Best Investor of 2008

premPrem Watsa of Fairfax Financial Holdings?

Yesterday, Fairfax—a financial services holding company whose subsidiaries include one of Canada’s largest property and casualty insurers—issued its annual report and letter to shareholders. In it, they disclosed that their investment returns for the year were 16.4%, achieved in a year in which all major stock indices were down nearly 50% and bond spreads widened to historic distances. Impressive out-performance to say the least.

Even though a handful of short fund managers and inverse ETFs may have outperformed Fairfax, none achieved comparable returns managing funds of a similar size. How did they do it? Nearly 75% of their investment portfolio was in cash and government bonds; their equity portfolio was fully hedged, and they held large positions in credit default swaps. Likely the only way one could have beaten those results would have been to go all-in on Wrigley or Family Dollar.

Since then, Fairfax has moved out of government bonds and into municipal bonds, and removed their equity hedges. Aside from applauding the show, what can one learn from Fairfax’s performance?

Most simply, it looks like asset allocation was the most important determinant of investing success in 2008. Even if one held the best “castles” with the widest moats, government bonds, cash, and gold would have served a better fortress for one’s investing capital.

Of course, one should not take too much tutoring from one year’s results, especially in a year as unprecedented as this one. Yet, one lesson is clear—wide moat businesses, no matter how desirable, need to be acquired at opportune times and at bargain prices for the investor to outperform market averages. Just buying castles is not enough; they have to be cheap.

Disclosure: I, or persons whose accounts I manage, own shares of Fairfax Financial Holdings at the time of this writing.

2 responses to “Best Investor of 2008

  1. That’s incredible. This is the first time I am reading about someone making big bucks with CDS. Do they have a big history of dealing with CDS?

  2. They’ve held CDS at least since 2005. Watsa et co. had been preparing for a 1 in 50, or 1 in 100 financial storm since then.

    In the 2006 annual report, they disclose: “Our concerns about the U.S. financial markets are why we continue to protect our shareholders from a 1 in 50 or 1 in 100 year event. With about half our equity exposure hedged against the S&P 500 (there are some basis risks as our stock positions are worldwide), our investment of $276 million in credit default swaps (with a notional value of $13.1 billion), and approximately 78% of our investment portfolios consisting of government bonds and cash, we feel that we have effectively protected our investment portfolios from a potential (though low probability) financial market disaster.”

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