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Stepan Lavrouk
Stepan Lavrouk
Articles (373) 

Seth Klarman: Venture Into Complexity

Sometimes the biggest value is found in the thorniest areas

October 10, 2019

Although he has an undeniably excellent record as a value investor, Seth Klarman (Trades, Portfolio) chooses to largely stay out of the limelight. Unlike some other investors who frequently give interviews and speak at conferences, Klarman has made relatively few such appearances. However, there are some highly illuminating pieces that outline his investing philosophy. An article from Superinvestor Digest explains why Klarman prefers to look for value in complex securities.

Go for difficult

Klarman believes that complexity is "fertile ground" for research, due to the fact  the majority of market participants are likely to be scared off by it.

“If the security is hard to understand and time consuming, many of the analysts and institutions will shy away from it.”

According to this logic, investors will be better off looking for value in more complex sectors (for instance, in the biotechnology sector) due to the fact these stocks are mostly likely going to be underfollowed. Indeed, when it comes to biotech, even the large institutions often choose to sit it out due to the difficult nature of the subject matter. Klarman’s contention is that this creates an opportunity for investors who have the knowledge and experience to figure out the sector.

There are a number of parallels that can be drawn between Klarman’s advice and that of other big names. Peter Lynch, himself a prolific value investor, strongly believes that average people should exploit the "edge that they already possess" by investing in industries where they have expert knowledge. So, for instance, a car mechanic should leverage their expertise by investing in the automobile industry, and a doctor should invest in pharmaceuticals. If your domain happens to be a particularly complex one, you may have even more opportunities to find value in stocks that aren’t understood by the majority.

Klarman’s prescription does seem to fly in the face of Warren Buffett (Trades, Portfolio)’s famous advice to only invest in businesses that are simple and easy to understand. But, in fact, there is no conflict here. Klarman’s advice is not to seek out difficult companies simply for the fact that they are opaque. Rather, it is to look for situations that are misunderstood by everyone but yourself. In other words, to invest in companies that lie within your own "circle of competence" - a classic Buffettism. Klarman’s only addition is that your circle of competence must not include too many other people.

Such events are rare because markets tend to be efficient more often than not. But occasionally, you will stumble across a scenario where everyone seems to be scratching their heads while it is blindingly obvious to you. And when you do, it pays to recall one more Buffettism - when you have the perfect pitch, swing for the fences.

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About the author:

Stepan Lavrouk
Stepan Lavrouk is a financial writer with a background in equity research and macro trading. Specific investing interests include energy, fundamental geoeconomic analysis and biotechnology. He holds a bachelor of science degree from Trinity College Dublin.

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