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Rupert Hargreaves
Rupert Hargreaves
Articles (926)  | Author's Website |

Seth Klarman on Admitting Your Mistakes

Investors make mistakes. It's how you react to them that is important

August 09, 2019 | About:

Admitting your mistakes, selling out and moving on is a critical part of becoming a successful investor. There's nothing shameful about making investment mistakes. Some of the best investors in the world have made plenty of errors that have cost them hundreds of millions or even billions of dollars.

Take Warren Buffett (Trades, Portfolio) for example. Buffett has admitted to making a handful of mistakes over his investment career. Mistakes such as Dexter Shoe and Tesco, which cost Berkshire Hathaway shareholders more than $1 billion in losses.

Then there is Bill Ackman (Trades, Portfolio). His mistimed trade with Valeant ultimately cost his investors $4 billion.

What separates these money managers from everyone else is that they admitted their mistakes, took the losses and moved on. They learned lessons and developed their strategies accordingly.

They did not try to take it out on the market or average down, which would ultimately have increased losses. Instead, they moved on and have since recovered the money lost. (The publicly traded vehicle of Bill Ackman (Trades, Portfolio)'s Pershing Square launched with a net asset value per share of $25 in October 2014. After reaching a low point in the mid-$15s, the NAV has since broken back above the IPO level. It only took five years, but Ackman is now back to square one after his massive loss.)

Admitting your mistakes

Seth Klarman (Trades, Portfolio) also admitted to making some serious mistakes in 2018. Writing in Baupost's annual letter to investors, the value manager said, "Needless to say, we also made mistakes in 2018." He went on to add:

"For example, our original thesis on Colony Capital, a three-way merger of real estate and investment firms, was just plain wrong, though that stock, which we continue to hold, at year-end traded at more than a 9% dividend yield and at a considerable discount to NAV. We purchased a few stocks, including Pacific Gas and Electric and Univar, right before those shares slumped badly, in the first case on tragic developments that led to financial distress and in the second on cyclical fears that we believe ignore business fundamentals. We remain holders of both."

There are two interesting takeaways from this paragraph. First, it is clear that Klarman is acknowledging his mistakes. Second, while he has acknowledged his mistakes, he remains convinced that these businesses remain attractive investments, otherwise he would have sold.

A process of continual due diligence

To make it into Baupost's portfolio, an asset first has to pass a rigorous due diligence process. Then, once the stock, bond or other asset has been acquired, Klarman's team continually evaluates the position and its value proposition. When the value proposition changes, the fund reconsiders its position.

This process of continued due diligence is designed to stop the fund from falling into any value traps. Looking at Bapost's track record of performance, it has certainly done that. However, Klarman and his team are also aware of the impact market sentiment might have on the share prices.

From his 2018 commentary, it seems that he's willing to give his investments the benefit of the doubt for a short period if they struggle due to market factors. He has undoubtedly already done the research and understands what is changing in these businesses and how it will impact the investment case. That's the big difference between blindly holding a losing investment and investing because you see the value.

The takeaway from Klarman's commentaryis that it is okay to be wrong, so long as you acknowledge your mistakes and understand where you went wrong. You can only do this if you have a deep understanding of the business in the first place. Investing is not a science, it is an art, and understanding your mistakes is a critical part of improving your craft.

Disclosure: The author owns shares in Berkshire Hathaway.

Read more here: 

Seth Klarman Advice on Keeping the Faith in Euphoric Markets 

Benjamin Graham's Investment Principles Are Still Relevant Today 

Dissecting Berkshire Hathaway's Insurance Results 

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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


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