insurance on your house each year. Similarly we may only have one or two economic depressions or financial panics in a century and hyperinflation may never ruin the U.S. economy, but the prudent, farsighted investor manages his of her portfolio with the knowledge that financial catastrophes can and do occur. Investors must be willing to forego some near-term return, if necessary, as an insurance premium against unexpected and unpredictable adversity.”
4. “To value investors the concept of indexing is at best silly and at worst quite hazardous. Warren Buffett has observed that “in any sort of a contest — financial, mental or physical — it’s an enormous advantage to have opponents who have been taught that it’s useless to even try.” I believe that over time value investors will outperform the market and that choosing to match it is both lazy and shortsighted.”
(I somewhat disagree with this. I think indexing is appropriate for most investors. What works for Warren Buffett, and what has worked for Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B), might not work for everyone else. He can do things most people can’t. That’s why he’s a billionaire and you’re not.)
5. “Warren Buffett likes to say that the first rule of investing is “Don’t lose money,” and the second rule is, “Never forget the first rule.” I too believe that avoiding loss should be the primary goal of every investor. This does not mean that investors should never incur the risk of any loss at all. Rather “don’t lose money” means that over several years an investment portfolio should not be exposed to appreciable loss of principal.
While no one wishes to incur losses, you couldn’t prove it from an examination of the behavior of most investors and speculators. The speculative urge that lies within most of us is strong; the prospect of a free lunch can be compelling, especially when others have already seemingly partaken. It can be hard to concentrate on potential losses while others are greedily reaching for gains and your broker is on the phone offering shares in the latest “hot” initial public offering. Yet the avoidance of loss is the surest way to ensure a profitable outcome.”
6. “It would be a serious mistake to think that all the facts that describe a particular investment are or could be known. Not only may questions remain unanswered; all the right questions may not even have been asked. Even if the present could somehow be perfectly understood, most investments are dependent on outcomes that cannot be accurately foreseen. Even if everything could be known about an investment, the complicating reality is that business values are not carved in stone. Investing would be much simpler if business values did remain constant while stock prices revolved predictably around them like the planets around the sun. If you cannot be certain of value, after all, then how can you be certain that are you buying at a discount? The truth is you cannot.”
7. “Frequent comparative ranking can only reinforce a short-term investment perspective. It is understandably difficult to maintain a long-term view when, faced with the penalties for poor short-term performance, the long-term view may well be from the unemployment line … Relative-performance-oriented investors really act as speculators. Rather than making sensible judgments about the attractiveness of specific stocks and bonds, they try to guess what others are going to do and then do it first.”
8. “Value investing is simple to understand but difficult to implement. Value investors are not supersophisticated analytical wizards who create and apply intricate computer models to find attractive opportunities or assess underlying value. The hard part is discipline, patience, and judgment. Investors need discipline to avoid the many unattractive pitches that are thrown, patience to wait for the right pitch, and judgment to know when it is time to swing.”
9. “Wall Street can be a dangerous place for investors. You have no choice but to do business there, but you must always be on your guard. The standard behavior of Wall Streeters is to pursue maximization of self-interest; the orientation is usually short term. This must be acknowledged, accepted, and dealt with. If you transact business with Wall Street with these caveats in mind, you can prosper. If you depend on Wall Street to help you, investment success may remain elusive.”
10. “Avoiding where others go wrong is an important step in achieving investment success. In fact, it almost assures it.”
Seth Klarman – Baupost 2009 annual meeting:
- Over the long run, the crowd is always wrong
- Hold cash when opportunities are not presenting themselves
- Great investments don’t just knock on the door and say “buy me”
- What is their edge on a name?
- Must have superior information
- Ability to be long term
- Well founded contrarian view
- Complexity – limits competition
- Flexible approach – will look at ALL asset classes
- Like to have a catalyst – reduces dependence on the market: Distressed debt inherently has a catalyst – maturity.
- Excessive diversification dilutes returns
- Limit risk with:
- Deep analysis
- Bargain purchase
- Sensitivity analysis
- Don’t use any recourse leverage on the portfolio
- Need a catalyst
- Great majority of personal assets in the fund
- It is crucial in a sound investment process to search a mile wide than a mile deep with they find something – also.. never stop digging for information.
- In employees, he values investment curiosity and intellectual honesty.
- Need to rigorously separate fact from fiction
- Team based collaborative culture
- Avoid organizing investment team into silos.
- Team of generalists
- Always look for forced urgent selling
- Don’t short many stocks. Instead they hedge for tail risk with CDS and options.
- They are happy to incur illiquidity
- Illiquidity risk is a risk they LOVE
- Comfortable holding cash for tomorrow’s opportunity
- They find it is hard to un-train people so they try to hire young.
- Learning organization
- Can’t let client pressures or market pressures distract them.
- An understanding that their clients expect certain times of underperformance
Klarman’s Twenty Investment Lessons of 2008
- Things that have never happened before are bound to occur with some regularity. You must always be prepared for the unexpected, including sudden, sharp downward swings in markets and the economy. Whatever adverse scenario you can contemplate, reality can be far worse.
- When excesses such as lax lending standards become widespread and persist for some time, people are lulled into a false sense of security, creating an even more dangerous situation. In some cases, excesses migrate beyond regional or national borders, raising the ante for investors and governments. These excesses will eventually end, triggering a crisis at least in proportion to the degree of the excesses. Correlations between asset classes may be surprisingly high when leverage rapidly unwinds.
- Nowhere does it say that investors should strive to make every last dollar of potential profit; consideration of risk must never take a backseat to return. Conservative positioning entering a crisis is crucial: it enables one to maintain long-term oriented, clear thinking, and to focus on new opportunities while others are distracted or even forced to sell. Portfolio hedges must be in place before a crisis hits. One cannot reliably or affordably increase or replace hedges that are rolling off during a financial crisis.
- Risk is not inherent in an investment; it is always relative to the price paid. Uncertainty is not the same as risk. Indeed, when great uncertainty – such as in the fall of 2008 – drives securities prices to especially low levels, they often become less risky investments.
- Do not trust financial market risk models. Reality is always too complex to be accurately modeled. Attention to risk must be a 24/7/365 obsession, with people – not computers – assessing and reassessing the risk environment in real time. Despite the predilection of some analysts to model the financial markets using sophisticated mathematics, the markets are governed by behavioral science, not physical science.
- Do not accept principal risk while investing short-term cash: the greedy effort to earn a few extra basis points of yield inevitably leads to the incurrence of greater risk, which increases the likelihood of losses and severe illiquidity at precisely the moment when cash is needed to cover expenses, to meet commitments, or to make compelling long-term investments.
- The latest trade of a security creates a dangerous illusion that its market price approximates its true value. This mirage is especially dangerous during periods of market exuberance. The concept of “private market value” as an anchor to the proper valuation of a business can also be greatly skewed during ebullient times and should always be considered with a healthy degree of skepticism.
- A broad and flexible investment approach is essential during a crisis. Opportunities can be vast, ephemeral, and dispersed through various sectors and markets. Rigid silos can be an enormous disadvantage at such times.
- You must buy on the