Francis Chou's Chou Associates Fund 2023 Annual Letter: A Review

Dear Unitholders of Chou Associates Fund,

The net asset value per unit (“NAVPU”) of a Series A unit of Chou Associates Fund at December 31, 2023 was $156.08 compared to $155.04 at December 31, 2022, an increase of 0.7%; during the same period, the S&P 500 Total Return Index increased 23.3% in Canadian dollars. In U.S. dollars, a Series A unit of Chou Associates Fund increased by 2.9% while the S&P 500 Total Return Index increased 26.3%.

The table shows our one-year, three-year, five-year, 10-year, 15-year and 20-year annual compound rates of return.

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 2023 Results

The major advancers in the year were the equity holdings of Ally Financial Inc. (ALLY, Financial), Bausch Health Companies Inc. (BHC, Financial), Wells Fargo & Company (WFC, Financial), Synchrony Financial (SYF, Financial), Berkshire Hathaway Inc. (BRK.B, Financial), and Citigroup Inc. (C, Financial). The decliners in the year were the equity holdings of EXCO Resources Inc. (EXCE, Financial), Liberty Global PLC and the warrant holding of Hertz Global Holdings Inc. (HTZ, Financial). The Canadian currency appreciated against the US dollar, which also negatively affected the Fund.

During the year, a subsidiary of The Paper Excellence Group, finalized the purchase of Resolute Forest Products in March 2023. The transaction was completed by way of a merger between RFP and a newly created subsidiary of Domtar (UFS, Financial), providing for the conversion of each share of RFP common stock into the right to receive US$20.50 per share, together with CVR (Contingent Value Rights) entitling the holder to a share of future softwood lumber duty deposit refunds. Each share, on a fully diluted basis at closing, is entitled to receive one CVR. The fund received the cash portion of the deal.

The Fund reduced its holding in EXCO Resources Inc. and increased its holding in Synchrony Financial.

The Fund also sold off its holdings in MBIA Inc. (MBI, Financial) and Overstock.com Inc. (BYON).

The Fund initiated investments in Navient Corporation (JSM, Financial).

DOES VALUE-INVESTING WORK OVER THE LONG TERM?

Over the years, I have been asked frequently whether value investing truly works over the long term. Prior to two years ago, that question was usually asked with great skepticism. In my mind, unequivocally, the answer is yes. It works because you are buying an asset for a far lower price than what it is worth.

As it happens, we have been managing five mutual funds over long periods, all in different market sectors. I thought perhaps if one of our five funds ranked in the top 5, I would be excited. So, we asked Fundata to supply the data and discovered that all five Chou Funds performed extremely well over the long term. Not only were our funds in the top 5, they were number 1 in several categories and performance periods! The results are presented below.

This strong performance is despite the fact that the results include the 2015 to 2020 period—a hellish time for value investing. In fact, the impact was so great, it even affected the 15-year and 20-year results.

Fundata fund rankings by category (as of December 31, 2023)

Note: Chou Asia Fund, Chou Europe Fund, and Chou Bond Fund do not have a 20-year performance history.

Source: All data courtesy of Fundata.

The market is so competitive that it is tough enough to get ranked in the top five for just one fund, but it is surreal to find that, looking at the various time periods, four of the five Chou Funds were frequently ranked number 1 against their peers.

Although we usually do not name other mutual funds, the ones that were ranked second in their category were frequently value funds. My fierce competitor and friend, Tim McElvaine, runs the McElvaine Value Fund, which was ranked second in the Canadian-focused small- and mid-cap equity category. I hope he retires soon so I do not have to compete with him; he has been snapping at my heels for the last 20 years.

So much for “Value investing is dead”

Do you have to be flawless in your stock selections to be ranked number 1? Absolutely not! Value investing gives you enough of a cushion to make mistakes and still get a decent rate of return. Let's look at some of the errors we've made across all our funds over the last several years, excluding some truly dumb mistakes.

The key to value investing is appraisal: knowing the true value of a company. If that is not precise enough, everything falls apart.

Mistakes of Commission

We tend to fish in troubled waters; in some years, our appraisals of distressed companies were off the mark. For example, perhaps we thought a company was worth 100 cents, but it was worth closer to 60 cents. The tendency is to put a much higher weight on asset value and not enough weight on the value of the operating company. The problem is that asset value can be a massive security blanket that can make us blind to the deterioration of the worth of the operating company.

A case in point is Sears Holdings. We were correct that the company's real estate plus the value of the brand names would afford some cushion against losses; however, we were inaccurate in our assumption that the former chief executive and chairman of the company, Eddie Lampert, would maximize returns for shareholders based on the real estate assets and the value of the operating retail company. Instead, he tried to reinvent the company, suffering huge losses along the way and almost wholly eroding the value of the considerable real estate assets that Sears held. Although the value of downside protection is important, most of the returns from an investment come from either the increase in the intrinsic value of the company, or the closing of the gap between the discounted purchase price and the full intrinsic value. When neither happens, then investors want to see the assets and the brand names divested or sold—sooner rather than later—for the benefit of the shareholders. Fortunately, we can say that in the case of Sears, we lost an insignificant amount of money on an actual dollar basis (as one Republican suggested, such amounts should be classified as “Trump change”). However, we did lose a tremendous amount in opportunity costs over that 10-year period. Trump change or not, it was still an unforced error. That was a mistake of commission.

Mistakes of Omission

We also made a number of mistakes of omission. Over the last 35 years, roughly half of our portfolio was invested in troubled companies, and the other half was in good companies, so we are well acquainted with investing in both types. But what happened in some years was that we spent too much time undervaluing the good companies. While our assessment showed that these investments were worth 100 cents, they were more accurately close to 150 cents, thus causing us to miss some good opportunities. These omissions, though they are unseen mistakes, are nevertheless as real as mistakes of commission. In summary, although the markets have been less kind to value investing, we can exacerbate the problem as practitioners, and I am the biggest culprit.

What about the next 35 years?

We believe value investing will continue to flourish over the next 35 years, and the Chou Funds will continue to do well, irrespective of the market sectors. After 35 years, we may not always be ranked number 1 against our peers in their respective categories, but we will be ranked relatively high. The long-term results of the Chou Funds have shown that we produce excellent results whether we are buying American, Canadian, Asian, or European equities or fixed-income instruments.

The point is this: how can anyone argue against the logic of buying something considerably cheaper than what a company is worth?

Portfolio Commentary

The Common Theme In New Purchases

We purchased shares in several new companies. They are half-decent companies that generate tons of free cash flow, sell at a low multiple of earnings, and have management that we can trust to make operating and capital allocation decisions wisely. But if there is a common theme in the new purchases, it is that they have been big buyers of their own stock over the last few years. We also believe that if their shares fall further, they will repurchase them in significant quantities in the market. What this entails is that their intrinsic value will increase on a per-share basis. That is music to my ears.

However, there is one caveat regarding companies buying back their shares. They should not be in a declining industry where new technology or processes will make their products less valuable. And as a corollary, the company should not buy back shares if it is a piece of CRAP (Cannot Realize A Profit). In this case, the remaining loyal shareholders are getting a larger piece of a crappy company.

EXCO Resources Inc. (“EXCO”)

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. The equivalent price was US$9.51 per share of EXCO.

Since it is a private company, I am not at liberty to divulge the latest financial statements, but what I can tell you is that my calculation of its PV-10 value was more than US$1.8 billion (roughly US$35 per share) based on the New York Mercantile Exchange (NYMEX) forward pricing as of June 30, 2023, and the net proved reserves were 2.7 trillion cubic feet equivalent. Its number of outstanding shares as of June 30, 2023 was 51,584,500. We estimate its EBITDA for the year ending 2024 will be between US$200 million and US$250 million. As a comparison, in 2018, the PV-10 value was US$750 million.

As of December 31, 2023, the share of EXCO was valued at $16.86 by Kroll, an independent third-party valuator.

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 28.6% of net assets as at December 31, 2023.

Other Matters

FOREIGN CURRENCY CONTRACTS: None existed at December 31, 2023.

CREDIT DEFAULT SWAPS: None existed at December 31, 2023.

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 2023 IRC Annual Report is available on our website www.choufunds.com.

As of March 15, 2024, the NAVPU of a Series A unit of the Fund was $168.63 and the cash position was approximately 25.9% of net assets. The Fund is up 8.0% from the beginning of the year. In U.S. dollars, it is up 5.7%.

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