Seth Klarman gives some timeless tips for value hunting in a bull market.
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As one of the world’s foremost value investors and one of the value investors with the longest records of outperformance still operating today, wisdom from Seth Klarman is highly valuable. Klarman’s hedge fund, Baupost began operations in 1990 and over the past nearly three decades, the hedge fund has traded through all different types of market environment including two of the largest stock market bubbles in history (excluding today’s bubble).
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With all of this experience, Klarman knows how to react during both bull and bear markets, and his advice on these topics is invaluable.
Value Hunting In A Bull Market - What Baupost tells investors
Reading through historical letters from Baupost to its investors, its amazing how many parallels there are between previous market environments and those of today. Below is an extract from Klarman’s December 22, 1997, letter to investors written as the dot-com bubble was starting to gain traction. As the S&P 500 rallied aggressively, Baupost trailed the index adding only 27.04% for the year, compared to the index’s 32.11% (it should be noted that during this period the fund held over 20% of its net assets in cash). Despite the wider market rally, Klarman wasn’t going to be drawn into the euphoria. Instead, he was already planning for the worst:
“The most favorable position going into a sudden downdraft (if you could correctly anticipate one) is to hold market hedges and/or cash (or better still, short positions, but short sellers have been aging in dog years for a long time). We hold both, although never enough in a downturn, because both are costly. Hedges, like any insurance, involve paying a premium. Premiums have skyrocketed in lockstep with the market's surge over the past two years, and have risen even more in the current volatile environment. Cash provides protection in a storm and ammunition to take advantage of newly created opportunities, but holding cash involves the considerable opportunity cost of foregoing presently attractive investments. Given the choice between holding mostly cash awaiting the periodic market tumble or finding compelling investments which earn good returns over time but fluctuate to a certain extent with the market amidst turbulence, we choose the latter. Obviously, we could not have earned the returns we have from investing, without investing.”
But while caution dominated Klarman’s portfolio management, he was also still finding plenty of opportunities to invest without compromising his standards:
“The upside of the recent market episode is that many good bargains have become even better ones, and numerous attractive new situations have surfaced. We are selectively deploying cash into what we believe are wonderful, long-term values, and are also repositioning ourselves, adding to some positions while reducing or deleting others, to take advantage of the lay of the present landscape. The opportunity to invest more money at lower prices will certainly be to our long-term financial benefit.”
The letter goes on to extol the virtues of Value Hunting in a bull Market, even when stocks have become unpredictable and the euphoria eventually subsides giving way to panic and mass selling:
“I must remind you that value investing is not designed to outperform in a bull market. In a bull market, anyone, with any investment strategy or none at all, can do well, often better than value investors. It is only in a bear market that the value investing discipline becomes especially important because value investing, virtually alone among strategies, gives you exposure to the upside with limited downside risk. In a stormy market, the value investing discipline becomes crucial, because it helps you find your bearings when reassuring landmarks are no longer visible. In a market downturn, momentum investors cannot find momentum, growth investors worry about a slowdown, and technical analysts don't like their charts. But the value investing discipline tells you exactly what to analyze, price versus value, and then what to do, buy at a considerable discount and sell near full value. And, because you cannot tell what the market is going to do, a value investment discipline is important because it is the only approach that produces consistently good investment results over a complete market cycle.”
So are you ready to go Value Hunting In A Bull Market because that is certainly the challenge today? What stocks do you like? Comment below.