it in the early days when he had fewer holdings and indexing wasn’t hot. It’s tough now. But having a long-term track record is something to admire.

Alternative Lender (read:subprime)

I have a weird story for you. One of lesser known speaker at the conference had Home Capital Group (HCG) as his biggest holding. A good part of his presentation was about investing in the right people, having honest management and integrity, which are all good things for obvious reasons.  During the Q&A, the speaker was getting a lot of questions on his HCG investment because the Ontario Securities Commision (OSC) has accused HCG of making misleading disclosures in 2015. Plus we are talking about subprime mortgages; not exactly clean stuff. His answers were weird and all over the place. He said, among other things, that he never heard of mortgage brokers until five years ago. Again, HCG is his biggest position; you would think he knew how the company gets its business. It didn’t look good. Maybe it’s the pressure of public speaking. Well not less than 7 minutes after he was done speaking and defending his position in HCG, the OSC accused the firm of misleading investors about how the lender handled a review of mortgage brokers who falsified documents about borrowers’ income. Boom! Could the timing be any weirder? Sure the speaker got crushed, but he saved himself of a major embarrassment on stage.

Like in the U.S., alternative lenders have offered financing on more aggressive terms, allowing buyers who might not have qualified otherwise to purchase expensive properties. The shares of HCG got crushed. Today, after the fallout, this fund manager hasn’t sold a single share. Instead he added to his position and is now the biggest shareholder of HCG. As for HCG itself, I think it will be acquired. They have good assets but it’s on the liability front that they are suffering.

Fairfax Financial AGM and Fairfax India AGM

The main event was the Fair Financial AGM followed in the afternoon by the Fairfax India annual general meeting. Fairfax’s CEO Prem Watsa discussed the state of his firms and took questions from investors for several hours. It’s a useful forum for investors to learn more about the famous value investor, his method, and his businesses. Like Berkshire Hathaway, Fairfax also uses the annual meeting to advertise the brands it owns and some of the companies it invests in. They range from pet health insurance to death care and restaurants. You see the some of the same people that attended the BRK AGM. The FFH AGM is also smaller and easier access I find. But if you never been to Buffett’s AGM in Omaha, you have to go at least once.

FFH had excellent results over its life time. Over 31 years (inception) the company’s book value grew at an impressive CAGR of 19.4%, compared to 7.9% for the S&P 500 and 5.5% for the TSX. Unfortunately, while FFH has an enviable long term record, recently the company has struggled to match the market. Over the last five years FFH is last among its peers and a lot of people have been critical of FFH. Compound growth over book value per share is up 0.2% while some of its peers are in the low double digits. During that period BRK compounded book value grew by 11.5% and the S&P 12.2%. FFH used a lot of hedging during that time period and it cost them a lot of money. I think he said since the Trump election he has corrected the error and the hedges are gone. FFH said that they would buy back a lot of stocks over the next couple years. Prem believes the intrinsic value of FFH is higher than is book value. This should be a good move.

Fairfax slide 1

Fairfax slide 2
 The slides during the meeting actually had the Peers’ name. Source: Fairfax Financial Holdings

Fairfax India

Why India?

A few years ago, everyone wanted to put money into China. The country’s GDP growth was the envy of the Western world. That was then. Today, China has fallen out of favor with investors. Economic growth is faltering, business failures are on the rise, and the country faces the potential of a damaging trade war with the United-States. So why are investors in love with India at this point? Basically, because the country has a government that has shown it can get things done to grow the economy. Prime Minister Narendra  Modi is regarded as a business-friendly leader who is able to move forward on priorities. The country is expected to grow upward of 7% in 2017 and 2018.

I found the Fairfax India (FIH-U) meeting more interesting than the parent company meeting. Fairfax India was more company focus. FFH is too big to go into the details of each investment. Fairfax India did some solid acquisitions in India. I think the fund will do well in the future. However I don’t like the 1.5% fee and 20% of the gain above 5% for management that it pays to FFH. Now this good money for FFH, I’m not sure how it’s in the best interest of FIH-U. It’s such a good business that Fairfax recently launched an African fund.

Conclusion

The whole Fairfax Financial week is top notch. I couldn’t attend all the events but I look forward to it next year. The events are good, the people are awesome, and you leave with a couple investment ideas.

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