Great Investors Focus On Absolute-Performance Rather Than Relative-Performance – Seth Klarman

Earlier this month The Washington Post published an article titled – Warren Buffett’s $100 Billion Problem. The article was reporting on the $100 Billion that Berkshire has accumulated in cash over the years, stating:

Warren Buffett celebrated his 87th birthday a few days ago, but the bigger number in his life is the $100 billion mound of cash that his Berkshire Hathaway has stockpiled.

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Buffett created his cash-gushing conglomerate out of an ailing textile firm that he took over more than 50 years ago. Berkshire Hathaway now has dozens of subsidiaries, from railroads to utilities to candy companies. It has 367,000 employees, $24 billion in annual profit and market capitalization approaching $500 billion.

The conundrum Buffett faces is an enviable one: What to do with all the money? In this case, $100 billion. The Sage of Omaha acknowledged the difficulties of deploying his cash during Berkshire’s annual meeting in May.

“The question is, ‘Are we going to be able to deploy it?’?” he told the thousands of faithful who made the pilgrimage to Omaha.

By necessity, the investor must hunt for big game; it takes a big acquisition to meaningfully move the bottom line of a company the size of Berkshire Hathaway.

In order to answer the question of Berkshire’s growing stockpile of cash this seems like a good time to remember the lessons of Seth Klarman in his book – Margin of Safety. One lesson in particular discusses the importance of focusing on absolute-performance rather than relative-performance. It’s a valuable lesson for all investors, large and small.

Here’s an excerpt from the book:

The flexibility of institutional investors is frequently limited by a self-imposed requirement to be fully invested at all times. Many institutions interpret their task as stock picking, not market timing; they believe that their clients have made the markettiming decision and pay them to fully invest all funds under their management.

Remaining fully invested at all times certainly simplifies the investment task. The investor simply chooses the best available investments. Relative attractiveness becomes the only investment yardstick; no absolute standard is to be met. Unfortunately the important criterion of investment merit is obscured or lost when substandard investments are acquired solely to remain fully invested. Such investments will at best generate mediocre returns; at worst they entail both a high opportunity cost—foregoing the next good opportunity to invest—and the risk of appreciable loss.

Remaining fully invested at all times is consistent with a relative-performance orientation. If one’s goal is to beat the market (particularly on a short-term basis) without falling significantly behind, it makes sense to remain 100 percent invested. Funds that would otherwise be idle must be invested in the market in order not to underperform the market.

Absolute-performance-oriented investors, by contrast, will buy only when investments meet absolute standards of value. They will choose to be fully invested only when available opportunities are both sufficient in number and compelling in attractiveness, preferring to remain less than fully invested when both conditions are not met. In investing, there are times when the best thing to do is nothing at all. Yet institutional money managers are unlikely to adopt this alternative unless most of their competitors are similarly inclined.



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The Acquirer's Multiple
The Acquirer’s Multiple® is the valuation ratio used to find attractive takeover candidates. It examines several financial statement items that other multiples like the price-to-earnings ratio do not, including debt, preferred stock, and minority interests; and interest, tax, depreciation, amortization. The Acquirer’s Multiple® is calculated as follows: Enterprise Value / Operating Earnings* It is based on the investment strategy described in the book Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations, written by Tobias Carlisle, founder of acquirersmultiple.com. The Acquirer’s Multiple® differs from The Magic Formula® Earnings Yield because The Acquirer’s Multiple® uses operating earnings in place of EBIT. Operating earnings is constructed from the top of the income statement down, where EBIT is constructed from the bottom up. Calculating operating earnings from the top down standardizes the metric, making a comparison across companies, industries and sectors possible, and, by excluding special items–earnings that a company does not expect to recur in future years–ensures that these earnings are related only to operations. Similarly, The Acquirer’s Multiple® differs from the ordinary enterprise multiple because it uses operating earnings in place of EBITDA, which is also constructed from the bottom up. Tobias Carlisle is also the Chief Investment Officer of Carbon Beach Asset Management LLC. He's best known as the author of the well regarded Deep Value website Greenbackd, the book Deep Value: Why Activists Investors and Other Contrarians Battle for Control of Losing Corporations (2014, Wiley Finance), and Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors (2012, Wiley Finance). He has extensive experience in investment management, business valuation, public company corporate governance, and corporate law. Articles written for Seeking Alpha are provided by the team of analysts at acquirersmultiple.com, home of The Acquirer's Multiple Deep Value Stock Screener. All metrics use trailing twelve month or most recent quarter data. * The screener uses the CRSP/Compustat merged database “OIADP” line item defined as “Operating Income After Depreciation.”