Keith Smith of Bonhoeffer Fund discussed the successful use of leverage to boost long-term equity returns at Best Ideas 2026, drawing on Berkshire Hathaway, Fairfax, and Shelby Davis and presenting current opportunities in Meritz Financial Group (Korea: 138040), Fairfax Financial Holdings (Canada: FFH), and Fidus Investment Corporation (US: FDUS).
Thesis summary:
Keith studies the safe use of leverage. Berkshire Hathaway’s float, 26% of investments, has cost about -3.3% a year on a 97% combined ratio, and total leverage near 50% helped compound 20% a year for 60 years. Buffett financed half his Japanese holding company stakes, bought at an 8.5% earnings yield, with 0.9% debt, locking in about 16% before rerating. Shelby Davis earned 23% a year for 50 years. The lessons: modest external debt, entrepreneurial leaders, growing assets.
Meritz Financial Group pairs a Korean long-term health insurer with a brokerage that leads in real estate finance and distressed workouts. Insurance float and brokerage deposits fund high-yield real estate debt with a 100bp yield edge over P&C peers; investment yield rose from 3.7% to 4.6% on investment leverage near 9x, with a health combined ratio around 90%. Ten-year ROE and incremental returns are both about 21%. The chairman owns 56%, and top executives earn about 5% of net income.
Fairfax Financial, led by Prem Watsa since 1985, runs what Keith calls a leveraged balanced fund: float, debt and equity invested about 74% in bonds and 26% in equities, levered about 2.6x. Fixed-income yields have risen from 1.9% to about 5%, so the bond book alone earns solid returns, while India and Greece add equity upside. Fairfax targets a 15% ROE, bought insurers at 1.7x premiums now valued at 0.7x; management owns 9%, Watsa 6.7%.
Fidus Investment is a BDC that uses low-cost SBA debt to lend to lower middle-market firms. First-lien floating-rate loans have risen to 72% of the book from 30% five years ago, 67% of deals are proprietary, and half the loans rest on recurring revenue. Non-accruals are 0.3%, interest coverage 3.0x and debt 0.7x equity. Fidus takes 2% equity stakes in about 80% of borrowers, adding about 3% a year toward a 14% five-year ROE versus 10% for the CCFLX benchmark.
Keith sees all three as cheap. Meritz trades at 8.6x earnings and 1.8x book with the highest ROE among peers; 4% organic growth, operating leverage and 6% buybacks support about 12% annual EPS growth. Fairfax trades at 1.4x book and 8.6x earnings, and 3% organic growth plus 3% buybacks imply 20-30% annual returns. Fidus trades near book at 8.4x earnings, a 12% earnings yield and 11% dividend yield, against an 11x Graham fair multiple. The danger is over-leverage; Keith would cap margin debt near 50%.
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