August 25, 2020

Pricey Unitholders of Chou Associates Fund,

The web asset benefit for every device (“NAVPU”) of a Sequence A device of Chou Associates Fund at June thirty, 2020 was $seventy three.09 in contrast to $103.28 at December 31, 2019, a reduce of 29.2% in the course of the same period of time, the S&P 500 Overall Return Index increased 1.seven% in Canadian bucks. In U.S. bucks, a Sequence A device of Chou Associates Fund lessened by 32.three% when the S&P 500 Overall Return Index lessened three.1%.

The desk exhibits our one-yr, three-yr, 5-yr, 10-yr, 15-yr and 20-yr annual compound costs of return.

Charges of return are historical overall returns that incorporate improvements in device charges, and think the reinvestment of all distributions. These annual compounded returns do not get into account any gross sales rates, redemption service fees, other optional bills or earnings taxes that you have to shell out and that could cut down these returns. The returns are not confirmed. The Fund’s previous effectiveness does not essentially indicate potential effectiveness. The desk is employed only to illustrate the results of the compound advancement level and is not supposed to replicate potential values of the mutual money or returns on the mutual money. Commissions, trailing commissions, administration service fees and bills all could be linked with mutual fund investments. You should examine the prospectus right before investing.

Factors Influencing the Very first Six-Month Outcomes

The largest decliners in the period of time were the fairness holdings of Wells Fargo & Business, Resolute Forest Products and solutions, Bausch Wellbeing, Citigroup, and EXCO Sources.

The maximize in charges of DaVita shares and Overstock desired shares assisted to offset some of the losses. The Canadian currency depreciated towards the US greenback, which also positively impacted the Fund.

Throughout the period of time, the Fund diminished its holdings in DaVita, Berkshire Hathaway, JPMorgan Chase, and Bausch Wellbeing. The Fund also obtained Overstock Sequence A-1 desired shares as digital dividends.

The Fund did not make any new investments or provide any protected connect with options in the 1st 50 % of 2020.

Portfolio Commentary

COVID-19 is a new condition and human beings, as we know, have no immunity to it. However, the actions of nearly all the governments in the planet have brought on extreme economic disruptions. Every field has been impacted to some extent – some worse than other folks and we are in a wait and see frame of mind right before we dedicate excessive money to the industry.

Financials – Banking companies and Coverage

Banking companies – In normal, we do not think that the intrinsic values of the banking companies have depreciated much in the prolonged-expression. In the brief-expression, the revenues and web curiosity margins could get a strike because of to very low curiosity costs (near to zero), and defaults on poor financial loans will probably maximize beneath the present-day anemic economic ailments. However, we think the unfastened monetary plan of now will advantage the banking companies in the prolonged-expression with its abnormal printing of money, because banking companies are constantly the 1st beneficiary of straightforward money. Possessing endured the annual tension checks, banking companies are also in much better financial shape than they were in the course of the Good Recession of 2008.

Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) – We feel it is the most effective run enterprise in the planet. They have good operating companies that deliver huge amounts of cash relative to the money deployed. When they simply cannot deploy them at an appropriate level of return, they give it to Warren Buffett (Trades, Portfolio) to redeploy them in the obtain of new companies or the stocks of outstanding companies at a sensible selling price. This is a kind of enterprise that executives need to examine carefully. Instead they are supplied all types of cookie cutter kind illustrations in business enterprise universities. Berkshire Hathaway has been operating because 1965 beneath Buffett and it is not a one-working day speculate.

Berkshire Hathaway had developed to as much as 32% of the Fund’s web assets more than the yrs because of to important money appreciation. We are really happy to maintain them for the prolonged-expression, but the overconcentration of securities more than 10% of the Fund can be frowned on by regulators. As a consequence, we have diminished the Fund’s position of Berkshire Hathaway in early 2020.

Resolute Forest Products and solutions (“RFP”)

As of June thirty, 2020, the industry selling price of Resolute Forest Products and solutions (NYSE:RFP) was US$2.eleven for every share, down 50% from the selling price at yr conclusion 2019. RFP has been a huge disappointment because our original obtain some eight yrs back. It exhibits how challenging it is to change all-around a troubled enterprise even with the most effective attempts of administration. Possessing mentioned that, it is really comical to knowledge how a commodity inventory can be hammered over and above all logical comprehension. RFP paid a distinctive dividend of US$1.50 a share in 2018, and it was buying and selling as very low as US$1.seventeen for every share in April 2020. Again in March 2020, the enterprise announced that it would buy again 15% of its frequent shares for US$100 million. At the cheapest yr-to-date selling price of US$1.seventeen, the total industry capitalization would be about US$99 million. In other text, instead of obtaining again 15% of the enterprise with US$100 million, it could repurchase 100% of the enterprise at one point. RFP shares have because recovered three hundred% to US$4.sixty nine as of August 25, 2020.

A single bright spot has been their lumber operations. The substantial charges for lumber need to make up the declines in newsprint and specialty papers. The COVID -19 pandemic has shifted the emphasis much more in the direction of lumber/pulp/tissue operations and I feel that need to deliver bigger cash movement in the potential.

In normal, our knowledge with a commodity business enterprise that has pretty much no pricing energy is to be careful when administration talks about investing in new equipment or upgrades that would noticeably reduced the cost framework in contrast to its competition. That could be genuine for six months to a pair of yrs, but in time, competition will have a new cost framework that is as aggressive if not outstanding to the enterprise. It is the same treadmill exactly where hardly everyone in the field can make a respectable return on the assets invested in the enterprise. The same story can be noticed repeatedly in a variety of commoditized industries. There is no sustainable prolonged-expression edge in a mediocre business enterprise with no pricing energy. It is essential not to get seduced by price reduction to guide benefit. If the enterprise simply cannot deliver a respectable return on guide benefit more than a prolonged period of time of time, that guide benefit is not worth much.

Bausch Wellbeing Companies Inc. (“Bausch”)

In early August, Bausch Wellbeing Companies Inc. (NYSE:BHC) announced that it is scheduling to spin off its eye care business enterprise, Bausch + Lomb, into an impartial publicly traded enterprise. This will enable the enterprise to focus on its gastroenterology, aesthetics/dermatology, neurology and global pharma business enterprise.

Chairman and CEO Joseph Papa mentioned, “We have seemed at the benefit of our pure well being companies like Alcon and Cooper and feel that Bausch + Lomb would compare really favorably when investors have an option to make a judgment about the relative benefit of the stand-by yourself business enterprise”.

Comparables like Cooper Companies and Alcon Inc. are at this time buying and selling in between 18 and 20 moments EBITDA. If Bausch + Lomb trades at very similar multiples as a stand-by yourself enterprise, the overall benefit of Bausch Wellbeing working with sum-of-the-sections strategy, web of debt, need to be worth north of $35 for every share, as an inference. For a prolonged time we have felt that Bausch was undervalued, but the investors were not giving credit history that administration has performed a excellent job in operating the operations, promoting non-main assets, as very well as de-leveraging its equilibrium sheet. They felt the procedure was as well slow, we hope the spin-off of Bausch + Lomb device will be the catalyst that is required for investors to selling price the enterprise closer to its intrinsic benefit.

EXCO Sources (“EXCO”)

In early July of 2019, the enterprise emerged from personal bankruptcy and the 1.seventy five lien expression financial loans were converted into 28.38 fairness shares for every single $1,000 in par benefit, just after netting out specified adjustments. We obtained 1,518,570 shares of EXCO (ASX:EXS) in the Fund. The equal selling price is $nine.5144 for every share of EXCO.

Seeking again on this financial commitment, we underestimated how prolonged the selling price of organic gasoline would keep very low for and how very low it has been relative to the selling price of oil. Traditionally, there had been a sturdy romance in between the charges of oil and organic gasoline. Thinking about the two fuels in terms of power equivalency, six,000 cubic toes (six mcf) of organic gasoline has the same amount of power material as 1 barrel of oil. In the previous, this six to 1 ratio guided the romance in between oil and organic gasoline charges but for the very last handful of yrs the ratio in between charges has long gone up to as substantial as 50 to 1.

Long story brief, it was not these a good thought in investing in the 1.seventy five lien of EXCO.

Does Price Investing Do the job?

With the lackluster returns by benefit money in new yrs in contrast to advancement and index money, there is some doubt as to regardless of whether benefit investing can however perform in the present-day industry. We maintain the view that benefit investing unquestionably functions, but only when executed adequately. Often it is less difficult to blame the industry setting than to confess our possess faults. While aspects these as very low curiosity costs, the reputation of passive investing and elevated industry valuations played a part in blunting returns for benefit investors, we also accentuated the problem. The critical to benefit investing is appraisal. If that is not exact enough, every little thing falls apart. We have a tendency to fish in troubled waters, and what brought on the most important problem in new yrs was that our appraisal of troubled companies was off the mark.

When we imagined a enterprise was worth 100 cents, it was basically worth closer to sixty cents. We tended to give much bigger fat to asset values and not enough fat to the benefit of the operating enterprise. We employed the asset benefit as a huge protection blanket and grew to become blind to the deterioration of the worth of the operating enterprise.

That was a error of fee. We also manufactured a bundle of blunders of omission.

Around the very last thirty yrs, about 50 % our portfolio was in troubled companies and the other 50 % was in excellent companies. So, we are very well acquainted with investing in each forms of companies. But what took place more than the very last handful of yrs was that we used most of the time undervaluing the excellent companies. When our evaluation confirmed that the investments were worth 100 cents, they were much more precisely near to one hundred fifty cents, so resulting in us to miss out on most of people options. These “omissions”, although they are unseen blunders, are however as true as blunders of fee. In summary, even though the markets have been less type to benefit investing, we exacerbated the problem as practitioners.

We feel the benefit investors can empathize with the image below:

Photograph: Courtesy of David Shapiro @davidshapiro61

Caution to the Buyers

Buyers need to be suggested that we run a very targeted portfolio, usually just three to 5 securities could comprise near to 50% of the assets of the Fund. In addition, the Fund has securities that are non-U.S. and could be subjected to geopolitical risks, which could trump or at least negatively affect the financial effectiveness of the enterprise. Also, we could enter into some by-product contracts, these as credit history default swaps when we truly feel that the industry ailments are right to use people devices. Because of any or all of these aspects, the web asset benefit of the Fund can be from time to time much more unstable than at other moments. However, we are not bothered by this volatility due to the fact our emphasis has constantly been, and carries on to be, on how reasonably priced we feel the Fund’s portfolio holdings are relative to what we feel to be their intrinsic benefit.

Other Issues

Foreign Currency CONTRACTS: None existed at June thirty, 2020.

Credit history DEFAULT SWAPS: None existed at June thirty, 2020.

U.S. Greenback VALUATION: Any trader who needs to obtain the Chou Funds in U.S.

bucks could do so.

REDEMPTION Fee: We have a redemption rate of 2% if unitholders redeem their models in less than three months. None of this rate goes to the Fund Manager. It is place again into the Fund for the advantage of the remaining unitholders.

Independent Assessment COMMITTEE: The Manager has proven an IRC as needed by NI 81-107. The associates of the IRC are Sandford Borins, Peter Gregoire and Joe Tortolano. The 2019 IRC Annual Report is obtainable on our web site www.choufunds.com.

As of August 25, 2020, the NAVPU of a Sequence A device of the Fund was $81.80 and the cash position was about 4.six% of web assets. The Fund is down 20.eight% from the starting of the yr. In U.S. bucks, it is down 22.%.

Except for the effectiveness quantities of the Chou Associates Fund, this letter is made up of estimates and views of the Fund Manager and is not supposed to be a forecast of potential situations, a assure of potential returns or financial commitment assistance. Any suggestions contained or implied herein could not be ideal for all investors.

Yours truly,

Francis Chou (Trades, Portfolio)

Fund Manager

  1. The option strategy of obtaining Chou Associates Fund in $US has been offered because September 2005. Performance for yrs prior to September 2005 is dependent on the $US equal conversion of the final results of the Chou Associates Fund ($CAN). The investments in the Chou Associates Fund ($CAN) are the same as the investments in Chou Associates Fund ($US) besides for the currency used.

About the writer:

Sydnee Gatewood

I am the editorial director at GuruFocus. I have a BA in journalism and a MA in mass communications from Texas Tech College. I have lived in Texas most of my daily life, but also have roots in New Mexico and Colorado. Abide by me on Twitter! @gurusydneerg