I love studying successful investors, especially fellow value investors. My academic and early investing years were spent studying Warren Buffett and Michael Price. Now I am intrigued by current managers and how they fared during the financial crisis. I covered Joel Greenblatt in a previous blog - his "magic formula" is simple to understand and would have pleased Benjamin Graham. I love it so much that ValueMyStock created our own daily report of stocks that pass his test.
Many investors have heard of Joel Greenblatt, mostly from his popular "The Little Book That Beats the Market" book. Fewer have heard of Seth Klarman, whose own book "Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor" is now out-of-print.
A graduate of Cornell University and Harvard Business School, Mr. Klarman got his chops in the real world working for Max Heine and Michael Price of the famed value investing fund Mutual Shares. His investment philosophy is preservation of capital, not stellar returns. He keeps a low profile and prefers the laid-back attitude of Boston to the financial chaos of New York City.
His Own Fund
In 1982 he founded Baupost, which started as an investment pot for a family of one of his former Harvard professors. In fact, "Baupost" is an acronym for these families' surnames. He was granted control over $27 million and has experienced phenomenal growth. For a man whose goal is preservation of capital, he now oversees $25 billion in assets, despite the fact that Baupost was closed to new investors years ago. Baupost is now the eleventh-largest hedge fund in the world, and Klarman is the fourth most successful fund manager in history, with net gains of $23 billion from inception through 2011. How did he fare during the financial crisis? Well, since 2007, the fund's assets have tripled. With returns like these, it is no wonder that his clients include the endowments of Yale, Harvard and Stanford.
Mr. Klarman does not have a publicly-known formula or list, such as Joel Greenblatt, but his extremely risk-averse style is worth studying. Mr. Klarman is a strict adherent to Benjamin Graham's style of value investing. He will look beyond equities and purchase distressed debt positions (as will Michael Price), but every investment must pass his "margin of safety." Margin of safety is used to describe the distance between what a stock is currently selling for and its calculated price, or intrinsic value. His aversion to risk is legendary - he maintains a huge cash position (at times up to 50% of his portfolio) rather than always chasing the next buying opportunity. He makes sure the price he will pay for a company is at its absolute best before pulling trigger.
His slow-and-steady, fly-under-the-radar style is in direct opposition to many of today's hedge fund managers, and it mates perfectly with the principles of value investing. The virtues of value investing (and any successful strategy, in my opinion) are research, patience and diligence. Every investor can learn from studying Mr. Klarman's style, and should be emboldened by his aversion to risk. I encourage readers to draw the following conclusions from his investment strategy:
1. The principles of Benjamin Graham are relevant today, just as they were 70 years ago. Adopting a Graham-style approach will bring investors closer to the performance of Warren Buffett, Seth Klarman and Joel Greenblatt.
2. Do not be afraid to sit on cash. Investment opportunities exist every day, but great opportunities come around less often. Keep enough cash to take advantage of a great opportunity rather than being locked up in average performers. A 30% return over the course of a year is not as good as an 80% return over the course of two years. How much cash do you maintain? Do you have the patience to sit on small or zero returns for several months?
3. Drawing attention to yourself and your trades creates expectations. Expectations lead to stress and short-term decisions, which can lead to failure. Mr. Klarman does not measure himself against other managers or indices. His investors trust his long-term outlook and do not hold him accountable to short-term benchmarks.
4. Accept the fact that sometimes there is a lack of buying opportunities. Do not buy for buying's sake. In 2010 Baupost returned 5% of capital to investors - Mr. Klarman did not find enough opportunities in the market.