Seth Klarman is a legendary investor. The Baupost Group, led by Klarman, has a reputation as one of the top-performing hedge funds in the world. In 2012, Bloomberg ranked it as the fourth best hedge fund in terms of net gains since inception (Baupost was established in 1982). Baupost is also reported to have earned an annual return of around 19% since inception as of 2010.
I recently got my hands on Baupost’s shareholder letters from 1995 to 2001 that are written by the low-profile Klarman. In it are insightful quotes that I think are worth sharing.
On the relationships between the past and the future
“Any contrarian knows that just as a grim present is usually a precursor to a better future, a rosy present may be a precursor to a bleaker tomorrow. Without me listing all the things that could go wrong, simply consider that none of these virtuous factors are cast in stone. Just as seeds are sown during the seven lean years that allow the seven fat years to ensue, so does the reverse hold true.”
In his 1995 letter, Seth Klarman rightly pointed out that the past is the past. A couple of good years in the past does not always indicate good years in the future and vice versa. We are now living at a time when these words ring louder than ever.
As investors, we should be aware that things can change rapidly when we least expect it.
Predicting the Dotcom bubble
“Even the slightest association with the Internet is cause for an upward thrust in a company’s share price. This is reminiscent of so many similar episodes over the last few decades, where everything from technology stocks to gambling shares to gold mines had their moment in the sun. We know the current mania will end badly; we do not know when.”
In a letter to shareholders in June 1996, Seth Klarman warned of the bubble emerging in internet stocks. Looking back, it seems obvious to us that Internet stocks were vastly overpriced and the bubble would soon burst. But hindsight is 20-20 and Klarman was one of the few investors who could see it at that time.
We all know by now what happened. In 1999, the dotcom bubble finally burst with the tech-heavy Nasdaq Composite Index subsequently falling by 78% from its peak.
On being adaptable
“Investors who find an overly narrow niche to inhabit prosper for a time but then usually stagnate. Those who move on when the world changes at least have the chance to adapt successfully.”
The investing environment has changed significantly over the past three decades.
For instance, investing in loss-making companies used to be frowned upon. But today, some of the best-performing stocks have been loss-making for numerous year. Netflix and Amazon are two prime examples of stocks whose values have skyrocketed despite them incurring losses in the last few years (Netflix is still making losses). But both these companies are increasingly worth more because of their sizeable market opportunity and their ability to easily turn a profit after reaching enough scale.
Investors who are able to adapt and use different investment approaches can maximise the opportunities afforded to them in the market.
On investing
“We regard investing as an arrogant act; an investor who buys is effectively saying that he or she knows more than the seller and the same or more than other prospective buyers. We counter this necessary arrogance with an offsetting dose of humility, always asking for whether we have an apparent advantage over other market participants in any potential investment. If the answer is negative, we do not invest.”
In his shareholder letter in December 1996, Klarman describes how he and the fund makes investment decisions. I believe this is a great analogy and applies to all investors.
On how value investing works
“Value investors should buy assets at a discount, not because a business trading below its obvious liquidation value will actually be liquidated, but because if you have limited downside risk from your purchase price, you have what is effectively a free option on the recovery of that business and/or the restoration of that stock to investor favour.”
As a proponent of value investing, Seth Klarman describes brilliantly how value investing works. If investors are able to purchase a stock that is trading well below its liquidation value, the stock is unlikely to fall much further. The investor, hence, can get the upside potential without the downside risk.
On the challenges of investing in a bear market
“In investing, nothing is certain. The best investments we have ever made, that in retrospect seem like free money, seemed not at all that way when we made them. When the markets are dropping hard and investment you believe is attractive, even compelling, keeps falling in price, you aren’t human if you aren’t scared that you have made a gigantic mistake.”
In his 1997 shareholder letter, Seth Klarman remarked how challenging it is to buy stocks in a falling market.
I believe many investors may have felt the same way when many REITs in Singapore fell by more than 50% in March this year. Even if we knew that REITs looked like attractive bargains after the fall, how many of us managed to pull the trigger to buy them at those discounted prices? Today, REITs have climbed steadily and investors who bought in just a few weeks ago would be sitting on some meaty gains.
Final words
Seth Klarman’s words in his shareholder letters contain an arsenal of insights and advice. If you want to read more of his letters you can head here.
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