March 15, 2022
Dear Unitholders of Chou Associates Fund,
After the distribution of $0.31, the net asset value per unit (“NAVPU”) of a Series A unit of Chou Associates Fund at December 31, 2021 was $142.25 compared to $93.50 at December 31, 2020, an increase of 52.5%; during the same period, the S&P 500 Total Return Index increased 27.5% in Canadian dollars. In U.S. dollars, a Series A unit of Chou Associates Fund increased by 53.4% while the S&P 500 Total Return Index increased 28.7%.
The table shows our one-year, three-year, five-year, 10-year, 15-year and 20-year annual compound rates of return.
| December 31, 2021 (Series A) | 1 Year | 3 Years | 5 Years | 10 Years | 15 Years | 20 Years | |
| Chou Associates Fund ($CAN) | 52.5% | 11.8% | 6.0% | 9.3% | 4.7% | 7.1% | |
| S&P 500 | ($CAN) | 27.5% | 23.0% | 17.0% | 19.1% | 11.3% | 8.3% |
| Chou Associates Fund ($US) | 53.4% | 14.7% | 7.2% | 6.9% | 4.1% | 8.3% | |
| S&P 500 | ($US) | 28.7% | 26.0% | 18.4% | 16.5% | 10.6% | 9.5% |
Rates of return are historical total returns that include changes in unit prices, and assume the reinvestment of all distributions. These annual compounded returns do not take into account any sales charges, redemption fees, other optional expenses or income taxes that you have to pay and that could reduce these returns. The returns are not guaranteed. The Fund’s past performance does not necessarily indicate future performance. The table is used only to illustrate the effects of the compound growth rate and is not intended to reflect future values of the mutual funds or returns on the mutual funds. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing.
Factors Influencing the 2021 Results
The largest increases in the year were the equity holdings of MBIA Inc. (MBI, Financial), Resolute Forest Products Inc., Overstock.com (OSTK, Financial) and Wells Fargo & Company (WFC, Financial). The Canadian currency appreciated against the US dollar, which negatively affected the Fund.
During the year, the Fund reduced its holdings in Wells Fargo & Company, The Goldman Sachs Group Inc. (GS, Financial), Bausch Health Companies Inc., Resolute Forest Products Inc., Citigroup Inc. (C, Financial) and MBIA Inc. The Fund eliminated its holdings in DaVita Inc. (DVA, Financial).
The Fund did not make any new investments or enter into any foreign currency contracts in 2021. The Fund sold four covered call options on the equity holdings of Resolute Forest Products Inc., MBIA Inc., and Bausch Health Companies Inc. during the year.
Portfolio Commentary
Financials – Banks and Insurance
Banks – In general, we do not think that the intrinsic values of the banks have depreciated much in the long term. In the short term, the revenues and net interest margins may take a hit due to low-interest rates (close to zero), and defaults on bad loans will likely increase under the current economic conditions. However, we think the loose monetary policy of today will benefit the banks in the long term with its excessive printing of money since banks are always the first beneficiary of easy money. Having endured the annual stress tests, banks are also in much better financial shape than they were during the Great Recession of 2008.
Resolute Forest Products Inc. (“RFP”) (RFP, Financial)
As of December 31, 2021, the market price of RFP was US$15.27 per share, up 133.5% from the price of US$6.54 at year-end 2020. Having said that, it is quite comical to us how a commodity stock can be hammered beyond all logical comprehension. RFP paid a special dividend of US$1.50 a share in 2018, and it was trading as low as US$1.17 per share in April 2020. Back in March 2020, the company announced that it would buy back 15% of its common shares for US$100 million. At the lowest price of US$1.17, the whole market capitalization would be approximately US$99 million. In other words, instead of buying back 15% of the company with US$100 million, it could repurchase 100% of the company. RFP shares have since recovered a very healthy 1,205.1% to US$15.27 as of December 31, 2021.
When the stock is that cheap, assuming that you don’t own any shares, a rational investor should back up the truck and buy every share that is offered in the market. But what makes it difficult for some investors to buy is not the rational side of his mind but more the psychological aspect of it. In the stock market, you are bombarded with noises that affect a person’s rationality. It can get radically altered. Stock prices can move unrelated to the fundamentals of a business. During a bull market, you may see several stocks trading at anywhere from 50 times going to more than 100 times earnings, and conversely, there can be several stocks sold at 10 times earnings going down to below five times earnings. The fundamentals of the company are ignored and, instead, investors are transfixed on the price movements of the last couple of years. Then new narratives are written most convincingly on why these are the new paradigms, and why they are not worth giving weights and considerations to what the assets are worth and what the company can earn over several years. I remember talking to one value manager in 1999 when the tech stocks were in full bloom. He said, “I have a family to feed and I will keep losing assets if I don’t accept the new headlines and paradigms. Sticking to buying companies that are undervalued is not the way to be successful in the long run”. He changed his philosophy before the tech stocks were about to go into a severe decline over the nextcouple of years.
One question that keeps popping up is with regard to the current crop of tech companies like Facebook, Apple, and Alphabet. Based on the current interest rate, they are not overvalued. We also admit that we totally misjudged the valuation of these three companies 10 years ago. Metaphorically speaking, when we thought it was worth US$100 per share, in fact, it was worth closer to US$200 per share. Unfortunately, we also made some mistakes in evaluating mediocre companies. When we thought a company’s share was worth US$100 per share, it was actually closer to US$60 per share.
In spite of the price of RFP trading at US$15.27 per share, it is still quite cheap. Let us look at a few facts. The shares may be able to get back close to US$400 million in duties (approximately US$5 per share), but the earning power over the next two years is most likely to be more than US$3 per share annually and the lumber prices may stay elevated for a while because there is an imbalance between supply and demand in housing that may take a few years before it comes back into equilibrium. Meanwhile, it is making money hand over fist.
One caveat though is that the value of RFP depends so much on lumber, a commodity business that is prone to a boom and bust scenario.
Every dog has its day.
Bausch Health Companies Inc. (“Bausch Health”) (BHC, Financial)
In early August 2020, Bausch Health announced that it is planning to spin off its eye care business, Bausch & Lomb, into an independent publicly-traded company. This will allow the company to concentrate on its gastroenterology, aesthetics/dermatology, neurology, and international pharma business.
We hope the spin-off of the Bausch + Lomb unit will be the much-needed catalyst for investors to price the company closer to its intrinsic value.
EXCO Resources Inc. (“EXCO”) (EXCE, Financial)
In early July 2019, the company emerged from bankruptcy and the 1.75 lien term loans were converted to 28.38 equity shares for every US$1,000 in par value, after netting out certain adjustments. We received 1,518,570 shares of EXCO in the Fund. The equivalent price was US$9.51 per share of EXCO.
Since it is a private company, I am not at liberty to divulge all the financial statements but what I can tell you is that my calculation of its PV-10 value was approximately US$1.2 billion based on New York Mercantile Exchange (NYMEX) forward pricing as of September 30, 2021. Its number of shares outstanding was 51,341,478. We estimate that its EBITDA for the year ending 2022 will be approximately US$225 million.
Although a substantial portion of EXCO’s oil & gas production is hedged for the year 2022, we believe that EXCO can fetch much higher prices as the hedges roll off.
Another dog has its day.
Caution to the Investors
Investors should be advised that we run a highly focused portfolio, frequently just three to five securities may comprise close 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 may trump or at least negatively influence the financial performance of the company. Also, we may enter into some derivative contracts, such as credit default swaps when we feel that the market conditions are right to use those instruments. Because of any or all of these factors, the net asset value of the Fund can be from time to time more volatile than at other times. However, we are not bothered by this volatility because our focus has always been, and continues to be, on how inexpensive we believe the Fund’s portfolio holdings are relative to what we believe to be their intrinsic value. Also, the Fund’s cash position was approximately 0.4% of net assets as at December 31, 2021.
Other Matters
FOREIGN CURRENCY CONTRACTS: None existed at December 31, 2021.
CREDIT DEFAULT SWAPS: None existed at December 31, 2021.
U.S. DOLLAR VALUATION: Any investor who wishes to purchase the Chou Funds in U.S. dollars may do so.
REDEMPTION FEE: We have a redemption fee of 2% if unitholders redeem their units in less than 3 months. None of this fee goes to the Fund Manager. It is put back into the Fund for the benefit of the remaining unitholders.
INDEPENDENT REVIEW COMMITTEE: The Manager has established an IRC as required by NI 81-107. The members of the IRC are Sandford Borins, Peter Gregoire and Joe Tortolano. The 2021 IRC Annual Report is available on our website www.choufunds.com.
As of March 15, 2022, the NAVPU of a Series A unit of the Fund was $140.15 and the cash position was approximately -0.1% of net assets. The Fund is down 1.5% from the beginning of the year. In U.S. dollars, it is down 2.4%.
Except for the performance numbers of the Chou Associates Fund, this letter contains estimates and opinions of the Fund Manager and is not intended to be a forecast of future events, a guarantee of future returns or investment advice. Any recommendations contained or implied herein may not be suitable for all investors.
Yours truly,
Francis Chou (Trades, Portfolio)
Fund Manager
