If you have been following Fairfax Financial Holdings Ltd. (TSX:FFH), you would have noticed that it has fallen 21% since the end of September. What has caused such a steep decline in such little time?
The trouble spurs from Fairfax Financial Holdings’s big bets on deflation and a market crash.
The bets
First, the company has hedged against a deflationary scenario by buying derivatives, which are linked to consumer price indexes in the United States, the European Union, the United Kingdom, and France. These contracts have an average life of about six years.
Second, as stated in its third-quarter interim report, “the company … has hedged its equity and equity-related holdings … against a potential broad and systemic decline in equity markets.”
The developments
Fairfax Financial Holdings’s deflationary bets were sitting on unrealized losses of $513.6 million at the end of the third quarter.
One of its big deflationary bets is in the United States, which accounted for more almost 41% of its unrealized losses.
This bet on the U.S. is expected to sit on more unrealized losses now that the exact opposite, inflation, is anticipated to occur. This is because Trump will become the president, and he intends to lower corporate taxes and invest in infrastructures.
To make matters worse, Fairfax Financial Holdings’s equity hedges are an even bigger drag on its shares as the market continues to go steadily higher. In the first three quarters of this year, it had a net loss of $845.6 million on its equity hedges.
Don’t count the company out just yet
First, Fairfax Financial Holdings is a holding company that owns subsidiaries, which are primarily engaged in property and casualty insurance, and reinsurance, and the management of the associated investments. So, it can invest the insurance premiums paid by policyholders for higher returns before that money is claimed.
Second, the company has delivered double-digit annualized returns under its CEO, Prem Watsa, since 1985. These returns have been supported by similar growth in its book value per share, which compounded at a rate of 20.4% from 1985 to 2015.
Third, it has a diversified portfolio of investments, including short-term investments, bonds, common stocks, and preferred stocks, worth more than $26 billion. Its equity holdings include BlackBerry Ltd., Helmerich & Payne, Johnson & Johnson, and Kennedy-Wilson Holdings, among others.
Conclusion
At about $605 per share, Fairfax Financial Holdings trades at a price to book of 1.17, which is lower than its five-year average price to book of 1.23. The company also offers a 2.4% yield at current levels. So, investors can consider buying some shares as a hedge or as a long-term holding.
