How Seth Klarman Looks For Bargains
By Rupert Hargreaves The following is a summary of Seth Klarman’s investing process as detailed in an interview with Barron’s on 4 November 1991 . Seth Klarman is always on the lookout for traditional value investments; he likes to buy a dollar for $.40, following in Benjamin Graham’s footsteps. This strategy is relatively straightforward, but it’s finding the ideas that’s the hard part. Click to enlarge Finding your own ideas is key Finding your own ideas when investing is integral to your own education. Anyone can follow the world’s most prominent investors into positions, but if you haven’t done the research yourself, it’s difficult to maintain conviction if the market moves against you. Moreover, if the position doesn’t work out, you can’t really learn from your mistakes if you didn’t have a set plan going in the trade. So, finding your own ideas and building an investment case around the information available to you is an extremely important part of the investment process. Klarman on searching for ideas How does Seth Klarman go about looking for ideas? Well, according to the Barron’s interview, around half of Klarman’s ideas have originated internally at Baupost. These ideas come from newspapers and magazines and there are several categories of ideas that Klarman looks for. The first is market inefficiency or imperfection to developments that are usually caused by institutional constraints. Many institutions have moved away from fundamental investing and this leads to opportunity. An example of this would be when a large company spins off a much smaller subsidiary and distributes the stock free to shareholders. The institutions tend to be natural sellers of the spinoffs. Seth says that whenever a spin-off is mentioned in the press or by one of his employees, it becomes an area of interest and something to research further. Another area where Baupost looks for ideas, or “rock to look under” as Klarman puts it, is when securities get downgraded from investment grade to below investment grade, i.e., distressed. Many investment funds aren’t allowed to hold non-investment-grade securities, so when the downgrade happens, they have to sell their position creating a short-term supply/demand imbalance. Once again, this is selling that’s not driven by fundamentals. Seth Klarman invests using a bottom-up approach, and while he does have a macro view, if the opportunities are there to be taken Baupost will invest, even if the economic environment is not perfect. And unlike many other firms, which rely on Wall Street forecasts to put together an economic outlook, Baupost builds its view of the economy by talking to other investors and company management teams – a simple approach but one that gives a more realistic view of the economy and its underlying trends. I am going to end this article with a short quote from the Barron’s interview as I think, even though it is around 25 years old, the quote is still highly relevant for today’s market: “I think the market is just as vulnerable to a sudden correction, and a very sharp sudden correction. For one thing, as I said, I think we have a market of fully invested bears. The institutional investors, being short-term and relative-performance oriented, are trying to all beat each other every three months, and hence will react to which ever direction the market is going in. As long as the market is generally flat to rising, they will stay in the market. But if they perceive that the market is going down — in other words, if the market starts to go down — they may all decide to get out at once, none of them wanting to be in longer than anybody else. We have put on a few circuit breakers, but they don’t address the fundamental problem of professional investors who feel compelled to stay in and hold overvalued securities.” – Source: Seth Klarman: 4 November 1991 Barron’s interview Disclosure: Rupert may hold positions in one or more of the companies mentioned in this article. You can find a full list of Rupert’s positions on his blog. This should not be interpreted as investment advice, or a recommendation to buy or sell securities. You should make your own decisions and seek independent professional advice before doing so. Past performance is not a guide to future performance.