Francis Chou’s Chou Associates Fund semi annual letter for the first half ended June 30, 2015.

Dear Unitholders of Chou Associates Fund,

The net asset value (“NAVPU” or “NAV”) of a Series A unit of Chou Associates Fund at June 30, 2015 was $121.07 compared to $124.19 at December 31, 2014, a decrease of 2.4%, while the S&P 500 Total Return Index increased 8.8% in Canadian dollars. In $US, a Series A unit of Chou Associates Fund was down 9.2% while the S&P 500 Total Return Index returned 1.2%.

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

Francis Chou's Chou Associates Fund

Francis Chou – Factors Influencing the First Six Months Results

Positive contributors to the Fund’s performance during the period ended June 30, 2015 included warrants of JP Morgan Chase & Company and Wells Fargo & Company and equity securities of Chicago Bridge & Iron Company and Sanofi ADR. The Canadian currency depreciated against the US dollar, which also contributed to the positive performance of the Fund.

Securities of Nokia Corporation ADR, Berkshire Hathaway Inc., Resolute Forest Product Inc., Sears Holding Corporation and MBIA Inc. were negative contributors to the Fund’s performance during the same period.

The fund decreased its holdings of Nokia Corporation ADR by 25%.

Olympus Re Holdings Limited was dissolved in February of 2015, and the Fund received a final liquidating distribution in the amount of $643,930.

Francis Chou – Market Commentary

It is tough to find bargains at the present time. There is hardly anything to buy at a compelling price. The few stocks we own are cheap but when the general stock market level is not cheap, it makes us nervous. Our experience has taught us that it is better to sit on the sidelines and wait for developments. However, as we wrote earlier, we continue to worry about several issues:

1) How low can interest rates go? In Europe, some sovereign bonds are trading at negative yields.

2) The Great Recession occurred in 2008, and now it is 2015 – that is seven long years. Although the recovery has been anemic, at least it’s recovering.

3) The velocity of money for M2 is at an all-time low. This can be further highlighted if we hypothesize about what would happen if M2 moved back up to the historical average. If a regression to the mean were to occur – the price levels could be 25% higher than what it is today. Carrying this logic one step further, with the current levels of money-printing growing at approximately 7.2% annualized, this could see a potential price level increase of 50%, if the velocity of money were to move back up to the historical average.

No one can predict the future with any high degree of certainty, but you wonder: if the current policies continue for any extended period of time, when will the chickens come home to roost?

4) Deflationary forces are strong now; eventually, the supply and demand will bring everything into equilibrium as they work through their economic cycles, but you cannot ‘un-print’ money.

5) Stock prices are close to an all-time high if measured by price to earnings ratio, premium to book value or current dividend yield.

6) Junk bonds, the biggest beneficiary of easy money, should be trading at 70, not at 100 cents on a dollar with a 5.5% coupon rate.

7) What happens to the bond and stock markets if interest rates start to rise?

You can make a theoretical case that if interest rates stay as low as they are now for the next 20 years, the stock market is cheap based on the discounted method of valuation. However, when we look at Japan as an example, its stock markets have been at a slump since 1989 — even though interest rates have stayed low for these 26-odd years.

The current conditions make me feel that investors are being set up for heartbreaking disappointment, especially for the unwary.

Francis Chou's Chou Associates Fund

Francis Chou – Europe and Greece

It appears that Greece has been a basket case forever. It is an eye opener to see that since the year 1800, Greece has spent roughly 50% of its time in default or debt rescheduling. It has too much debt and whatever deal it can strike with the Troika, (the European Commission, the International Monetary Fund, and the European Central Bank) it won’t solve the problem; only give them some short-term relief. The people of Greece will pay to a degree with some austerity problems but in a few more years we will have another round of brinkmanship (negotiations) between the Troika and Greece.

Mark Grant, who is a Managing Director of Southwest Securities and one of the most colorful writers on the Greek recurring bailouts, captures the essence of what the bailout really means with this anecdote. Even when I disagree with his conclusions, he is enjoyable to read.

“It is a slow day in a little Greek Village. The rain is beating down and the streets are deserted. Times are tough, everybody is in debt, and everybody lives on credit.

On this particular day a rich German tourist is driving through the village, stops at the local hotel and lays a €100 note on the desk, telling the hotel owner he wants to inspect the rooms upstairs in order to pick one to spend the night. The owner gives him some keys and, as soon as the visitor has walked upstairs, the hotelier grabs the €100 note and runs next door to pay his debt to the butcher.

The butcher takes the €100 note and runs down the street to repay his debt to the pig farmer.

The pig farmer takes the €100 note and heads off to pay his bill at the supplier of feed and fuel.

The guy at the Farmers’ Co-op takes the €100 note and runs to pay his drinks bill at the taverna.

The publican (tavern manager) slips the money along to the local lady of the night drinking at the bar, who has also been facing hard times and has had to offer him “services” on credit.

The hooker then rushes to the hotel and pays off her room bill to the hotel owner with the €100 note.

The hotel proprietor then places the €100 note back on the counter so the rich traveler will not suspect anything.

At that moment the traveler comes down the stairs, picks up the €100 note, states that the rooms are not satisfactory, pockets the money, and leaves town.

No one produced anything. No one earned anything. However, the whole village is now out of debt and looking to the future with a lot more optimism. And that, Ladies and Gentlemen, is how any new Greek bailout package is likely to work.”

The Greek debt crisis and fiscal irresponsibility is truly a tragic case but most of it has been institutionalized and has been embedded into the Greek culture. A New York Times article published on May 1, 2010, cast a glaring light on how deep the problem lies.

“In the wealthy, northern suburbs of this city, where summer temperatures often hit the high 90s, just 324 residents checked the box on their tax returns admitting that they owned pools.

So tax investigators studied satellite photos of the area — a sprawling collection of expensive villas tucked behind tall gates — and came back with a decidedly different number: 16,974 pools.

That kind of wholesale lying about assets, and other eye-popping cases that are surfacing in the news media here, points to the staggering breadth of tax dodging that has long been a way of life here.

Such evasion has played a significant role in Greece’s debt crisis…Various studies, including one by the Federation of Greek Industries last year, have estimated that the government may be losing as much as $30 billion a year to tax evasion — a figure that would have gone a long way to solving its debt problems.

To get more attentive care in the country’s national health system, Greeks routinely pay doctors cash on the side, a practice known as “fakelaki,” Greek for little envelope. And bribing government officials to grease the wheels of bureaucracy is so standard that people know the rates. They say, for instance, that 300 euros, about $400, will get you an emission inspection sticker.

Some of the most aggressive tax evaders, experts say, are the self-employed, a huge pool of people in this country of small businesses. It includes not just taxi drivers, restaurant owners and electricians, but engineers, architects, lawyers and doctors.

The cheating is often quite bold. When tax authorities recently surveyed the returns of 150 doctors with offices in the trendy Athens neighborhood of Kolonaki, where Prada and Chanel stores can be found, more than half had claimed an income of less than $40,000. Thirty-four of them claimed less than $13,300, a figure that exempted them from paying any taxes at all.

Such incomes defy belief, said Ilias Plaskovitis, the general secretary of the Finance Ministry, who has been in charge of revamping the country’s tax laws. “You need more than that to pay your rent in that neighborhood,” he said.

He said there were only a few thousand citizens in this country of 11 million who last year declared an income of more than $132,000. Yet signs of wealth abound.

“There are many people with a house, with a cottage in the country, with two cars and maybe a small boat who claim they are earning 12,000 euros a year,” Mr. Plaskovitis said, which is about $15,900. “You cannot heat this house or buy the gas for the car with that kind of income.”

It reminds me of a funny story of how the Greek people have learned how to dodge or minimize paying for any goods and services.

Three Greeks and three Germans were traveling by train to a conference. At the station, the three Germans each bought a ticket and watched as the three Greeks bought only a single ticket. “How are three people going to travel on only one ticket?” asked one German. “Watch and you’ll see,” answered one Greek.

They all boarded the train. The Germans took their respective seats but all three Greeks crammed into a restroom and closed the door behind them. Shortly after the train departed, the conductor came around collecting tickets.

He knocked on the restroom door and said, “Ticket, please.” The door opened just a crack and a single arm emerged with a ticket in hand. The conductor took it and moved on. The Germans saw this and agreed it was quite a clever idea. So after the conference, the Germans decided to copy the Greeks on the return trip and save some Euros.

When they got to the station, they bought a single ticket for the return trip. To their astonishment, the Greeks did not buy a ticket at all. “How are you going to travel without a ticket?” asked one perplexed German. “Watch and you’ll see,” answered one Greek. When they boarded the train, the three Germans crammed into a restroom and the three Greeks crammed into another one nearby. The train departed shortly. A few minutes later, one of the Greeks walked over to the restroom where the Germans were hiding. He knocked on the door and yelled, “Ticket, please.”

Francis Chou's Chou Associates Fund

Francis Chou – Debts at Negative Yields

I never thought that in my lifetime we would ever see a situation in a developed economy when there is a negative yield on interest rates. A few months ago, Finland floated a five-year note at a negative yield. It sold €1 billion worth of notes at an interest rate of negative 0.017%. In other words, noteholders or bondholders are willing to pay the government the privilege of holding its notes. And this is not an aberration. Countries like Germany, France, Sweden, Netherland, Belgium and Austria have seen their two-year sovereign debt trading at negative yields.

So, you have come to this ridiculous situation where you can borrow money for free.

The question now is, how can one capitalize on the situation? There are several possible ways of doing that, but one way of seeking to take advantage of this type of situation is through an interest rate swap. An interest rate swap is a derivative contract between two counterparties whereby they agree to exchange one stream of interest payments for another, over a set period of time.

We are still considering the use of interest rate swaps and other similar derivatives. If we do use these contracts, we will do our best to quantify the risk of loss from these contracts and minimize losses if interest rates do not move in the manner that we anticipate. Of course, there is no guarantee that our use of these interest rate derivatives will work as intended or that we will accurately predict or analyze the direction of future interest rates.

Francis Chou – We are starting to look at credit default swaps (CDS)

One way of assessing investors’ appetite for risk is to check the prices of credit default swaps (CDS). In a CDS, one party sells credit protection and the other party buys credit protection. Put another way, one party is selling insurance and the counterparty is buying insurance against the default of a specific third party’s debt. If the protection buyer does not own debt issued by the third party, then CDS are more appropriately viewed as an investment transaction, rather than a hedging transaction, for the protection buyer notwithstanding the insurance-like features of a CDS. In most CDS, the protection buyer makes the premium payments over the life of the CDS, frequently on a quarterly basis.

We believe that CDS are starting to sell at prices that are becoming interesting. It is not as cheap as it was in 2006-2007. We are continuing to monitor CDS prices and may potentially invest in CDS in the future. We are looking at who deals in such investments and we want to examine carefully what counterparty risk we may be exposed to. The mechanics of investing in a CDS have changed somewhat from six years ago.

To make money in a CDS, you don’t need a default of the third-party’s debt. A dislocation in the economy or deterioration in the credit profile of the issuer may cause the CDS price to rise from these low levels. The negative aspect is that, like insurance, the premium paid for the protection erodes over time and may expire worthless. There is no guarantee that the Manager will make money for the Fund on any particular CDS or correctly predict an increase of value in any particular CDS.

Francis Chou – Caution to the Investors

Investors should be advised that we run a highly focused portfolio. In addition, we may have securities that are non-U.S. and could be subject 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 with regard to CDS and interest rate swaps. Because of these factors, the net asset value of the Fund can be volatile. However, we are not bothered by this volatility because our focus has always been, and continues to be, on how inexpensive we believe the investments are relative to their intrinsic value.

Francis Chou – Other Matters

COVERED CALL OPTIONS: The Fund had no covered call options in its portfolio as at June 30, 2015.

REDEMPTION FEE: We have a redemption fee of 2% if unitholders redeem their units in less than 12 months. None of this fee goes to the Fund Manager. It is put back into the Fund for the benefit of the remaining unitholders. Please note this change will be in effect for all funds moving forward.

INDEPENDENT REVIEW COMMITTEE: The Manager has established an IRC as required by NI 81-107. The members of the IRC are Sandford Borins, Joe Tortolano and Peter Gregoire. The 2014 IRC Annual Report is available on our website www.choufunds.com.

As of August 14, 2015, the NAV of a Series A unit of the Fund was $123.77 and the cash position was approximately 25.4% of net assets. The Fund is down 0.3% from the beginning of the year. In $US, it is down 11.6%.

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

Fund Manager

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