Today I read the March 1990 issue of Outstanding Investor Digest (too bad it looks like the publisher had permanently stopped the subscription service). Highlighted in this issue was Baupost’s letter to clients in January 1990 written by Seth Klarman (Trades, Portfolio) and Howard Stevenson. I’m always thrilled to bump into gems like this. Below are my notes from the letter.
On unusual times in the investment world – interesting to note that the U.S. market has had a positive return the last nine years and also 11 of the last 12. How history rhymes!
“These are unusual times in the investment world. Assuming reinvestment of dividends, the stock market has now had a positive return the last eight years in a row and in eleven of the last twelve. From the market low reached in July 1982 until today, the Dow Jones Industrial Average has provided an annualized return of over 23%. This compares to roughly a 9% annual return from stocks during the past fifty years. Many investors have lately come to expect 15%, 20% or even 30% a year on their money. Investors in LBO funds eagerly anticipate annualized returns of 50% or more. It is as if all financial laws have been repealed, and investment returns are now correlated only to how much one aspires to make. Realistically, this level of return for the market as a whole is unsustainable for any significant period of time. Financial markets decline as well as rise, and the return from securities over the long run has to be closely tied to business results.”
On relative performance and what to do during uncomfortable times:
“We have always cautioned against a relative performance orientation, and while it is at times uncomfortable to stand apart from the crowd, we would rather be uncomfortable than poorer. Increasingly, our portfolio is oriented away from market-sensitive securities in favor of event-sensitive securities with catalysts in place to realize value. More of our portfolio is in fixed income securities than ever before; we are delighted to have senior credit status, a high current income and a fixed-maturity while earning rates of return more typically earned on equity investments. We have frequently pointed out the difficulty of evaluating investment performance. In particular, while it is easy to compare returns, it is difficult to assess risk. After investments are made… return is known, but no more is known about risk than before."
“Most of our major positions have catalysts that will help in the realization of underlying value regardless of the direction of financial markets and regardless of macro-economic conditions. Of course, any investment is subject to price fluctuations related to market movements.”
On position establishment and averaging down:
"As always when we are accumulating securities, we take a partial position with the hope of averaging down in price. We do not want to take a full position too early, only to watch the price drop further when we have no additional buying power. Financially, we are better off having the opportunity to buy at lower prices, as they offer both lower risk and higher return.
There are times when the financial markets provide great investment opportunities and other times when the pickings are slim. Unfortunately, neither of those times are identifiable ahead of time. It is crucial to fight the tendency many investors have of letting stock prices guide their investment emotions. When prices are rising, most investors are prone to making optimistic assumptions; when the market drops, then tend to become more negative. We try to keep a level head regardless of the direction of the market, and do not let stock price fluctuations guide our emotions. We believe the only sensible strategy is to ignore the market as a whole and seek individual opportunities that represent good value with low risk."
On relative investment value:
"While we are not interested in relative investment performance, we are extremely interested in relative investment value. We always want to own the best values, the most undervalued securities. If that means that we have to sell something we bought a month ago to buy something better, we will. If that means taking a loss on something we expect will recover in order to buy something even cheaper, we will. Buying the best relative value accomplishes two things. It ensures that you will earn the highest possible return over time by continuously purchasing the best bargains. More importantly, this maximizes one’s margin of safety, thereby minimizing risk for the portfolio. We experienced this process in actions taken during January. As the stock market fell and the distressed bond market plunged, the composition of our portfolio changed dramatically. We reassessed the relative attractiveness of a number of positions, selling some and buying several new ones."