Seth Klarman's guide to finding value
Georgina Russell, WG'07
Issue date: 12/5/05 Section: News
If Benjamin Graham were alive today, he might, at first blush, be more impressed by the appreciated value of Seth Klarman's book Margin of Safety, than with the performance of his investment fund … that's at first blush. Seth Klarman is a value investor and Portfolio Manager of the investment partnership The Baupost Group, and when Klarman first published Margin of Safety it had an original cover price of $25. The book is now out of print, and today sells on eBay for $1,145. That's an increase of 4580%. But you can't deploy billions of dollars of capital on the purchase of a single book, so Klarman has done it in the stock market through The Baupost Group. Founded in 1982, The Baupost Group now manages $5.4 billion, and had you put $1 in the fund at inception, you would have $55 today. That's a whopping increase of 5500% … alas, first blushes are just that.
Klarman, accompanied by his colleague, Scott Nathan, visited Wharton on Monday as part of the Investment Management Club's Speaker Series. Klarman is a graduate of Cornell and Harvard Business School. Nathan also hails from HBS, but with a degree from HLS and Harvard undergrad, he is perhaps more affectionately termed, a triple H'er. Klarman gave us the good and the bad on value investing, and left the ugly entirely for another investment strategy, growth investing.
That was then, this is now. From Ben to Seth.
Benjamin Graham articulated his value investment strategy over fifty years ago in what has become a veritable value investor's bible. Though it's clearly not the most expensive one on the subject, Graham's book, The Intelligent Investor, has sold over one million copies.
Graham recommended that investors looking to beat the market consider investments in unpopular stocks or companies involved in special situations. In the Graham school, value investors are the guys defending the underdog, making over the ugly ducklings, and lifting up fallen angels. All this goes on while the rest of his investing classmates behave with herd mentality and with drama queen hyperbole tagging as "outcasts" those who have made a minor misstep, and extolling otherwise mundane players as "golden boys" for reasons difficult to understand. As Graham puts it, "the market is fond of making mountains out of molehills and exaggerating ordinary vicissitudes into major setbacks." Consider, that with large companies, we see extreme overvaluation when things are good, and dire forecasts resulting from temporary setbacks.
Though Benjamin Graham passed away in 1976, we are fortunate today to have Seth Klarman as one of the world's most recognized value investors.
It works! (if you can make it work)
Klarman tells us that although much has changed since Graham's time, the good news is that the value investing discipline has remained, and indeed, "it does work." However good that news may seem, "discipline" and "work" are perhaps the key words here. Klarman emphasizes that value investing is as much an art as it is a science, and reiterates what Graham identified last century - psychology is every bit as important in investing as economics is.
On the one hand, psychology and the irrationality it creates, is what makes value investing possible. As Klarman puts it, "The Baupost Group seeks situations triggered by urgent, panicked, or mindless selling." Yet on the other hand, one's own psychology is what can make or break one as an investor. Klarman highlights two requirements for successful investors that wisely articulate this point: one, "the intelligence and honesty to admit one's mistakes," and two, "the confidence to hold cash until bargains exist." In fact, all of this might lead one to ask if perhaps we should call it Existentialist Investing.
Klarman's Caveats
For those of you thinking, "I can do this. I'm at Wharton. I'm a leader. I don't watch the market, I make the market. I was able to get this self control thing down after my first MBA-unlimited-free-alcohol-with-foozball-and-pizza pub experience and I even have Professor Allen's notes," you should probably hear Klarman's bad news.
If you've already realized that value investors aren't the cool kids, but the kids who are just too cool to be cool, then what follows may seem obvious. In the realm of value investing, being popular isn't such a good thing (unless of course you're the author of a book on the subject, but we've already discussed that).
Just let Seth tell you: Klarman warns that value investing popularity has hit a new high over the last few years. When you couple that with an overwhelming influx of capital into the hands of newly minted fund managers, he says, what you get is investment opportunities in short supply - no fun when you've got $5.4 billion to deploy.
Furthermore, Klarman has identified a new class of investor he has termed value pretenders (and you wondered why his book is so expensive!). "These investors apply a dip strategy. They buy what's down, not what's cheap."
But despite the bad news a crowded market brings, Klarman rises above it all and shows us he is a value investor to his core. He doesn't get caught up in Mr. Market's exuberance, but looks beyond it to the upcoming opportunities this frenzy brings. The value pretender, he says, "is setting us up for an avalanche of opportunity." And yes, the man puts his money where his mouth is. The Baupost Group holds over 40% of its fund in cash.
Last Laugh
While the present market climate may be relatively boring for value investors, fortunately Klarman leaves us with the growth investor's sideshow as interim entertainment. When pressed by an audience member on the subject of the growth investor's ability to succeed "from time to time," Klarman's in your face confidence remains un-rattled, "I think growth investing is a stupid style. Bet on the two horse at Philadelphia Park and you'll do well from time to time."
Klarman, accompanied by his colleague, Scott Nathan, visited Wharton on Monday as part of the Investment Management Club's Speaker Series. Klarman is a graduate of Cornell and Harvard Business School. Nathan also hails from HBS, but with a degree from HLS and Harvard undergrad, he is perhaps more affectionately termed, a triple H'er. Klarman gave us the good and the bad on value investing, and left the ugly entirely for another investment strategy, growth investing.
That was then, this is now. From Ben to Seth.
Benjamin Graham articulated his value investment strategy over fifty years ago in what has become a veritable value investor's bible. Though it's clearly not the most expensive one on the subject, Graham's book, The Intelligent Investor, has sold over one million copies.
Graham recommended that investors looking to beat the market consider investments in unpopular stocks or companies involved in special situations. In the Graham school, value investors are the guys defending the underdog, making over the ugly ducklings, and lifting up fallen angels. All this goes on while the rest of his investing classmates behave with herd mentality and with drama queen hyperbole tagging as "outcasts" those who have made a minor misstep, and extolling otherwise mundane players as "golden boys" for reasons difficult to understand. As Graham puts it, "the market is fond of making mountains out of molehills and exaggerating ordinary vicissitudes into major setbacks." Consider, that with large companies, we see extreme overvaluation when things are good, and dire forecasts resulting from temporary setbacks.
Though Benjamin Graham passed away in 1976, we are fortunate today to have Seth Klarman as one of the world's most recognized value investors.
It works! (if you can make it work)
Klarman tells us that although much has changed since Graham's time, the good news is that the value investing discipline has remained, and indeed, "it does work." However good that news may seem, "discipline" and "work" are perhaps the key words here. Klarman emphasizes that value investing is as much an art as it is a science, and reiterates what Graham identified last century - psychology is every bit as important in investing as economics is.
On the one hand, psychology and the irrationality it creates, is what makes value investing possible. As Klarman puts it, "The Baupost Group seeks situations triggered by urgent, panicked, or mindless selling." Yet on the other hand, one's own psychology is what can make or break one as an investor. Klarman highlights two requirements for successful investors that wisely articulate this point: one, "the intelligence and honesty to admit one's mistakes," and two, "the confidence to hold cash until bargains exist." In fact, all of this might lead one to ask if perhaps we should call it Existentialist Investing.
Klarman's Caveats
For those of you thinking, "I can do this. I'm at Wharton. I'm a leader. I don't watch the market, I make the market. I was able to get this self control thing down after my first MBA-unlimited-free-alcohol-with-foozball-and-pizza pub experience and I even have Professor Allen's notes," you should probably hear Klarman's bad news.
If you've already realized that value investors aren't the cool kids, but the kids who are just too cool to be cool, then what follows may seem obvious. In the realm of value investing, being popular isn't such a good thing (unless of course you're the author of a book on the subject, but we've already discussed that).
Just let Seth tell you: Klarman warns that value investing popularity has hit a new high over the last few years. When you couple that with an overwhelming influx of capital into the hands of newly minted fund managers, he says, what you get is investment opportunities in short supply - no fun when you've got $5.4 billion to deploy.
Furthermore, Klarman has identified a new class of investor he has termed value pretenders (and you wondered why his book is so expensive!). "These investors apply a dip strategy. They buy what's down, not what's cheap."
But despite the bad news a crowded market brings, Klarman rises above it all and shows us he is a value investor to his core. He doesn't get caught up in Mr. Market's exuberance, but looks beyond it to the upcoming opportunities this frenzy brings. The value pretender, he says, "is setting us up for an avalanche of opportunity." And yes, the man puts his money where his mouth is. The Baupost Group holds over 40% of its fund in cash.
Last Laugh
While the present market climate may be relatively boring for value investors, fortunately Klarman leaves us with the growth investor's sideshow as interim entertainment. When pressed by an audience member on the subject of the growth investor's ability to succeed "from time to time," Klarman's in your face confidence remains un-rattled, "I think growth investing is a stupid style. Bet on the two horse at Philadelphia Park and you'll do well from time to time."