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Rupert Hargreaves
Rupert Hargreaves
Articles (924)  | Author's Website |

Seth Klarman Advice on Keeping the Faith in Euphoric Markets

Some solace from Baupost's investment manager

August 09, 2019 | About:

It is straightforward to generate a strong investment return in bull markets. All you need to do is buy a low-cost index tracker fund, sit back and let the tracker do its work.

But in periods of market turbulence, achieving a positive or market-beating performance becomes much harder. It is in these periods of volatility that we find out who has been swimming naked.

Investors who bought tracker funds without really knowing what they were doing, hoping for free money and effortless returns, might have a shock as their portfolio declines with the market. Investors who bought stocks on impulse without doing their due diligence may also suffer, as well as story stock investors who bought into stories without considering companies' underlying fundamentals.

You could argue that the best way to avoid these issues is to jump out of the market just before the downturn arrives. Unfortunately, this isn't possible (unless of course, you have a crystal ball). As a result, the only way to make sure your portfolio is not impacted by market volatility is to prepare for the worst from the very beginning.

Concentrate on the downside

This is the route Seth Klarman (Trades, Portfolio) has decided to take. During the past three decades, Klarman has steered his hedge fund, the Boston-based Baupost Group, through some of the most volatile markets in history. From the dot-com boom and bust to the Financial Crisis, Baupost has successfully navigated these stormy seas, and it usually came out on top.

We can learn a lot from Klarman's actions not just during these periods of market turbulence, but before and after as well. For example, his letters to investors In the late 1990s warned about the frothy state of the market and explained what Baupost was doing at the time to protect itself from the growing risks.

In a letter to investors in 1995, the value manager wrote:

"Anecdotally, too, this market is greatly overextended. People with no previous investment experience are starting hedge funds. Everyone seems to know someone who owns stock in a company that has just come public, not to mention the certifiable mania among the general public to own mutual funds and Internet stocks. Just a few days ago, the last remaining bearish Wall Street market strategist turned bullish, arguing that the 'valuation paradigm' had changed."

He went on to say "Today, virtually everyone 'knows' that over the long-run, stocks will outperform other investment alternatives," but the proponents of this viewpoint were ignoring the cyclical lows the market made in 1974 and 1982. "Another dangerous notion," Klarman continued, "is that dips in the market always represent buying opportunities."

Baupost tries not to think like that. As the hedge fund's manager went on to say, "We firmly believe that one of Baupost's biggest risks, and, needless to say, that of other investors, is that we will buy too soon on the way down. Sometimes cheap stocks become a whole lot cheaper."

Keeping the faith

The biggest challenge rational investors face in periods of market exuberance is keeping the faith. It can be challenging to stick to your investment strategy underperforming the market. Baupost is a master at overcoming this challenge and keeping its discipline in euphoric environments. As Klarman summarized in his letter:

"We have said before and will repeat here that you do not really need Baupost to invest your money in bull markets. An index fund could likely perform better. The true investment challenge is to perform well in difficult times. It is unfortunately not possible to reliably predict when those times might be. The cost of performing well in bad times can be relative underperformance in good times. We have always judged that a worthwhile price to pay."

We may never be able to achieve the same status in the investment world as Seth Klarman (Trades, Portfolio), but we can learn a lot from the strategy he has used to build Baupost into the multi-billion dollar hedge fund giant it is today. Keeping your cool in overheated markets is just one of the strategies Klarman has used over the past three decades.

Disclosure: The author owns no share mentioned.

Read more here: 

Benjamin Graham's Investment Principles Are Still Relevant Today 

Dissecting Berkshire Hathaway's Insurance Results 

Berkshire's Buybacks Continue at a Snail's Pace

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About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

Visit Rupert Hargreaves's Website

Rating: 5.0/5 (5 votes)



Asawhneyy - 1 month ago    Report SPAM

Year 1995-2019=24 years?

Thomas Macpherson
Thomas Macpherson premium member - 1 month ago

Great stuff Rupert. As a professional investment manager myself, the last 5 - 6 years have been pretty lonely as a value investor. I eagerly read Seth's work on probably a daily basis and use it almost as a professional anti-anxiety drug. I've never lost faith in my investment process and have a reasonable long-term track record (though past performance is no assurance of future returns). I give a lot of credit to Seth for keeping me grounded. Thanks for posting. Best. - Tom

Rupert Hargreaves
Rupert Hargreaves - 1 month ago    Report SPAM

Hi Tom,

Thanks for the comment as always. You're not the only one who's been looking to Klarman for advice recently. I've been doing so as well. I think it's so valuable to go back and remind ourselves of his advice every so often to keep it fresh in our minds. Best, Rupert

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