“…With the exception of an arbitrage or a necessarily short-term investment, we enter every trade with the idea that we are going to hold to maturity in the case of a bond and for a really long time, potentially forever, in the case of a stock. Again, if you don’t do that, you are speculating and not investing…” – Seth Klarman
Seth Klarman: Background & bio
Seth Klarman is (was?) virtually unknown outside value circles, despite his impressive record and value of assets under management. On average Baupost has returned 19% p.a. despite holding a large portion of its assets in cash. During the financial crisis, Seth Klarman’s funds lost somewhere between 7% and 13%, certainly outperforming the majority of its hedge fund peer group.
The group then rebounded during 2009, returning 27%. At the end of the second quarter of this year, Baupost announced yet another strong quarter, ending with the best month the group has had in terms of returns in more than five years, even though around 35% of the portfolio remained invested in cash. Around 14% of the portfolio was also invested in liquidating claims in the Lehman estate, according to the firm’s Q2 letter.
At year end 2013, Baupost Group had AUM of $approximately $30 billion.
According to a lecture given by Bruce Greenwald: “Warren Buffett says that when he retires, there are three people he would like to manage his money. First is Seth Klarman of the Baupost Group, who you will hear from later in the course. Next is Greg Alexander. Third is Li Lu.”
Mr. Klarman attended Cornell University where he received a degree in economics, and later attended Harvard University where he earned an M.B.A.
Reading through Klarman’s speeches and letters to investors, you quickly discover that the hedge fund manager is not around to make a quick buck. Klarman’s strategy is built around the notion that financial markets are inefficient, a viewpoint held by other well-known value investors (Buffett, Graham).
Klarman is a traditional value investor, looking for companies, bonds, credit instruments and real estate opportunities that all trade below what he, and his analysts believe is intrinsic value. However, a margin of safety must be incorporated. Seth Klarman it seems, will never chase a stock just because it’s the stock of the moment. Of course, Klarman also considers the word ‘investment’ to be the same as that set out by Benjamin Graham:
“An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”
Like Buffett and more notably, Graham, Klarman takes the view that stocks are, at their most basic, a fractional interest in a business, not a chip in a casino. Therefore, patterns or performance cannot be modelled with any kind of accuracy, or predictability. Seth Klarman also references Graham’s ‘Mr Market‘ analogy when he is talking about his investment process. Ask Mr Market for advice on how to make money and you’ll be led in the wrong direction. But if you look to Mr Market as an eccentric but useful counterparty, who will often, in a state of depression and panic, offer to sell you a fractional interest in his business at a marked down price, you’re on the right track.
Further, Klarman like Buffett is acutely aware of how an investor’s time horizon affects performance. Indeed, Klarman has made multiple references to the short-term nature of the fund management industry, how many investment managers have become fixated on short-term performance, increasing levels of speculation as they rush to catch market moves. In his preface to Security Analysis: Sixth Edition, Seth Klarman notes how the coverage of financial markets on dedicated news networks, ferments the view that investors should have a view on everything the market is doing, and that they should be aware of every market movement. Short clips of market movements push the culture that investment decisions can be made in under a minute. Of course, this makes Mr Market redundant.
Still, Klarman’s investments are made with a long-term horizon, with almost no trades made for short-term profit:
“…If someone asked me to invest their money with the goal of turning a quick profit over the next six or twelve months, I’d have no idea how…You might as well go to a casino…”
A way of thinking Buffett himself preached as early as 1963:
“…Our business is one requiring patience. It has little in common with a portfolio of high-flying glamour stocks…It is to our advantage to have securities do nothing price wise for months, or perhaps years, why we are buying them. This points up the need to measure our results over an adequate period of time. We suggest three years as a minimum…”
A great example of Klarman’s investment style is to look at how he traded during the dot-com bubble. From 1997 through to 2000, as the wider market surged, Klarman’s Baupost underperformed. For example, for the first half of 1999, to October 31 1999 the group returned 8.3%, while over the same period the S&P 500 returned around 23.8% but despite the fact that Klarman believed the market was ‘frothy’, Klarman kept buying. In fact, during the first half of 2000 Baupost’s cash weighting had dropped to 4.6% of AUM; usually the group would hold around 40% of AUM in cash. For the financial year ending October 27 2000, Baupost posted a return of 22.4%.
When the market started to fall, Klarman profited. The S&P 500 peaked during September and by the time Klarman wrote his letter to investors during December, the market had fallen more than 13% from its peak.
“ … I must remind you that value investing is not designed to outperform in a bull market. In a bull market, anyone…can do well, often better than value investors. It is only in a bear market that the value investing discipline becomes especially important…it helps you find your bearings when reassuring landmarks are no longer visible …”
Klarman learnt his trade by reading the teachings of Graham and Dodd but over the years his strategy has changed. Indeed, when quizzed on his strategy, Klarman stated that he views Graham and Dodd’s work as template for investing, rather than a detailed road map:
“…When I think of Graham Dodd, however, it’s not just in terms of investing but also in terms of thinking about investing. In my mind, their work helps create a template for how to approach markets, how to think about volatility in markets as being in your favor rather than as a problem, and how to think about bargains and where they come from…The work of Graham and Dodd has really helped us think about the sourcing of opportunity as a major part of what we do—identifying where we are likely to find bargains. Time is scarce. We can’t look at everything…”
This template as it were, has helped build confidence in his own abilities, buying when others are fearful and holding through both the good times and the bad.
Graham-Dodd’s investment road map has helped Seth Klarman keep his cool in times of market stress. But despite their invaluable teachings, Klarman actually believes that their work is now somewhat out-of-date:
“… The world is different now than it was in the era of Graham and Dodd. The business climate is more volatile now. The chance that you buy very cheap and that it will revert to the mean, as Graham and Dodd might have expected, is probably lower today than in the past…”
Whether or not this view is correct is up for debate. However, the developments in technology over the past 80 or so years since Benjamin Graham started teaching at the Columbia Business School, have seriously changed the way equity and debt markets operate. The availability of information has also reduced the amount of mispriced securities there are available in the market place.
Nevertheless, Baupost’s average holding period remains similar to that as defined by Graham-Dodd and Buffett:
“… With the exception of an arbitrage or a necessarily short-term investment, we enter every trade with the idea that we are going to hold to maturity in the case of a bond and for a really long time, potentially forever, in the case of a stock. Again, if you don’t do that, you are speculating and not investing…”
Seth Klarman: Shareholder letters
- December 8, 1995
- Excerpts fromKlarman’s 2010 Letter
- Excerpt from Baupost 2007 Year End Letter
- Excerpt from Baupost 2004 Shareholder Letter – A Paucity of Worry
- Baupost Shareholder Letters 1995 – 2001
- My Favorite Quote from Baupost's 2011 Annual Letter
Exclusive ValueWalk Series
- Lessons For Retail And Institutional Investors
- Value Investing in a Turbulent Environment [1997-2001]
- Value Investing In A Market Bubble [1997-2001]
- Klarman: The Patient Investor
- Looking For Opportunities
- Yield Pigs
- Wall Street Is The Worst Enemy Of The Average Investor
- Klarman: The Margin of Safety – Part Eight
- Areas of Opportunity for Value Investors
- Part ten: Portfolio Management
Seth Klarman: Quotes
“Investing in bargain-priced securities provides a “margin of safety”-room for error, imprecision, bad luck, or the vicissitudes of the economy and stock market.”
“So if the entire country became security analysts, memorized Benjamin Graham’s Intelligent Investor and regularly attended Warren Buffett’s annual shareholder meetings, most people would, nevertheless, find themselves irresistibly drawn to hot initial public offerings, momentum strategies and investment fads. People would still find it tempting to day trade and perform technical analysis on stocks. A country of security analysts would still overreact. In short, even the best trained investors would make the same mistakes investors have been making forever, and for the same immutable reason – that they cannot help it.”
“In capital markets, price is set by the most panicked seller at the end of a trading day. Value, which is determined by cash flows and assets, is not. In this environment, the chaos is so extreme, the panic selling so urgent, that there is almost no possibility that sellers are acting on superior information. Indeed, in situation after situation, it seems clear that fundamentals do not factor into their decision making at all.”
“?Most institutional investors? feel compelled? to swing at almost every pitch and forego batting selectivity for frequency?.”
“Baupost build numerous new positions as the markets fell in 2008. While it is always tempting to try to time the market and wait for the bottom to be reached (as if it would be obvious when it arrived), such a strategy has proven over the years to be deeply flawed. Historically, little volume transacts at the bottom or on the way back up, and competition from other buyers will be much greater when the markets settle down and the economy begins to recover. Moreover, the price recovery from a bottom can be very swift. Therefore, an investor should put money to work amidst the throes of a bear market, appreciating that things will likely get worse before they get better.”
“Many equity investors feel compelled to remain 100% invested in equities at all times. Bond investors are often similarly constrained. We strongly believe that this mentality leads to pursuit of relative rather than absolute investment returns, a direction we certainly want to avoid…A smaller pool of funds seeking to avoid meaningful declines in market value at every point in time and seeking more aggressive return objectives cannot afford to be fully invested in the absence of attractive opportunities.”
“The overwhelming majority of people are comfortable with consensus, but successful investors tend to have a contrarian bent,” Klarman said over lunch one day in an empty Boston restaurant. “Successful investors like stocks better when they’re going down. When you go to a department store or a supermarket, you like to buy merchandise on sale, but it doesn’t work that way in the stock market. In the stock market, people panic when stocks are going down, so they like them less when they should like them more. When prices go down, you shouldn’t panic, but it’s hard to control your emotions when you’re overextended, when you see your net worth drop in half and you worry that you won’t have enough money to pay for your kids’ college.”
One theme of Margin of Safety is that people like me aren’t equipped to be investors. “No one knows what he’s doing unless he’s a full-time professional,” he said. “As in many professions, full-time experts have an enormous advantage. Investing is highly sophisticated and nuanced. The average person would have an incredibly hard time competing.”
“Everybody these days is a just-in-time investor. People say, ‘I’m going to leave my money in the market as long as possible, and then pull it out of the market just before I have to write the tuition check.’ But I think we’re seeing that the day you need to pull it out of the market, the market might be down 50 percent. It’s critical not to be greedy. Avoid leverage and don’t invest money that you can’t stand to lose.”
“Here’s how to know if you have the makeup to be an investor. How would you handle the following situation? Let’s say you own a Procter & Gamble in your portfolio and the stock price goes down by half. Do you like it better? If it falls in half, do you reinvest dividends? Do you take cash out of savings to buy more? If you have the confidence to do that, then you’re an investor. If you don’t, you’re not an investor, you’re a speculator, and you shouldn’t be in the stock market in the first place.”
- How To RideKlarman’s Coattails
- The Value ofKlarman
- Why Most Investment Managers Have It Backwards by Klarman
- Klarman’s Best Ideas (for Now) – Seeking Alpha
- Channeling Graham and Dodd: A Conversation with Klarman
- Valuing a Business – Klarman’s 3 Methods
- Klarman Lecture Notes
- Klarman Interview
- Klarman Comments on Money Management and Baupost’s Approach
- Seth Klarman: Second Coming of Benjamin Graham?
- MIT Speech & Remarks (MIT – October 20, 2007)
- A scaredy-cat approach pays off for hedge fund (SMH – May 19, 2007)
- Manager Frets Over the Market, but Still Outdoes It (NYT – May 13, 2007)
- Klarman on the Art of Complex Deep Value Investing (GuruFocus – September 27, 2006)
- The $700 Used Book: Why all the buzz about Seth Klarman’s out-of-print investing classic? (BW – August 7, 2006)
- Klarman Speech at Columbia Business School (CBS – April 20, 2006)
- Portfolio Talk – A bottom-fisher reveals his catch (Fortune – June 18, 1990)
- Are these New Warren Buffetts?
- Value Investing: 3 Lessons from Seth Klarman's "Margin of Safety"
- 30 Big Ideas from Seth Klarman's Margin of Safety
- Profile of Klarman & Baupost Group ~ market folly
- Notes To Klarman's Book “Margin Of Safety” - ValueWalk
- Klarman | Value-Stock-Plus
- Klarman Warns of 2007-Like Bubble
- Klarman's Baupost to Gain More Than $900 Million on Deal
- Klarman - Baupost Group - 2015 Stock Picks
- Nodes of term Seth Klarman | Zero Hedge
- Klarman On "Born Bulls", Bitcoin, & "The Truman Show
- Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor by Klarman
- Security Analysis: Sixth Edition, Foreword by Warren Buffett, Commentary by Klarman
Recommended Reading List
- The Intelligent Investor
- Joel Greenblatt’s You Can Be a Stock Market Genius: Uncover the Secret Hiding Places of Stock Market Profits
- The Aggressive Conservative Investor
- Mr. Market Miscalculates: The Bubble Years and Beyond
- Money of the Mind
- Minding Mister Market:: Ten Years on Wall Street with Grant’s Interest Rate Observer
- John Adams: Party of One
- The Trouble With Prosperity: The Loss of Fear, the Rise of Speculation, and the Risk to American Savings
- The Trouble With Prosperity: A Contrarian’s Tale of Boom, Bust, and Speculation
- Bernard M. Baruch: The Adventures of a Wall Street Legend (Trailblazers, Rediscovering the Pioneers of Business)
- Buffett: The Making of an American Capitalist
- While America Aged
- When Genius Failed: The Rise and Fall of Long-Term Capital Management
- The End of Wall Street
- Origins of the Crash: The Great Bubble and Its Undoing
- Moneyball: The Art of Winning an Unfair Game, Liar’s Poker The Big Short: Inside the Doomsday Machine.
- The Big Short: Inside the Doomsday Machine
- Too Big to Fail
Seth Klarman: Videos
- An Interview withlarman and Charlie Rose
- Klarman - YouTube
- The Ben Graham Center for Value Investing Seth Klarman
- Columbia MBA- Greenwald Class 21: Seth Klarman 2010
- Klarman from todd sullivan on Vimeo
- Interview with Seth Klarman, MBA 1982 -Born to be an Entreprenuer
- Klarman Introduces Ben Graham's Security Analysis, Sixth Edition, 2008
- Harvard - Psychology of Leadership - 23. Let's Talk Business
- The Best of Value Investing - Part 1
- Interview with Klarman, MBA 1982 - Margin of Safety - Harvard Business School.flv