Book excerpt: How Fairfax Financial got its groove back

Open this photo in gallery:

Few people saw it in real time, but history will reveal the year 2017 as the time everything shifted for Fairfax Financial Holdings Ltd. FFH-T. The firm was 32 years old. Most companies are dead by that age; Fairfax was just growing up. Leadership had managed extraordinary things along the way and was getting ready to enjoy the sweet satisfaction of saying, “We finally arrived.”

Almost a decade earlier, many at the company also thought their day had come. This time, it looked more convincing – even if it would be another five years before the transformation was obvious to everyone. “We were wrong when we thought we had a turnaround in place in the 2008 to 2010 era,” offers Roger Lace, chairman of Hamblin Watsa Investment Counsel Ltd., Fairfax’s investment arm. “And we struggled for several more years due to the impact of hedging. But by 2017 and 2018, it became obvious we were emerging as a transformed company. We could see it clearly – even if a lot of investors were not ready to believe it.”

The whole post-2016 era has been about this transformation slowly coming into focus in fits and starts. The pieces were falling into place, and a new Fairfax emerged. What made it so hard to see? Blame the hurricanes, floods, forest fires and earthquakes. Basic insurance catastrophe stuff: It hit back to back with a vengeance, and on its heels there arrived a black swan event for the ages in the form of the COVID-19 pandemic. It took a few years for the dust to settle and the N95 masks to come off before the market realized what was hiding right in front of its nose.

Open this photo in gallery:

For Fairfax, the mid-2010s were a time to reset and fine-tune its value strategy. That meant letting deflation fears slide and preparing for a big turn in inflation and bond yields. It also meant it was time to finally say goodbye to ill-suited short sales in the form of equity hedges.

“Despite our earlier success, it turned out our skills were not in short selling,” Rick Salsberg observed in hindsight years later. “It works differently from value investing where you buy and there is no nasty consequence for holding on for a while,” added Mr. Salsberg, chief executive Prem Watsa’s trusted consigliere up until his passing in 2024. “With short selling, you have to realize you can’t always outlive the market if the bet is going in the wrong direction. It’s almost infinite how much you can lose.”

Mr. Watsa, Fairfax’s chairman and CEO, admits that this time, unlike with the Big Short, the whole hedging effort was a mistake. The failed bet wiped out years of profits and served as a wake-up call that Fairfax had lost the script a bit on its own value playbook. There were smarter, cheaper ways to play both defence and offence. It was time to get back to value basics.

Ironically, Fairfax shares would hit the skids just as the company’s financial picture was brightening. Investors failed to see that the company’s insurers were racking up profits even in the face of massive catastrophe losses. In 2017 alone, Fairfax took a US$1.3-billion hit from natural disasters and still recorded its strongest profit to date. This was a new-look Fairfax. The same happened when COVID-19 froze the global economy, handing Fairfax a US$669-million hit.

Still, the stock kept sliding. Investors seemed to be sitting back and waiting for Fairfax to drive into some more potholes. In 2020, the shares traded as low as $319 and a rock-bottom valuation of barely half book value. That made no sense to Fairfax, so, like any smart value investor would, they decided to take advantage.

First, they made the biggest, cleanest (no more shopping in the bargain bin) and most impactful acquisition the company had ever done. The buying binge era was ending, but Fairfax could not resist picking up Allied World in 2017. Allied – a property, casualty, and specialty insurer and reinsurer operating out of Bermuda – was in great running shape when purchased, doing about US$3.5-billion in underwriting at a strong profit. Overnight, the company went from middle- to heavyweight. It enjoyed a whopping boost of about 30 per cent to gross premiums, investment portfolio and shareholders’ equity.

Frustrated investors, however, had stopped paying attention. Their faith had been tested, first by a lengthy slump when Fairfax digested a string of acquisitions from the 1990s, then the earnings drought driven by equity hedges. Wrestling back through the catastrophes of 2017 and 2018, Fairfax had finally set the table for its makeover comeback, only to see the black swan madness of COVID-19 spoil the party.

“The world stopped in 2020. Literally!” Mr. Watsa told shareholders. “Without any warning, the world’s economies closed. And our insurance subsidiaries were hit by COVID-19 losses of US$669-million! At the same time, stock markets crashed in March, 2020. It was a real-life stress test.” The test had two parts to it – one to its financial integrity and the other to its culture, where people were not expendable and Mr. Watsa insisted there be no layoffs. It passed on both counts.

Open this photo in gallery:

The Big Long: Invest in yourself

The longer Fairfax’s value-minded investment team stared at the company’s moribund stock, the less they could look away. Soon they were champing at the bit to invest in themselves. The company made out as well as anyone on the Big Shorts, but now it was time for what we will call the Big Long. Not a single move, it was made up of a number of investments, each a different way to buy more of itself. Together they marked a total break with the one-way bets on market crashes that investors knew the company for.

The shares spent a lot of time in the $600 to $700 range in the 2016–18 period, a level at which many frustrated investors had bought the stock, way back in 1999. In the aftermath of COVID-19, the stock reeled all the way down to the $350 level several times. “I couldn’t believe what we were seeing,” says Mr. Watsa. “The fundamentals were all improving and the stock went south. It just did not make any sense.” As contrarians, he and Fairfax decided to buy as much as they could afford, in as many ways as they could come up with. You could teach a full MBA course on allocation based on all the moving parts of the Big Long. Here is a breakdown of those different moves, including a swaps trade for the ages:

• Kick off a new era of buybacks. Mr. Watsa started talking more about Henry Singleton, the legendary CEO of Teledyne who orchestrated the most aggressive and successful buyback strategy in corporate history. Mr. Watsa called him “the Michael Jordan of buybacks,” and, now that it was taking a break from buying companies, Fairfax was going to lace up its Air Watsas and spend a decade playing some serious buyback ball. The company still thinks its stock is a bargain – it is still dunking in 2025, even after the stock did a five-bagger.
• Let the CEO’s wallet do some talking. Mr. Watsa told shareholders during COVID that the stock was trading at “a ridiculously cheap price” then personally ponied up $150-million at $400 (in 2024, he sold back a majority at $1,500). The company retired those shares, making it another kind of buyback.
• Getting creative with swaps. Late in 2020, Fairfax had invested most of its cash on hand, so rather than borrowing from the bank, it turned to total return swaps (TRSs) to get exposure to a gain in its shares. TRSs are not a buyback per se, but they are another way to pay now to benefit from a rise in value of your own company. How brilliant has that unusual trade been? At the end of 2024, the investment had returned US$2-billion – and counting.
• The Odyssey manoeuvre. Same challenge here again – not enough money on hand to buy back shares. The solution this time was to sell 10 per cent of Odyssey to pension funds, to fund a US$1-billion buyback. The value genius in this manoeuvre was it was sold at an attractive 1.7 book value, a richer valuation than what Odyssey was being carried at on Fairfax’s books, and then the company bought back its own shares at about half that – 0.9 times book value.
• Buy your stock back in pieces. As earnings and cash flow picked up, Fairfax did a sort of indirect buyback by boosting its controlling stake in various assets. These asset purchases increased Fairfax’s share of earnings, which increased the value of the holding company itself. This asset buyback strategy accelerated the importance of a third stream of profits, one that made Fairfax’s results richer and a lot less lumpy.

Imagine being a shareholder, watching your stock slide to $350 and then the CEO tells you a fair price would be about a thousand dollars higher. Just talk? Consider, his wallet had just spoken to the tune of $150-million of his own money. In 2021, Mr. Watsa did a bullish calculation in his letter where, based on book value growth, he suggested a stock price of $1,335 was appropriate. By the time the stock passed that level in January, 2024, the stock was in full sprint, reaching $2,000 before the end of the year. It was a good reminder to investors to read his annual letter closely.

The Big Turn: Timing the death of a 40-year bull market in bonds

In the same period, Fairfax taught the rest of the insurance industry a master class on navigating rate cycles by calling the Big Turn. History will probably show that the initial trigger for the death of the bond bull market emerged in 2016 with the election of Donald Trump and his tax cuts. But it took years before everything lined up in 2021 to put it in motion.

Mr. Watsa and Brian Bradstreet, Fairfax’s fixed income strategist, began to pivot in 2016 from extreme fear of deflation to a realization the bigger interest-rate cycle may be about to turn back up, not down. Fairfax pulled back, stayed in short-term bonds, mostly in cash, then waited. Many investors had worked their entire careers in an era of low and declining rates. They thought Fairfax was nuts. But inflation did fire up and the massive flood of fiscal and monetary stimulus fed it gasoline. The flames raged dramatically in the fourth quarter of 2021 and continued through 2022 with one of the worst-ever bear markets for bonds.

The losses blew a hole through the capital of individual investors and corporations. Companies needed to either sell the bonds at a loss or recapitalize some other way. Insurance companies suffered losses in their book values of between 10 per cent and 30 per cent for the year. Several regional U.S. banks almost went down in the storm for the same reason.

Fairfax didn’t get touched. It was one of the few big insurers worldwide to actually see an increase in book value. And all that cash sitting in short-term assets rolled straight into the bond market where yields zoomed from near zero to 5 per cent, giving it a head start on earning higher returns. Fairfax had dodged a bomb and grabbed the prize.

Abridged and adapted by the author from The Fairfax Way. Published 2025 by Viking, an imprint of Penguin Canada.

Editor’s note: In a previous version of this excerpt, several dollar amounts were mislabeled with the wrong currencies. This version has been corrected.