When I started writing this blog, my Major Article List was a big thing to me. I wrote some pretty good things at RealMoney.com, and I wanted to have a record of the best of that. I only wish I had done the same thing for my Columnist Conversation comments, because many of them were far better than most articles at RealMoney. Give TST credit, they would frequently take my best comments, and turn them into posts, and pay me for them. They did not have to do that.
But, I would love to republish many of my best timeless posts here. I offer a deal to RealMoney: In exchange for being able to republish old posts and comments of mine here, I will offer you new posts of mine, or the best of my old posts at my blog, so long as they are timeless.
Seth Klarman: Investing Is Art First, Craft Second And Science Third
Seth Klarman is considered to be one of the best value investors of all time. Unfortunately, he does not give many interviews or lectures. Q2 2020 hedge fund letters, conferences and more Luckily, those interviews and speeches that he does give are stuffed full of information and highly insightful comments that value investors can learn Read More
Regardless, when I was at RealMoney, I wrote a series that dealt with the motives of various investors as it stemmed from their balance sheets. For those that have access to RealMoney, here are the articles (note: I wrote different titles than what was used):
The main idea is this: There are a wide variety of investors, and they have differing abilities to hold assets. Why should investors have differing abilities to hold assets? And why should that matter?
When will you need the cash? That should be a central question for every investment adviser, dictating asset allocation. This is basic asset-liability management. This gets neglected in investing more often than most imagine.
- Mutual funds know that money will be pulled if they underperform. This forces them to be more short-term in investing. An exception can be closed-end funds, since they have captive capital, so long as the discount to NAV doesn’t get too great, and they attract activist investors.
- Same thing for hedge funds; they tend to be volatility-averse on average; and their investors may be technically more sophisticated than mutual fund investors, in practice, they make the same mistake of chasing performance.
- Average individual investors chase trends; that is very short-term.
- ETPs react to the market. Indexed investing amplifies a market as it grows, and muffles a market as it shrinks.
- Endowments can resist short-term underperformance for a few years, then the trustees get antsy.
- Same thing for Defined Benefit [DB] pension plans, but more so.
- Most banks and insurers have short liability structures so they can’t allocate that much to long duration assets like stocks and esoteric illiquid assets. Life insurers could invest there, but the risk-based capital regulations make it unworkable. That leaves P&C insurers writing long-tailed business; many of them are value investors, and use the long-duration liabilities (as Buffett calls it “float”) to invest in a wide number of cheap assets where it may take a while for value to be realized.
- Trusts, limited partnerships, etc., hinge on how much leverage they employ and how often the terms of the leverage shift, as well as any limitations on when capital must be distributed. Sometimes that’s not obvious, as in the failure of many mortgage REITs when the repo haircuts got boosted in the midst of the financial crisis, leading to forced selling, as they did not have enough capital to post as margin against all the assets that they held. The forced selling led to falling prices for mortgages, which led to further increases in the repo haircut, which created a self-reinforcing spiral until a new class of investors held many of the mortgages, and many mortgage REITs were bankrupt or broken.
With respect to institutional investors, my experience is the more of the investment is done internally, the more patient the capital tends to be. Perhaps that’s the illusion of control, but I tend to think that investors have more trust in their own reasoning than in the reasoning of external managers.
The longer the time that you can invest and wait for returns, on average, the more aggressive you can be in investing. The investor that can “Buy-and-hold” can take on the most difficult situations if there is a sufficient discount in the price to make the wait worthwhile, and avenues that allow for change to be encouraged.
So, when I think of how my investment is affected by those that invest alongside me, I divide them up this way:
- Strong Hands — long liability structures, excess capital, experienced, patient, never compelled to do anything; they can live with short-term losses.
- Weak Hands — no balance sheet or short liability structures, have to make a certain return each year, less experience, leveraged; they can’t live with short-term losses.
When I go through 13F filings, I note the quirkiness of the assets held, and often held for a long time. Almost all of the 13Fs that I track I would classify as strong hands. They don’t care about the next quarter; they are thinking about the next 3-5 years. They care about the growing underlying value of the businesses; they wouldn’t care if stock market was only open one day per month. Some, like Seth Klarman, do little on the long side when opportunities are not compelling. Like underwriters at well-run insurers, when an insurance market is nuts, you stop writing business, and spend time improving your skills.
So for my own investing this past period after I finished my 13F analysis, I took the companies that had:
- The 100 largest increases in my 13F investors
- The 100 largest increases in cash invested as a fraction of market cap
- The 100 with the greatest number of my 13F investors
- and the 100 largest positions as a fraction of market cap,
and put them in as competitors in my ranking system, against my current portfolio. Because of redundancy, it was about 320 companies in all. I think it was a good exercise, because it made me think about a bunch of companies that I would otherwise never consider. Anyway, the process is complete, and the equity portfolios have some promising new names with good prospects, and fellow shareholders that are for the most part “strong hands.”