Seth Klarman Is Worth Listening To

I had no idea who Seth Klarman was until I read this article in today’s Wall Street Journal. I don’t closely follow the world of investors, except from a human interest perspective (what are these guys’ philosophies, what makes them tick). I must say that this guy is good, really good. As a fan of Black Swan theorist Nassim Taleb, I would admit it’s hard to tell if he’s lucky or good, but …

Sometimes I feel a bit lonely among the large crowd of economists and investment advisors who are diametrically opposed to me as an Austrian School student of economics. I think and analyze and read about this stuff constantly and when I find someone who agrees with my conclusions or at least the main concepts I have about the economy and economics, I feel something between vindication and pride.

Read this article and let me know what you think. I know many of my readers are far more sophisticated at investing than I am. But, after reading about Mr. Klarman and his commentary about the present situation, I think I would like to get to know him.

Seth Klarman is worth listening to, especially when markets go mad.

Mr. Klarman is president of the Baupost Group, an investment firm in Boston that manages $22 billion. His three private partnerships have returned an annual average of around 19% since inception in 1983—and nearly 17% annually over the past decade, as stocks went nowhere.

To measure Mr. Klarman’s importance as an investor, you need only see the value his rivals place upon his words. You could have earned at least a 20% average annual return since 1991—better than twice the performance of the market—merely by buying and holding Mr. Klarman’s book, “Margin of Safety”: Published that year at a cover price of $25, hard copies now fetch up to $2,400.

But the professorial Mr. Klarman speaks in public about as often as the Himalayan yeti. He made an exception last Tuesday, when I interviewed him in front of a standing-room-only crowd of 1,600 financial analysts at the CFA Institute annual meeting in Boston. He then made another exception, speaking with me over the phone later to clarify points that he feared had been misconstrued.

Mr. Klarman specializes in buying securities that nauseate other investors. As the credit crisis exploded, he put more than a third of his assets into high-yield bonds and mortgage-related securities. I asked him what he had meant, in a recent letter to his clients, when he compared the financial markets to a Hostess Twinkie. “There is no nutritional value,” he said. “There is nothing natural in the markets. Everything is being manipulated by the government.” He added, “I’m skeptical that the European bailout will work.”

Some members of the audience gasped audibly when Mr. Klarman said, “The government is now in the business of giving bad advice.” Later, he got more specific: “By holding interest rates at zero, the government is basically tricking the population into going long on just about every kind of security except cash, at the price of almost certainly not getting an adequate return for the risks they are running. People can’t stand earning 0% on their money, so the government is forcing everyone in the investing public to speculate.”

“We didn’t get the value out of this crisis that we should have,” Mr. Klarman told the audience. “For our parents or grandparents, it was awful to have had a Great Depression. But it was in some ways helpful to carry a Depression mentality throughout their later lives, because it meant they were thrifty with their money and prudent in their investment decisions.” He added: “All we got out of this crisis was a Really Bad Couple of Weeks mentality.”

You could have heard a pin drop as Mr. Klarman proclaimed, “I am more worried about the world, more broadly, than I ever have been in my career.” That’s because you can make good investing decisions and still end up with bad results if you reap your profits in currencies that do not hold their purchasing power, he explained.

“Will money be worth anything,” asked Mr. Klarman, “if governments keep intervening anytime there’s a crisis to prop things up?”

To protect against that “tail risk,” said Mr. Klarman, Baupost is buying “way out-of-the-money puts on bonds”—options that have no value unless Treasury bonds plummet. “It’s cheap disaster insurance for five years out,” he said.

Later, I asked Mr. Klarman what he would suggest for smaller investors who share his worries.

“All the obvious hedges”—commodities and foreign currencies, for example—”are already extremely expensive,” he warned.

Especially gold. “Near its all-time high, it’s a very hard moment to recommend gold,” said Mr. Klarman.

Mr. Klarman pointed out that his own ideas “on bottom-up opportunities in undervalued securities are more likely to be accurate than my top-down views on what’s going to happen in the world at large.” In other words, while you might want to insure against a disaster scenario, you shouldn’t bet the ranch on it.

And, said Mr. Klarman, one of the best ways to protect against a decline in purchasing power is to buy whatever is “out of favor, loathed and despised.” So forget about gold or other trendy hedges. Instead, wait patiently for markets—European stocks, perhaps—to get so cheap that they turn most investors’ stomachs. Then you can pounce.

As Mr. Klarman put it, “Sometimes, when you can’t figure out a good defense, the best thing to do is to go on offense.”

The reporter’s notes of his interview (Jason Zweig) have been posted on the Web as well.


8 comments to Seth Klarman Is Worth Listening To

  • Peridotic

    I am not surprised not many people know him. But he is very popular in the Value Investing community. Not well known among the mainstream. Since Buffett and others overshadows him. Plus he has written a book that is out of print and it is worth upwards to a $1,000. To read it you have to pirate it and I don’t think he cares though. Funny thing, I don’t think he ever foresee piracy of the book when he decided to let it be out of print.

    Yes he doesn’t talk very often. So it is interesting to hear him say this but I think he is using this option he is buying as insurance if a black swan occurs, but he is still waiting for the market to drop.

  • Marco

    Total stud. His book, margin of safety, is a bible for most institutional value investors. He doesn’t speak much but what he does say is eloquent in it’s simplicity as compared to some hedge fund managers who believe they may be a little more important than the rest of us. His driving ideology, the absolute preservation of capital, should be what every investor (professional or amateur) should aspire to.

  • Peridotic

    Concurrently agree Marco, Jeff, I was wondering what are your thoughts about Klarmans economic outlook? Maybe do a separate post on that. Keep up with the good work.

    • I don’t give investment advice, but in general I agree with his view of the economy. I am reserving my views on gold for the time being. I like the contrarian view, since I see myself as being a contrarian.

  • Carl

    I know him. Seth’s returns are not luck.

    He and his team work hard and are extremely patient. It is not unusual for Seth’s fund to be sitting on large piles of cash. His investors have learned to trust him and not scold him when he is waiting things out. Seth is a sponge when you talk to him. You can always tell that his mind is two steps ahead of whatever you are discussing at the time.

  • [...] suggest you listen to Seth Klarman, or David Stockman for a starter. And read the article I just posted by Doug French on contrarian [...]

  • brucewat2

    excellent article, thanks for posting. I saw this piece also on Klarman, and it also discusses another billionaire investor’s view on things, particularly gold: