Seth Klarman on the Disruptive Forces of Technology

Baupost's most recent letter touches upon technology and its effects

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Mar 23, 2016
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In his most recent annual letter to Baupost's shareholders, Seth Klarman (Trades, Portfolio) discussed his views on how flexible investors' approach should be and the potential that technology has to transform investing and research.

Klarman also mentioned that no industry is safe from a transformation due to the big technological changes we face.

"While operating within the constraints of value investing principles, we are determined to look far and wide for opportunity, building our competencies over time based on learning and experience. We must neither be confined by a narrow mindset of what may or may not be undervalued nor become so aggressive in pursuing opportunity that we deviate far beyond our circles of competence. I tell our team that we wouldn’t be doing our jobs if we remained locked in the past, buying only the melting ice cubes of previously good businesses now in decline as though technological change weren’t accelerating the obsolescence of entire industries."

This paragraph is critical. As investors we need to be constantly evolving, sticking to fundamentals while figuring out new ways to value securities. So, as Klarman mentioned, we can build our competencies and expand our circles of competence, but be very honest and conscious about the boundaries of those circlec. Also, it is critical to revise our investment thesis over time, as businesses are constantly threated by what Charlie Munger calls creative destruction. To remain locked in the past could prove costly and harmful for long-term success in investing.

"We would also be remiss if we failed to take advantage of new analytical tools and resources. We must consider new ways of thinking. We must continuously ask ourselves whether any investment under consideration is just too hard to properly assess: Is the fruit too high hanging? In investing, there are no style points awarded for degree of difficulty. However, the complexity and opacity that may cause others to discard potential opportunities as “too hard” can drive market inefficiencies that result in opportunity for us. In 2015, we took a close look at “big data” technology as a research tool and potential “edge” for Baupost. While there are a number of applications that may be interesting over time, we continue to strongly believe that our investment success will ultimately depend not so much on big data as on big judgment."

If we stick to our circle of competence, opportunity will come. Sometimes, as investors we believe that the harder a business is to value, the better investment it is. However, as the author mentions, there are no points awarded for degree of difficulty. When looking for value we are likely to encounter it in obscure and discarded places. This happened in the energy sector and its recent downturn. Klarman's opinion about big data is very important. While it can help a lot in research, it cannot replace the value of having an experienced and objective judgment.

"Disruptive forces continue to roll across the global business landscape. Unprecedented changes are taking place as technology advances and entrepreneurs drive creative destruction. Numerous industries, including the behemoth energy, pharmaceutical, automobile and retailing sectors, are experiencing waves of increased competition and disruption. In many cases, the new competitors simply have a better business model. Andreessen Horowitz co-founder Marc Andreessen has said that 'we are in the middle of a dramatic and broad technological and economic shift in which software companies are poised to take over large swathes of the economy. Many of the winners are Silicon Valley-style entrepreneurial technology companies that are invading and overturning established industry structures.' Certainly, no investor can blithely assume that what has heretofore been regarded as a 'good business' will automatically retain its pre-eminence and, for some, even viable existence."

Here Klarman discusses the shift that we are experiencing from product economy to services economy. Software and services providers are now taking over big portions of GDP. Understanding this and how it can affect the moats of certain businesses is critical and something that we need to keep our eyes on.