If you consider yourself a value investor, and, like much of the value investing community, devour every word written by and about value investing and investors, you probably already know about Seth Klarman. Klarman is a hedge fund manager whose investing style has been compared by many to a young Warren Buffett. Like Buffett and other value investors, Klarman tries to focus on investing in companies that are trading significantly below what he views as the companies’ fair value. Unlike Buffett, who focuses mostly on large cap stocks (companies with a market cap of more than $10 billion), Klarman tends to focus more on small caps (companies with a market cap of less than about $2 billion). Large caps tend to be followed by lots of analysts, and are less likely to be mispriced (or as mispriced) as smaller cap stocks that have a lesser following.
Like Buffett, Klarman will also make large bets on a particular stock if he’s firm in his convictions. He trusts himself. Klarman is also well known for keeping large amounts of cash on hand in good times. This theoretically lowers returns a bit during a bull market, but also lowers risk. Klarman has been known to say that there is too much focus on returns – without any regard for the risks that were taken to create those returns. I’d have to agree. If you’re investing in risky investments and putting large amounts of money at risk, and some of those investments pan out, you could look very good on paper – but you also put your money at risk. Klarman will keep half his money in cash and still outperform the overall market with his portfolio as a whole. This is a testament to how talented he really is.
Klarman also wrote a famous book called Margin of Safety, which has become something of a collector’s item in investing circles. It sells for hundreds of dollars. I have a copy in ebook form that was sent to me awhile back. I haven’t read it yet. I’ve been told that it’s an excellent book on value investing, but that it’s unnecessary at that price. I would suggest getting it at the library, if you can, but most libraries don’t have the book either. A book you might consider that focuses on special situation investing as well is You Can Be a Stock Market Genius by Joel Greenblatt. Klarman also contributed a chapter to the new edition of Benjamin Graham’s investment classic Security Analysis. Anyone that considers themselves a value investor should check this book out.
Anyway, I was combing through some of the material at the excellent blog, Old School Value, and I came across an article filled with excerpts from Klarman’s Baupost Group annual letter. Here are a couple things that caught my eye:
“Robert Rubin once observed that some people are more sure of everything than he is of anything. One can see the investment universe as full of certainties, or one can see it as replete with probabilities. Those who reflect and hesitate make far less in a bull market, but those who never question themselves get obliterated when the bear market comes. In investing, certainty can be a serious problem, because it causes one not to reassess flawed conclusions.”
“One must also balance one’s own perception of the truth with one’s best assessment of what others believe. In investing, other people’s perception of reality influences price more than any underlying truth; your own assessment, even if correct, if valueless if it is already reflected in the market price.”
Klarman is also known for believing that once you identify a security that you believe is undervalued, you also need to look for a catalyst that will unlock that value and bring the price into line with your view of its true value. He’s a wise man, indeed. Keep this advice in mind if you’re trying to pick your own. Thanks for reading.
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Thanks for the link and the mention. Really appreciate it. Will be back to read some more of your good stuff.
I was not familiar with Klarman, but his philosophy sounds interesting and in sync with my own and I’ll be sure to check him out.