Francis Chou’s Chou Associates Fund Manager’s Letter To Unitholders for the period ended December 31, 2014.

Dear Unitholders of Chou Associates Fund,

After the distribution of $0.71, the net asset value per unit (“NAVPU”) of a Series A unit of Chou Associates Fund at December 31, 2014 was $124.19 compared to $111.46 at December 31, 2013, an increase of 12.1%; during the same period, the S&P 500 Total Return Index increased 24.2% in Canadian dollars. In $U.S., a Series A unit of Chou Associates Fund was up 2.7% while the S&P 500 Total Return Index returned 13.7%.

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

Chou Associates Fund

Chou Associates Fund: Factors Influencing the 2014 Results

The weakness of the Canadian dollar against the U.S. dollar had a positive impact on the results of the Fund. The difference in performance results between the NAVPU priced in Canadian dollars, versus U.S. dollars, is attributable to the fact that on December 31, 2013, one U.S. dollar was worth approximately $1.06 Canadian, whereas one year later, on December 31, 2014; one U.S. dollar was worth approximately $1.16 Canadian.

Positive contributors to the Fund’s performance during the period ended December 31, 2014 included equity securities of Berkshire Hathaway, Resolute Forest Products, Goldman Sachs and International Automotive Components, as well as Wells Fargo warrants.

Securities of MBIA, and Sanofi were negative contributors to the Fund’s performance during the same period.

Our covered call options of Overstock.com expired in March of 2014.

PTGi Holdings. changed its name to HC2 Holdings, which were sold in their entirety. The Fund also sold all of its equity holdings of Actavis PLC.

Chou Associates Fund: A Tale of two Scenarios

I have been managing money since 1981 and one of the benefits of managing money for so long is that you get exposed to many financial and economic scenarios.

When I was thinking about the current market, I couldn’t help but recall what happened over the fifteen year period 1966 to 1981. The Dow Jones Industrial Average, hit a high of approximately 1000 in 1966 and for the next fifteen years it would approach that level only to recede back again. Inflation, which was subdued in the 1960s, started to go up in the 1970s, the result of printing money in the 1960s to finance the war in Vietnam.

By 1980, the combination of high inflation and low GDP growth was the story of the day. Economists coined the term ‘Stagflation’. When Paul Volcker was named Chairman of the Federal Reserve Board (Fed) in 1978, his first mandate was to tame inflation. By June 1981, the federal funds rate rose to 20%. Eventually in June 1982, a highly important economic measure – the prime interest rate, reached 21.5%. The 30-year bond hit a high of 15.2% yield when he put the brakes on money printing. The Dow tumbled, selling at a severe discount to the book value of the Dow.

At that time, I was wondering how much lower the market could go. This was how I looked at the scenario; the interest rate was so high that I felt it could not remain at that level for any extended period of time without just killing the economy. Volcker’s mandate was to break the back of inflation, and when he did that, interest rates were bound to go lower. Even if they didn’t, the market was incredibly cheap: approximately 6 times earnings and roughly 6% dividend yield. The Dow had been earning for a long time, on average, 13% on its equity and there was nothing to suggest that it was not going to earn the same in the future.

If interest rates went down, the end result would be that the companies would be worth a lot more. The discount rate that you use to discount future earning power is somewhat linked to the prevailing long term interest rate. When companies borrow money, the rate they pay, depending on their credit rating, is benchmarked to the prevailing interest rate plus or minus a few points.

The climate for investing in 1980 was one of extreme fear. For example, pension funds, as a group, invested only 9% of net investable assets in equities. In contrast, in 1971, 122% of net funds available were purchased into equities; in other words, they sold bonds, to buy more of the equities. Those who wanted to get into the investment field in the late 1970s and early 1980s were considered pariahs at the time, and were to be avoided at all social gatherings as one who would avoid the plague.

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