Seth Klarman of Baupost is a great investor. Jason Zweig is a great writer. When combined, we get a great Klarman-Zweig Interview published Fall 2010 in the Financial Analyst Journal (Volume 66 Number 5) by the CFA Institute. Here is Part 1 of tidbits from that conversation. Part 2 is available here.
Graham and Dodd’s works help Klarman “think about volatility in marks as being in your favor rather than as a problem.” Volatility is a good thing because it creates opportunities and bargains.
Intrinsic Value, Exposure
“A tremendous disservice is perpetrated by the idea that stocks are for the long run” because most people don’t have enough staying power or a long time horizon to actually implement this belief. “The prevailing view has been that the market will earn a high rate of return if the holding period is long enough, but entry point is what really matters.”
“If we buy a bond at 50 and think it’s worth par in three years but it goes to 90 the year we bought it, we will sell it because the upside/downside has totally changed. The remaining return is not attractive compared with the risk of continuing to hold.”
Baupost does not sell short because the “market is biased upward over time…the street is biased toward the bullish side.” But this also means that there are more “low-hanging fruit on the short side.”
“We do not borrow money. We don’t use margin.” However, it should be pointed out that Baupost has substantial private real estate investments, many of which would employ leverage or financing. Perhaps it’s the non-recourse nature of real estate financing that distinguishes whether Klarman is willing to employ leverage. In addition, Baupost does engage in derivative transactions (such as interest rate options) that are quasi forms of leverage (e.g., premiums in return for large notional exposure).
The “inability to hold cash and the pressure to be fully invested at all times meant that when the plug was pulled out of the tub, all boats dropped as the water rushed down the drain.”
“We are never fully invested if there is nothing great to do…we always have cash available to take advantage of bargains – we now have about 30 percent cash across our partnerships – and so if clients ever feel uncomfortable with our approach, they can just take their cash back.”
“…probably number one in my mind most of the time – how to think about firm size and assets under management. Throughout my entire career, I have always thought size was a negative. Large size means small ideas can’t move the needle as much…As we entered the chaotic period of 2008…for the first time in eight years, we went to our wait list...We got a lot of interesting phone calls from people who needed to move merchandise in a hurry – some of it highly illiquid…So, to have a greater amount of capital available proved to be a good move.”
“…I think returning cash is probably one of the keys to our future success in that it lets us calibrate our firm size so that we are managing the right amount of money, which isn’t necessarily the current amount of money.”
“Not only are actual redemptions a problem, but also the fear of redemptions, because the money manager’s behavior is the same in both situations.” In preparation for, or the mere threat of possible redemptions, may prompt a manager to start selling positions at exactly the wrong time in an effort to make the portfolio more liquid.
“Having great clients is the real key to investment success. It is probably more important than any other factor…We have emphasized establishing a client base of highly knowledgeable families and sophisticated institutions…”
Ideal clients have two characteristics:
- “…when we think we’ve had a good year, they will agree.”
- “…when we call to say there is an unprecedented opportunity set, we would like to know that they will at least consider adding capital rather than redeeming.”
“Having clients with that attitude allowed us to actively buy securities through the fall of 2008, when other money managers had redemptions and, in a sense, were forced not only to not buy but also to sell their favorite ideas when they knew they should be adding to them.”