Saturday, September 15, 2012

Defensive Investing

I received an email from an aspiring value investor.  He was inquiring about how and where to start on his value investing journey. 

Here is my initial response. 


We'll your background sound a lot like mine but I'm sure you didn't lose as much (percentage wise) as I did when I started.

Taking responsibility for your own investments is a very wise move because there are ways to invest that will save you a lot of money in the long run.

For example, if you invest in mutual funds, you are basically giving away 2-3% of your money every year for expert money management. The problem is these so called professionals don't really care about you. All they care about is their job. You see the biggest risk to them is losing their million dollar a year job. So what they do to minimize that risk is to perform as close to the index as possible. If their performance is to far below the index people will pull their money out and if they are relatively close nobody will pull their money out. So they don't really care about you doing well or outperforming in the long run.

The solution to this problem is quite easy. Fire all advisors and just buy a very low cost index fund, like a vanguard fund or a TD e-series fund. These index funds effectively get you the same thing without the huge fees and expenses.

Now the next question is if you want to be an passive or active investor. Ben Graham used the terms defensive or enterprising investors in his book.

If you want to minimize the time you spend on investing you would be a defensive or passive investor. If you want to do this I would recommend three investment options for you. They are, in no particular order, investing in Fairfax Financial common stock, investing in the Horizons HAV ETF, and lastly investing in Chou mutual funds.

With that said, it appears that I have gone against what I have said above regarding mutual funds. The major differences are in the cost and value you receive. Always remember price is what you pay, value is what you get. When you buy the Horizons HAV ETF you are paying a relatively low fee of 0.7%, I believe. Now that is a very low fee but what you are getting is top notch investment management by Vito Maida, a proven value investor. His long term record speaks for itself and he is ultra conservative. Don't expect huge gains but you will achieve steady long term growth.

As for the last option, Chou mutual funds, you are again getting top notch investment management from a great value investor. Francis Chou has slightly higher fees but again you are getting a good money manager. He doesn't buy stocks just for the sake of buying them. He is disciplined to buy when they represent good value and isn't afraid of going against the crowd. He can and does underperform at times but so do all value investors. Value investors are patient and wait for bargains. That said, Mr. Chou has an outstanding long term track record.

Last and certainly not least is Fairfax Financial (FFH). You can buy the common stock in CAD or USD on the TSE. Put your money in Fairfax and sleep soundly at night. Fairfax is run by Prem Watsa who is sometimes referred to the Warren Buffett of Canada. Fairfax is similar to Berkshire Hathaway (Warren Buffett's company) in that they are predominately insurance companies, Fairfax more so. When you match an insurance company with proven value investing, what you get a cash flow machine. This is proven in Fairfax's long term record. The have grown book value at something like 24% for the past 26 years. Now don't get too excited because the past is the past. Looking forward expect them to grow book value at 10-15% over the long term, not the short term.

If you want an even better strategy, buy or dollar cost average into Fairfax when it trades below book value. Be more aggressive the lower it goes. The rest of the time just keep accumulating cash in your savings account. Fairfax's stock price, like all companies, move up and down based on expectations of fear and greed. When it sells below book value people are fearful, and when it sells for 3 times book value people are greedy. With that said, Fairfax will likely only sell below book value when it appears the sky is falling and all the pundits on TV are screaming sell, sell, sell. It takes courage and a willingness to stand alone when everyone else is heading for the exits.

Now if you want to be an enterprising or active investor that is another story... (to be continued).


Disclosure: Long FFH

1 comment:

  1. I like the fairfax investing strategy. Have actually owned it for a few years and while I haven't seen a lot of gains yet I suspect I will in the long-run. My only concern with FFH is their disaster exposure, they lost about a billion dollars the other year so it is possible that a hundred year storm could bankrupt them. Not trying to be negative but that is what keeps me from putting everything into the company, I would not be comfortable with more than 15% exposure.

    Another, somewhat similar company is Leucadia National. Given that you are a value investor / buffett fan I am sure you have heard of them. They got hammered during the financial crisis and they are changing leadership but the new guy has a great track record and in spite of the financial crisis they are still up when you look past 5 years. I think you could employ a similar strategy to that outlined with FFH on Leucadia and between the two you should do well over time and have excellent diversification.

    Also, you should know that your blog is simply the best Canadian investing source on the web. Period. I like the no-BS, evidence based analytical style. This site is a great starting point for investments, I basically read your thesis, due my own due dilligence which generally confirms what you are saying and I'm done. My only complaint is that there is just so little material. Not to put that on you, I'm sure this is something you do in your spare time but I could use more. Could you recommend any other similar sites?