I recently got the opportunity to read a Barron's interview with Seth Klarman (Trades, Portfolio) in 1991. Overall, Klarman discusses his investment philosophy and some attributes that have propelled Baupost's success. Among my favorite quotes are the following:
"We have historically done very well in down markets. Our general predisposition is that we ought to run our money as if it is our own. And in fact it is our own. As I said, each of the people that work here has his money invested, as well. So we tend to only make investments when we think there is a compelling opportunity being presented. And often we will hold a third or half in cash or even more, awaiting such opportunities. As a result, while we do not do any allocation based on our view of the macro economy or top-down view of the market, by looking bottom-up for opportunities and failing to find them, that tends to self-regulate."
"We have not gotten the kinds of calls that people might when there has been a defacto run on the market. Our clients, many of them, are individual businesspeople and have made their own money. They call up and encourage us to maintain the kind of conservative posture that we have. And, in fact, they often say: "Let me know if you ever decide to change because we want out if you do." So we are very lucky that when we feel that there is nothing to do, the clients are supportive of that."
"We will buy dollars for 40 cents, or dollars for 60 cents when they are attractive dollars to buy. I think that we implement it a fair bit differently than many value investors or many so-called value investors who frankly I'm not sure are buying good value at all. Value to some extent is in the eye of the beholder. It is very hard to pin down what the value of a future set of cash flows from a business, be it cable TV or biotechnology, is going to be. Some are easier to predict than others. But it is very hard to predict what those future cash flows are going to be. And it is very hard to ascertain the correct discount rate to bring them back to the present with."
"When we look at value, we tend to look at it on a very conservative basis -- not making optimistic forecasts many years into the future, not assuming growth, not assuming favorable cost savings, not assuming anything like that. Rather looking at what is there right now, looking backwards and saying, Is that the kind of thing the company has been able to do repeatedly? Or is this a uniquely good year, and is it unlikely to be repeated? We tend to look at hard assets as much as possible."
"When a company has cash on the books, or marketable securities on the books, we think we understand that. And the more you get into businesses that depend on things going right in the future, the harder we find it to understand it. So we tend to buy asset-rich businesses, very predictable businesses. But perhaps most important, we are not just focusing on equities. We focus on any security of a company that is mispriced. We can even find some companies where one security, like the equity, is overvalued, but where another security, like the debt, might be undervalued. We have flexibility in our partnership agreement to do pretty much anything we like."
There are a lot of lessons to gather from Klarman's comments. In my view, these are among the most important ones:
When managing money, get the right investors. The best way to remove pressure from ourselves when managing other people's money is not to educate them, but to be careful in accepting investors who share the same mindset, and are willing to be patient. This is easier said than done, as both parties have short-term incentives. For the money manager, it is the willingness to increase AUM, and for investors it is the common practice of wanting results immediately.
Don't be afraid to hold cash. One trait that several value investors share is their patience, and the willingness to wait indefinitely until an attractve opportunity arrives. A great example is Warren Buffett (Trades, Portfolio) during the dot com bubble, when he was called a has-been, or Seth Klarman (Trades, Portfolio) himself, who after years of limiting contributions, finally opened the fund after the 2008 crisis to seize opportunities.
Focus on assets and predictability. While the income statement is generally the first thing that Wall Street reads, value investors take a look at the balance sheet first to get a clear picture of the company, as hard assets erode at a slower pace than earnings and are less manipulated. When fear invades the market, we can see that some companies are selling below the value of their assets, even after deducting liabilities. This is less common today, however, importance of the balance sheet remains the same.
Have a flexible approach. As Klarman mentions, value investing is the purchase of the proverbial 50 cent dollar. This can be found not only in equities, but also in debt, derivatives and even hard assets, such as Buffett's play on silver years ago. Having flexibility is in part due to having the right investors, so the link between these points should not be understated.
