Allegheny 2015 Shareholder Letter Notes

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Jeremy’s Notes

Allegheny (Y) CEO Weston Hicks says the company is paying off debt in order to remain financially flexible should investment opportunities arise in the coming years

“We are sometimes asked why we are deleveraging at this point, with interest rates so low. The answer is when heading into stormy seas it makes sense to batten down the hatches. We believe that financial flexibility and corporate resiliency will be more valuable in 2016 and beyond.”

Allegheny (Y) CEO Weston Hicks says the world seems to be transitioning to a deflationery environment

As I have noted in prior years, the world economy appears to be transitioning to a slower growth, deflationary environment. Factors contributing to deflation include world economies in a “debtor’s prison;” excess capacity in commodity markets; deteriorating demographics in OECD countries as well as China; automation and robotics eliminating jobs; technology allowing for capitalism to be replaced by the “sharing economy;” and a continued lack of income growth for the vast majority of the country, in part a result of highly concentrated savings. In such an environment, it is possible that our growth will depend on capital reallocation and the effect of deflation on our $10 billion of net loss reserves.”

Scott’s Additions

In these conditions it is easy to fall into the trap of thinking that more risk is better

“Financial markets have been extremely favorable for the past six years. Following the 2008 Financial Crisis, equity investors have enjoyed a long period of positive returns, as the S&P 500 recovered from its early 2009 low of 666 to over 2000 at the end of 2015. Insurance markets too have been accommodating. Global catastrophe losses have been significantly below average levels for the past three years, and liability claims inflation has been subdued. With conditions like this, it is easy to fall into the trap of thinking that more risk is better.”

Increase risk when the market pays you to

“Alleghany’s approach is to increase risk when the market price of risk is high and to decrease risk when it is low. Today, expected returns on most investment classes are low, so we have tried, for the most part, to stay at the higher end of the quality spectrum, whether we are talking about bonds or equities.”

We focus on what we can control–growing the intrinsic value of Alleghany corporation

“Of course, the performance of our stock price – which can be easily blown around like leaves on an autumn day – can deviate from market returns over relatively short (3-5 year) periods of time based on investor preferences, stock price momentum, and other factors beyond our control. Because stock prices today are increasingly a function of basket trades (due to indexing), momentum strategies (due to increased computer power and lower trading costs), and algorithmic trading, we focus on what we can control – growing the intrinsic value of Alleghany Corporation over the long-term – and hopefully making intelligent risk and capital allocation decisions.”

Last year I said that the stock market appears to be fully valued, I wish I was wrong

“In last year’s annual report, I said that “the U.S. stock market appears to be fully- if not over-valued, especially considering the fact that many companies are producing little revenue growth and continue to enjoy record profit margins. Equities appear to offer attractive returns only in comparison to the sub-2% interest rates offered on U.S. government bonds.” In early January, the stock market, as measured by the Russell 2000, was about 20% below where it was at the end of 2014. I wish I had been wrong ”

China will have a difficult time transitioning to a service based economy

“China’s demographic profile, massive debt overhang, and underdeveloped social safety net will make the transition to a consumer-driven, services-intensive economy difficult.”

When the Fed started QE it entered the Hotel California

“We believe that when the Fed started quantitative easing, it entered Hotel California. As the classic Eagles song concludes, “you can check out any time you like, but you can never leave.””