To paraphrase an oldWall Street advertisement, when Seth
Klarman speaks, people listen. He tends to shy away from
mostinvestment conferences, but when he does hold court, it's
standing room only. And for good reason. His book, "Margin of
Safety : Risk-Averse ValueInvesting Strategies for the Thoughtful
Investor," is considered to be a classic of the modern era,
fetching more than $1,000 on Amazon.com, now that it is out of
And he backs up his words with numbers. Thehedge fund manager
has racked up 20% annualizedgains for nearly three decades.
Outside of the Oracle of Omaha,
, such sustained greatness is hard to find.
What is Klarman's secret? Identifying valueinvestments that
have a built in margin of safety. Hewill only make an investment
if he is extremely confident that the investment won't lose much
value, even if his initial investment thesis eventually proves to
be wrong. After all, not losingmoney is just as important as
Seth Klarman's Biography
Klarman launched his investment firm, Boston-based Baupost Group,
back in 1982 at the ripe old age of 25. By then, he had already
developed a strong track record under the tutelage ofmutual fund
legend Michael Price and started off with $27 million infunds to
invest. Klarman now manages more than $25 billion, making Baupost
one of the 10 largesthedge funds in the world, thanks to a
30-year track record that includes just two losing years.
Harvard, Yale and Stanford are all clients, and more are hopping
on board everyyear . The amount of money he's tasked with
managing has tripled since just 2007.
Klarman is the first to admit he's never going to have
phenomenal gains in any given year, as John Paulson did during
the U.S. housing crisis or George Soros did when the British
pound collapsed. He never swings for the fences with
high-riskstocks , nor does he useleverage to juice his returns.
Instead, his steady performance is the result of a succession of
small victories -- singles and walks, to extend the baseball
And he's perhaps the most patient hedge fund manager on the
planet. Most fund managers, even Warren Buffett, get itchy and
buy and sellshares (or whole companies) almost every quarter. In
contrast, Klarman is perfectly content to wait for the right
opportunities toopen up. That's why at any given time, as much as
30% to 50% of his portfolio may be parked incash . Think about
that. Thisfund manager racks up robust annual gains, even when a
decent chunk of his portfolio earns almost nothing. That means
his risk-adjusted returns are simply off the charts.
Unfortunately, most of us will never be lucky enough to be
Klarman's client. His Baupost Group only accepts funds from a
select group of university endowments, non-profit foundations and
highnet worth families. Yet we can take a look at his public
communications and learn to mimic his style.
||Klarman will only make an investment if he is extremely
confident that the investment won't lose much value, even
if his initial investment thesis eventually proves to be
Seth Klarman's Investment Strategy And Big Wins
Wall Street firms aren't on closeterms with Klarman. If they
areunderwriting a hot newstock in a covetedIPO , he will simply
say "no thanks." He understands that much of the action on Wall
Street simply exists to generate fees for the big firms.
Hisbuy-and-hold approach means that he won't churn up alot of
trading fees, as his rivals do.
Frankly, the currentbull market holds little appeal to an
investor like Klarman. He prefers chaos and distress, putting his
idle cash into play only when themarket , or an individual stock,
has fallen well below any perceivedintrinsic value . For example,
he generated decent, though unspectacular returns in the late
1990s, when many investors were making a killing in the dot-com
bubble. But when the bubble burst in 2001, Klarman went to
That year, for example, he made a $150 million investment in
bankrupt rental equipment firm NationsRent when itsbonds were
selling for pennies on the dollar. Five years later, he unloaded
his investment for a cool $1 billion. Fast-forward to 2008, and
Klarman racked up further huge gains by buying
distressedhigh-yield bonds .
Seth Klarman's Portfolio: What's He Holding Now?
Though Klarman's approach isn't best suited to the current bull
market, and he's holding a considerable amount of cash, he's
still able to pounce on major opportunities as they arise. For
example, after the massive oil spill in the Gulf Coast in 2010,
he began building a huge stake in beleaguered energy firm
In a similar vein, Klarman began a series of share purchases
of troubled insurance firm
American International Group (
. Notably, he waited until the fourth quarter of 2012 to start
buying, several years after the financial crisis had passed, just
to be sure that AIG was truly on the road to recovery. Still,
even with a late start, his investments in AIG have risen more
than 35% over the past fewquarters .
If history is any guide, Klarman will become a very active
buyer when the market hits a rough patch. Until then, he's likely
to proceed with caution, ensuring that his firm's portfolio racks
up another year in the win column as his existing holdings rise
in tandem with the market.
Action to Take -->
If you'd like to follow Klarman's approach, you'll need to keep
an eye out for large, established companies that have been beset
by short-term problems. In any given year, you'll find a few
dozen companies in the S&P 500 that have fallen far from
their52-week high , and often times, these companies are in need
of an operational overhaul. Klarman likes to assess the depth of
these company's woes, making sure that the problems are indeed
fixable. But as he found with BP and AIG, most investors simply
shun broken companies, even when a fix is in place. Indeed that
notion of "buying when a company is out of favor," is also the
secret of Warren Buffett, the late Sir John Templeton, and many
other top-performing managers.