"For years, when someone asked me what my biggest fear was as an investor in managing my portfolio, my answer was that it was buying too soon on the way down from often very overvalued levels," Seth Klarman (Trades, Portfolio) said in an interview during the financial crisis.
He went on to explain during the great market crash of 1929, trying to time the market would have been entirely impossible, and being too early would have been "indistinguishable from being wrong." This is one of the most prominent risks value investors face in a bear market. As Klarman said:
"Of course, getting in too soon as the market falls involves great risk for all investors, including value investors. Certainly, when a few securities start to get cheap even as the bull market continues, a value-starved investor will step up and buy them. Soon enough, many of these prove to be no bargain at all as the flaws that caused them to be rejected by the bulls become more glaringly apparent when the world gets worse. (This is particularly applicable in today's market and we should all be reminding ourselves before making any purchases.) "
The challenge investors face, then, is being able to time the market and invest at just the right time, when all the information is factored into the share price. That includes depressed fundamentals:
"Most declines have matched deteriorating fundamentals. As we waited patiently for opportunity to arise during 2007, we refused to deviate from our high standards. Some stocks and corporate bonds fell to levels that looked tempting, but in most cases, the declines merely matched deteriorating fundamentals – especially in the financial, housing, and retail sectors – and were no real bargain."
Not the time for risk-taking
In these uncertain times (both today and in 2008), it is critical to remain focused on your investment plan and maintain high investment standards.
The situation is changing fast. It is impossible to tell, at this stage, which companies will emerge from the rubble in one piece. It could be some time before we have an answer.
So, now is not the time for taking risks. If it is impossible to evaluate a potential investment, then don't try. There will be other options in the future. As per Klarman's advice, don't buy something just because it looks cheap. If something looks too good to be true, that's probably because it is. Stocks tend to be cheap for a reason, even in bear markets. It is vital that investors remain rational and don't make any investment decisions based on emotion rather than fundamental analysis.
This includes avoiding losses. Losses are just part of investing, and sometimes, it is better to take the loss and move on to a better investment opportunity. Don't let losses dictate your actions.
Klarman's hedge fund, Baupost, was able to take advantage of some once in a lifetime opportunities in the financial crisis because the hedge fund had plenty of capital available. As Klarman explained in a 2008 interview, the fund also waited patiently for the perfect opportunity and didn't chase stocks lower.
Klarman has been managing the business for several decades, and during this time, he has seen some of the most volatile market periods in history. The value investor knows that keeping your discipline is the most valuable weapon an investor can have in times of uncertainty. Ignoring this lesson can be costly. The market will recover in time, and the only way to profit from that is to stay solvent.
Disclosure: The author owns no share mentioned.
Read more here:
- Hunker Down, but Be Prepared
- Low Risk and High Uncertainty Bets in Uncertain Times
- What Warren Buffett's Irish Bank Investments Can Teach Us
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