Seth Klarman is President of the Baupost Group, LLC. His firm, founded in 1982, manages $15 billion for institutional and high net worth clients. His now out of print book "Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor" sells for $1,200 on Amazon and $2,000 on eBay and has been stolen from most libraries.
The following is a summary of Seth Klarman's lecture, given to the Richard Ivey School of Business on March 17th, 2009.
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Klarman opened his speech by pointing out that peoples' investing temperament seems to be influenced by the state of the market when they graduated from school. As he said, "If you remember how cheap things can get, you don't easily forget that lesson." I attended this lecture in person while completing my MBA, and this statement had a direct impact on me as I would be graduating in one of the worst market climates in history.
In defining value investing, Klarman describes it as a risk averse approach. He says that it's a series of principles and a way of thinking about investing that forces you to first focus on risk, and only then on returns. As the downside is where the pain is for most people, value investing protects against that first.
Klarman's understanding based on research he has seen is that value investing via a mechanical approach (purely quantitative according to P/E, P/B, etc.) adds about 1% to 2% a year. He wonders, however, why anyone would trust a dumb formula when they can do even better through proprietary analysis and investigation. In doing so he can tell when some situations that look cheap (according to a mechanical method) aren't in fact that cheap. As such, his firm's approach to value investing is to follow the philosophy's principles while relying on their own fundamental and detailed research.
Klarman's approach to investing is based on three underlying pillars:
Klarman started his firm in a similar fashion to Benjamin Graham's beginnings. He had a small amount of capital and would rummage around for mis-priced situations where there was a reason for mispricing and a catalyst present that would enable him to make money. Over the years his firm developed the following core principles:
More information about Seth Klarman as well as insights into the Baupost Group's holdings can be found at GuruFocus.com.
Jonathan Goldberg
http://www.jonathangoldberg.com/
The following is a summary of Seth Klarman's lecture, given to the Richard Ivey School of Business on March 17th, 2009.
---------------
Klarman opened his speech by pointing out that peoples' investing temperament seems to be influenced by the state of the market when they graduated from school. As he said, "If you remember how cheap things can get, you don't easily forget that lesson." I attended this lecture in person while completing my MBA, and this statement had a direct impact on me as I would be graduating in one of the worst market climates in history.
In defining value investing, Klarman describes it as a risk averse approach. He says that it's a series of principles and a way of thinking about investing that forces you to first focus on risk, and only then on returns. As the downside is where the pain is for most people, value investing protects against that first.
Klarman's understanding based on research he has seen is that value investing via a mechanical approach (purely quantitative according to P/E, P/B, etc.) adds about 1% to 2% a year. He wonders, however, why anyone would trust a dumb formula when they can do even better through proprietary analysis and investigation. In doing so he can tell when some situations that look cheap (according to a mechanical method) aren't in fact that cheap. As such, his firm's approach to value investing is to follow the philosophy's principles while relying on their own fundamental and detailed research.
Klarman's approach to investing is based on three underlying pillars:
Focus on risk before focusing on return. This is not risk in the form of beta or volatility but risk in the sense of how much you can lose if you do in fact lose. He mentions that beta or volatility risk is not really risk unless you must sell on the day the price happens to be low. This approach he describes is very different from wall street where reports tend to be written using single point estimates focusing on the upside, with rarely a mention of the various possibilities of potential downside risk. Adopt a view toward absolute returns. The world seems to focus on relative performance instead of absolute performance. This sticks most investment firms to the group of "ensured mediocrity" as many just try to lose less than their peers. In focusing on absolute performance, the thought to Klarman of losing any of his clients' capital is unacceptable. Employ a bottom-up investment approach.Most of the world employs a top-down investment approach by analyzing the economy, interest rates, etc and then applying these findings to decisions to invest in certain sectors that should perform well in the relevant environment. Klarman does not know anyone with a long-term success rate in doing this. Macro forecasting is very difficult to do, and another issue is that even if you are right you must also be early or prices would have already moved to reflect your viewpoint. While Klarman will still think about the macro environment, he analyzes all his investments using a bottom-up approach.
Klarman started his firm in a similar fashion to Benjamin Graham's beginnings. He had a small amount of capital and would rummage around for mis-priced situations where there was a reason for mispricing and a catalyst present that would enable him to make money. Over the years his firm developed the following core principles:
Picking clients to ensure the firm will be able to maintain a flexible investment approach. This flexibility also allows the firm to capitalize on opportunities in different markets and asset classes.Large amount of employee capital invested in the firm.He wants his firm to be the best place for employees to invest their capital. This ensures a vested interest in the work the employees are performing and would also be a great selling point. Having an edge, a reason to think they can outperform.The biggest edge any investor can have, and his own firm's biggest advantage, is in having a long term investment horizon. Lots of funds feel pressure to hold cash or to buy short-term situations but are unable to seek out 3-5 year holds as the capital may only be available for 6 months.Foster strong relationships. The firm works hard to ensure they have the best brokers and that they are these brokers' best clients. If they are somebody's first or second largest client then they know they will be made aware of opportunities when large blocks of shares come on the market, etc.Having a niche. The firm's particular focus is in complicated situations, one of their favourite areas being in distressed debt. As many firms have mandates to sell when debt hits this distressed level, Klarman's firm is able to take advantage of the ensuing mispricing and is able to make a profit. This is a much more ideal situation then buying from a seller who knows more than you and who has done the analysis and has decided to sell as a result. Klarman's firm really likes situations where there is a supply/demand imbalance. Other examples are situations where a stock is getting kicked out of an index or where a stock is being spun-off from its parent company. In both these situations there are many institutions and indices that would need to sell indiscriminately. As Klarman says, "Time is scarce so you want to look at these situations where there is a good chance of mispricings."
More information about Seth Klarman as well as insights into the Baupost Group's holdings can be found at GuruFocus.com.
Jonathan Goldberg
http://www.jonathangoldberg.com/
