If you're a serious value investor, you're probably very familiar with the name Seth Klarman. But in case you haven't run across his name, let's briefly take a look at why it's worth tuning in and listening closely to what he has to say.
U.S. based Klarman runs the Baupost Group, a private investment partnership that ranks among the largest hedge funds in the world.
He's an uncompromising value investor who will often keep huge chunks of his fund in cash until he finds compelling-enough opportunities; it's a strategy that has helped him produce an average annual return of 19% over the two-plus decades that he's captained Baupost.
Klarman is also the author of one of the most sought-after books on value investing: Margin of Safety.
Thanks to hedge-fund-tracking blog market folly, I was able to sift through some of Klarman's investing letters, including his most recent, to find some great — and, in most cases, timeless — investing wisdom. Eat your heart out Warren Buffett!
Timeless investing wisdom
1. Of course, any contrarian knows that just as a grim present is usually precursor to a better future, a rosy present may be precursor to a bleaker tomorrow.
This sentiment has been expressed in a lot of different ways, but, if you ask me, it's impossible to hear it enough. At the heights of the dot-com and U.S. housing bubbles, few thought that anything could go wrong.
In the wreckage of those bubbles, few thought that anything could go right. When was the best time to buy? That's a gimme.
The same often holds true for individual shares. At the height of bubbles, investors are sometimes willing to pay triple-digit price-to-earnings multiples for some companies.
But things can and will change. The company that was trading at 100 times earnings a decade ago might be trading at just 10 times forward earnings today. Which will likely prove the better buy point?
2. Today, virtually everyone "knows" that over the long run, shares will outperform other investment alternatives.
This comes from a Baupost letter from 1995. Since then, it seems the drumbeat for relying on shares has only grown.
Sure, it has been shaken a bit by the recent financial crisis, but I don't think I'm going out on much of a limb to say that many investors still have a faith in shares as an investment, although not quite to the religious level of faith property bulls seem to practice.
It is, of course, rubbish. Shares and property can be great investments, but price matters. There's no magic here.
Buy shares at attractive prices and you'll be happy with the results, but pay too much and you'll likely be disappointed. As ever, it's important to seek out individual bargains.
3. We firmly believe that one of Baupost's biggest risks, and, needless to say, that of other investors, is that we will buy too soon on the way down. Sometimes cheap shares become a whole lot cheaper…
This is something that always has to be on value investors' radars since the market often doesn't pay much mind to what a share is actually worth and overshoots to either the upside or the downside.
During the financial crisis, I bought more than a few shares prior to their ultimate bottom, and I'm sure that plenty of other investors could tell similar stories.
The trick, of course, is to stay focused on your fundamental analysis and valuation work rather than the wacky swings of the market and, if anything, use further downdrafts as an opportunity to add to the position at a better price.
4. … you must consider the competitive landscape and the behaviour of other market participants. As in (American) football, you are well-advised to take advantage of what your opponents give you: if they are defending the run, passing is probably your best option, even if you have a star running back.
For Sun Tzu fans, The Art of War is replete with similar thoughts. For instance, "He who knows when he can fight and when he cannot will be victorious."
5. Bottom-up value investors would not wish to bet the ranch on a macroeconomic view, but neither would they be wise to ignore the macroeconomy altogether. Disaster hedging — always an important tool for investors — takes on heightened significance in today's unprecedentedly challenging environment.
This certainly is a tough pill for many bottom-up investors to swallow, but when it comes from Seth Klarman it'd be silly to dismiss it out-of-hand.
Klarman has been known to use gold as a disaster hedge, and cash can also be another potential disaster defence.
This article, written by Matt Koppenheffer, was originally published on Fool.com. Bruce Jackson has updated it.