Seth Klarman founded the Baupost Group in Boston, USA, in 1982. He has provided 20% plus annually compounded growth to investors and now manages USD 29 billion. Often called “the next Warren Buffet”, Klarman said (well before the corona virus outbreak) that, “the rocket fuel that has propelled markets in 2019 will run out” and that markets were in a “liquidity trap for over-exuberant investors”.
Klarman is famous for holding large amounts of cash in times of high valuations. In December 2019, 31% of his huge portfolio was made up of cash. Now as share prices worldwide have collapsed, he has the firepower to invest. For the first time since 2011 he has opened his fund for new capital and is relishing the prospect of buying bargains.
Klarman’s investment philosophy is described in his rare to find book, “Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor” that retails on Amazon for over USD 800. He also publishes an annual newsletter and has written a preface to Graham and Dodd’s sixth edition of “Securities Analysis”.
What can one learn from Klarman?
Klarman provides a “road map” for investing. This is not a simple formula or a set of filters to follow. Klarman’s is a comprehensive investment philosophy that focuses on absolute performance and preservation of capital. This is achieved by:
- The strategy of investing only in a security trading at an appreciable discount from underlying value – the concept of a margin of safety. The element of a bargain is key.
- A focus first on risk (target risk first not return) and how much one might lose (probability and quantum of possible losses). To counter risk he diversifies reasonably and hedges when appropriate.
- Value alone is not sufficient. He looks for a catalyst for realization of underlying value. Although he admits that this is never a sure future occurrence, these triggers should be likely in the future
- Value investing means being contrarian and that means being initially (and also often for longer time periods) “wrong” vis a vis the market and thus likely to suffer paper losses.
- He often holds a large portion of his portfolio in CASH which is unlike all public mutual fund managers. Klarman has said that “the prudent far sighted investor manages the portfolio with the knowledge that financial catastrophes can and do occur. Forgo some near term returns as an insurance premium against unexpected and unpredictable adversity”.
Personal characteristics / traits of Klarman
- Hard work and persistence (takes years of analytical and investment experience)
- Unusually strict discipline
- Patience. He says that a good investor must deal with down cycles where cheap stocks become cheaper and up cycles when bargains are scarce and markets have too much investment capital
- Analyst and portfolio constructor – not just one of them
- Klarman says that in investing it is never wrong to change your mind, it is only wrong to change your mind and do nothing about it. He writes that huge sums have been lost by investors holding on to securities after the reason for holding them is no longer valid.
Top down and bottom up
Klarman starts by identifying broadly where the most attractive opportunities are likely to arise before drilling down to find bottom up targets within these broad areas. He looks for:
- Securities selling below “discount price”
- Rate of return situations (Mergers and tender offers)
- Asset conversion opportunities (financial distress, recapitalizations)
Klarman’s views on most other Fund Managers
- They are “plagued with short term relative performance orientation. Klarman points out that one cannot eat a relative performance cash flow when there is a loss even though performance might be better than an index.
- Spend too much time meeting investors and too little working hard on analysis and investing.
- Many asset management companies separate analytical responsibilities from portfolio management. According to Klarman this results in mistakes as the people who decide have not properly analyzed the investment opportunities
- Indexing is, for Klarman, “another fad” and is based on the assumption that markets are efficient – which according to Klarman they are not as Indexing only succeeds in a bull market
Klarman says that far too many people approach the stock market with a focus on making money quickly and this involves speculation not investing. Following Klarman’s value investing strategies, he says, will not get you rich quick but you keep what you have and retain the chances that you will get rich slowly.
Kai Taraporevala is a Singapore based advisor and Non-Executive Director to HNW families and international companies.