With the stock market rallying on everything but fundamentals, sensible humans are selling smart money and insiders are selling stocks into the ramp and getting defensive at this juncture.
If you have sold any stocks, as we have, you know that you are immediately uncomfortable. With the government on a quest to destroy the currency, investors are torn about holding their dollars to invest at lower prices, or putting them into something "safe" like precious metals to fight against the inflation that is seemingly here. With cash returning near 0%, it would seem to make sense to invest the cash somewhere else to get a return and not worry about the safety of the money.
To that, I propose a preferred security from OdysseyRe Holdings. The former symbol was ORH, but it has been delisted as the company was taken over by another insurance company: Fairfax Financial (FFH). FFH is run by a person I refer to as the Warren Buffett of the North. It was the most profitable company in Canada last year, and the stock price is flirting with all time highs, while most of the market is still down around 30% from its highs. I'd go so far as to say that Prem Watsa is an even better investor than Buffett. During the crash, Prem was in cash, then bought near the lows, and is now about 25% hedged. As you can see, the difference in price of FFH compared to BRK.A is quite impressive.
During the last two years of market chaos, FFH is up 30% while Berkshire shares are down 30% in that same time frame. FFH also had $7 billion in cash as of their December 2008 filing (of which much has been invested), but their market value is only slightly higher than that.
All this is to say that Fairfax is a financial fortress with an investor who has outperformed Buffett himself at the helm.
So where do ORH preferred shares come in? Well, now that ORH is 100% owned by Fairfax, the preferred shares are wrapped into the financial fortress that is Fairfax Financial. The probability that our preferred shares become worthless is low in my estimation.
ORH offers an A and B series of preferreds. I highly prefer the B series as an alternative to cash.
First, it is currently trading at a 16% discount to redemption value. The company can redeem the shares at $25, but they currently trade at $21.
Second, I like the way the interest rate is structured. It is a 3.25% interest rate over the 3 month LIBOR. So it is variable. Compared to the near 8% fixed rate one could get on the A shares, it seems like a bad deal. But hear me out. The current 3 month LIBOR is about .25%. It can't go much lower. On top of that, the shares are priced 16% lower right now - so that actual income received right now is around 4.4%. If LIBOR were to go to 0%, the rate we receive would drop to 4.15%, which is about 40 times greater than the rate paid on cash.
The only direction the interest rate we can get paid can go is up from here. If inflation takes off and the bond market collapses, thus driving interest rates much higher as most people expect, then the income we receive will go up along with interest rates. So if rates jump from near 0% to 10% - our income per share goes from the current 4.5% to over 13%. No need to worry about inflation hurting our fixed income. If rates drop further because bond prices go up, we can benefit from a rising share price.
The flip side is that the price of the security could drop as well. This is the risk. But I feel that any price I can get them under $25 is a deal as I feel there is almost zero chance of Fairfax defaulting on their liabilities. In fact, I secretly hope investors panic and offer me their shares under $20 again as they did during last year's crises.
So I do not like stocks at these levels, but at the same time I do not like holding cash. If rates skyrocket due to tanking bond prices, my income is protected. If rates go down, I gain from the value of my shares rising to par, which is $25. Either way, I see it as a great alternative to cash while I wait for the stock market to come back to more fundamentally sound prices.
Disclosure: Author's clients are long 112,580 shares of ORH-PB and author is long 850 shares in his personal account.