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05-05-2013, 10:51 AM
Note: Seth Klarman is an american billionaire who founded the Baupost Group, a Boston-based private investment partnership. In 1991, Klarman authored Margin of Safety, Risk Averse Investing Strategies for the Thoughtful Investor, which since has become a value investing classic. Now out of print, Margin of Safety has sold on Amazon for $1,200 and eBay for $2,000.
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At the CFA Institute 2010 Annual Conference in Boston (held 16–19 May), Jason Zweig sat down with legendary investor Seth Klarman to gain insights into Mr. Klarman’s successful approach to investing.
Zweig: The first question I would like to ask you, Seth, concerns your work at Baupost. How have you followed Graham and Dodd, and how have you deviated from Graham and Dodd?
Klarman: In the spirit of Graham and Dodd, our firm began with an orientation toward value investing. When I think of Graham and Dodd, however, it’s not just in terms of investing but also in terms of thinking about investing. In my mind, their work helps create a template for how to approach markets, how to think about volatility in markets as being in your favor rather than as a problem, and how to think about bargains and where they come from. It is easy to be persuaded that buying bargains is better than buying overpriced instruments.
The work of Graham and Dodd has really helped us think about the sourcing of opportunity as a major part of what we do—identifying where we are likely to find bargains. Time is scarce. We can’t look at everything.
Where we may have deviated a bit from Graham and Dodd is, first of all, investing in the instruments that didn’t exist when Graham and Dodd were publishing their work. Today, some of the biggest bargains are in the hairiest, strangest situations, such as financial distress and litigation, and so we drive our approach that way, into areas that Graham and Dodd probably couldn’t have imagined.
The world is different now than it was in the era of Graham and Dodd. In their time, business was probably less competitive. Consultants and “experts” weren’t driving all businesses to focus on their business models and to maximize performance. The business climate is more volatile now. The chance that you buy very cheap and that it will revert to the mean, as Graham and Dodd might have expected, is probably lower today than in the past.
Also, the financial books of a company may not be as reliable as they once were. Don’t trust the numbers. Always look behind them. Graham and Dodd provide a template for investing, but not exactly a detailed road map.
Zweig: Seth, you started your career at Mutual Shares, working for Max Heine and alongside Mike Price. Can you give us a couple of lessons you learned from those gentlemen?
Klarman: What I learned from Mike—and I worked most closely with him—was the importance of an endless drive to get information and seek value. I remember a specific instance when he found a mining stock that was inexpensive. He literally drew a detailed map—like an organization chart—of interlocking ownership and affiliates, many of which were also publicly traded. So, identifying one stock led him to a dozen other potential investments. To tirelessly pull threads is the lesson that I learned from Mike Price.
With Max Heine, I learned a bit of a different lesson. Max was a great analyst and a brilliant investor—and he was a very kind man. I was most taken with how he treated people. Whether you were the youngest analyst at the firm, as I was, or the receptionist or the head of settlements, he always had a smile and a kind word. He treated people as though they were really important, because to him they were.
Zweig: One of the striking lessons that came out of the global financial crisis of 2008 and 2009 is the way traditional value investors got slaughtered. What went wrong, and why did so many smart people get caught by surprise?
Klarman: Historically, there have been many periods in which value investing has underperformed. Value investing works over a long
period of time, outperforming the market by 1 or 2 percent a year, on average—a slender margin in a year, but not slender over the course of time, given the power of compounding. Therefore, it is not surprising that value could underperform in 2008 and 2009.
I would make two points. First, pre-2008, nearly all stocks had come to be valued, in a sense, on an invisible template of an LBO model. LBOs were so easy to do. Stocks were never allowed to get really cheap, because people would bid them up, thinking they could always sell them for 20 percent higher. It was, of course, not realistic that every business would find itself in an LBO situation, but nobody really thought much about that.
Certainly, many of the companies had some element of value to them, such as consumer brands or stable businesses, attributes that value investors might be attracted to. But when the model blew up and LBOs couldn’t be effected, the invisible template no longer made sense and stocks fell to their own level.
Second, because of the way the world had changed, it was no longer sufficient to assume that a bank’s return on book value would always be 12 or 15 percent a year. The reality was that instruments that were rated triple-A weren’t all the same. Watching home-building stocks may not have been the best clue to what was going on in the mortgage and housing markets.
Equity-minded investors probably needed to be more agile in 2007 and 2008 than they had ever needed to be before. An investor needed to put the pieces together, to recognize that a deteriorating subprime market could lead to problems in the rest of the housing market and, in turn, could blow up many financial institutions. If an investor was unable to anticipate that chain of events, then bank stocks looked cheap and got cheaper and earnings power was moot once the capital base was destroyed. That’s really what primarily drove the disaster.
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Read the complete interview on
Seth-Klarman-CFA-Conference-2010.pdf (Size: 421.75 KB / Downloads: 73)
. It is a bit long but there are many parts that worth reading
--------------------------------
At the CFA Institute 2010 Annual Conference in Boston (held 16–19 May), Jason Zweig sat down with legendary investor Seth Klarman to gain insights into Mr. Klarman’s successful approach to investing.
Zweig: The first question I would like to ask you, Seth, concerns your work at Baupost. How have you followed Graham and Dodd, and how have you deviated from Graham and Dodd?
Klarman: In the spirit of Graham and Dodd, our firm began with an orientation toward value investing. When I think of Graham and Dodd, however, it’s not just in terms of investing but also in terms of thinking about investing. In my mind, their work helps create a template for how to approach markets, how to think about volatility in markets as being in your favor rather than as a problem, and how to think about bargains and where they come from. It is easy to be persuaded that buying bargains is better than buying overpriced instruments.
The work of Graham and Dodd has really helped us think about the sourcing of opportunity as a major part of what we do—identifying where we are likely to find bargains. Time is scarce. We can’t look at everything.
Where we may have deviated a bit from Graham and Dodd is, first of all, investing in the instruments that didn’t exist when Graham and Dodd were publishing their work. Today, some of the biggest bargains are in the hairiest, strangest situations, such as financial distress and litigation, and so we drive our approach that way, into areas that Graham and Dodd probably couldn’t have imagined.
The world is different now than it was in the era of Graham and Dodd. In their time, business was probably less competitive. Consultants and “experts” weren’t driving all businesses to focus on their business models and to maximize performance. The business climate is more volatile now. The chance that you buy very cheap and that it will revert to the mean, as Graham and Dodd might have expected, is probably lower today than in the past.
Also, the financial books of a company may not be as reliable as they once were. Don’t trust the numbers. Always look behind them. Graham and Dodd provide a template for investing, but not exactly a detailed road map.
Zweig: Seth, you started your career at Mutual Shares, working for Max Heine and alongside Mike Price. Can you give us a couple of lessons you learned from those gentlemen?
Klarman: What I learned from Mike—and I worked most closely with him—was the importance of an endless drive to get information and seek value. I remember a specific instance when he found a mining stock that was inexpensive. He literally drew a detailed map—like an organization chart—of interlocking ownership and affiliates, many of which were also publicly traded. So, identifying one stock led him to a dozen other potential investments. To tirelessly pull threads is the lesson that I learned from Mike Price.
With Max Heine, I learned a bit of a different lesson. Max was a great analyst and a brilliant investor—and he was a very kind man. I was most taken with how he treated people. Whether you were the youngest analyst at the firm, as I was, or the receptionist or the head of settlements, he always had a smile and a kind word. He treated people as though they were really important, because to him they were.
Zweig: One of the striking lessons that came out of the global financial crisis of 2008 and 2009 is the way traditional value investors got slaughtered. What went wrong, and why did so many smart people get caught by surprise?
Klarman: Historically, there have been many periods in which value investing has underperformed. Value investing works over a long
period of time, outperforming the market by 1 or 2 percent a year, on average—a slender margin in a year, but not slender over the course of time, given the power of compounding. Therefore, it is not surprising that value could underperform in 2008 and 2009.
I would make two points. First, pre-2008, nearly all stocks had come to be valued, in a sense, on an invisible template of an LBO model. LBOs were so easy to do. Stocks were never allowed to get really cheap, because people would bid them up, thinking they could always sell them for 20 percent higher. It was, of course, not realistic that every business would find itself in an LBO situation, but nobody really thought much about that.
Certainly, many of the companies had some element of value to them, such as consumer brands or stable businesses, attributes that value investors might be attracted to. But when the model blew up and LBOs couldn’t be effected, the invisible template no longer made sense and stocks fell to their own level.
Second, because of the way the world had changed, it was no longer sufficient to assume that a bank’s return on book value would always be 12 or 15 percent a year. The reality was that instruments that were rated triple-A weren’t all the same. Watching home-building stocks may not have been the best clue to what was going on in the mortgage and housing markets.
Equity-minded investors probably needed to be more agile in 2007 and 2008 than they had ever needed to be before. An investor needed to put the pieces together, to recognize that a deteriorating subprime market could lead to problems in the rest of the housing market and, in turn, could blow up many financial institutions. If an investor was unable to anticipate that chain of events, then bank stocks looked cheap and got cheaper and earnings power was moot once the capital base was destroyed. That’s really what primarily drove the disaster.
------------------------------------
Read the complete interview on
Seth-Klarman-CFA-Conference-2010.pdf (Size: 421.75 KB / Downloads: 73)
. It is a bit long but there are many parts that worth reading
