Seth Klarman's Value Investing Lessons ~ market folly

Wednesday, June 15, 2016

Seth Klarman's Value Investing Lessons

Back in 2009, Baupost Group's Seth Klarman talked with the Ben Graham Center for Value Investing and the Richard Ivey School of Business.  In it, Klarman talks about his approach to investing and the timing of the talk (right after the financial crisis) leads to a few interesting tidbits.

Seth Klarman's Value Investing Lessons

Klarman says that, "All people are risk averse, it's a human tendency to be risk averse." He focuses on how the pain people feel from losing money is so much worse than the joy they receive from gaining money.

He gives the example of flipping a coin where heads you double your money, tails you lose everything you have.  Klarman argues almost everyone wouldn't take that trade for the fear of losing everything is so big.

Klarman then outlines Baupost's approach:

"What can go wrong?  How much can you lose?  We don't think of risk in an academic sense of beta, which doesn't make any sense to us at all.  Volatility's not risk, volatility is volatility.  Volatility creates opportunities and isn't necessarily risk at all, unless you absolutely needed to sell the day that prices are really low.  Rather, risk is the probability of losing and how much you can lose if you lose.  So we focus on risk before we focus on return."

He also notes that, "Long term orientation is critically important."

Klarman then goes on to focus on an aspect of the business that's not talked about as much but is just as important:

"Relationships are incredibly important.  In the buyside part of Wall Street, we work really hard to have the best brokers and be really good clients for them.  We don't want to be somebody's 50th biggest client.  Because we'll never get a phone call that says 'we've got a big block of this for sale, are you interested?'  But if we're somebody's first or second client, they're going to call."

On where Baupost looks for ideas:

"We think there are a lot of smart people out there.  We don't think we're the world's best analysts of businesses, we think we're good at that.  We think we're very good at complicated situations, the messier, the better.  We like situations with a catalyst where there's some reason that a pricing irregularity will correct.  But at a discount and something will cause it to correct.  That leads us into interesting places.  One of our favorite areas is distressed debt."


"Spinoffs are an interesting place to look because there's a natural constituency of sellers and there's not a natural constituency of buyers."

On the mental approach needed:

"This business is largely about psychology.  If you're down a huge amount, you're not thinking straight.  If the markets do something that completely surprises you, you can be a deer in the headlights.  It's a huge benefit to not have your own psychology get interrupted."

Lastly, Klarman had an excellent quote on trying to figure out who you'd be buying from and why they're selling:

"Inevitably, you want to buy from people that don't know what they're doing.  Warren Buffett has this saying that if you're playing poker and you look to your left and look to your right and you can't figure out who the patsy is, it's you.  Investing is the same way.  If you are buying something and there's a chance that the person knows more than you, there's a chance you're a sucker.  If you're buying and management is selling, you might want to think twice if you can figure that out.  If you're buying and Steve Mandel at Lone Pine Capital is selling, that's a really bad thing, because Steve Mandel does great analysis and probably knows more than you do."

Klarman is also the author of Margin of Safety, a hard to find book that's no longer in print.  It's revered by many value investors as a prime source of wisdom.

Embedded below is the video of Seth Klarman's talk:

For more from this respected investor, head to Seth Klarman's recommended reading list.

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