Seth Klarman: Value Investing, Investment Strategies and Advice for Success

I just watched the first 37 minutes of the following video by Seth Klarman. In this post I will briefly mention what I learned from the video.

About Seth Klarman:

Seth Klarman is the Chief Investment Officer at the Baupost Group, a Boston-based hedge fund with about 30 Billion USD in AUM. Seth Klarman is also the author of "Margin of Safety", and a believer in Benjamin Graham's value investing methods. He also believes in the importance of a long-term orientation.

Learnings:

1. Focus on risk first, before returns

This boils down to the idea that if you "avoid the losers, the winners will take care of themselves".

2. Look for mispriced companies, and a catalyst to reduce the mispricing

You want to purchase companies below intrinsic value. If it is trading at a value which is 2/3 of the total value of assets, it is a bargain.

3. About Risk

Firstly, risk is a measure of the probability of losing money, and the amount of money that can be lost. If you assume the worst case scenario when you make an investment decision, and still think a company is undervalued, then this is a relatively low risk investment. 

Secondly, volatility is not risk. Although the two are often mixed up, it is important that you distinguish between the two. Risk, as is mentioned above, is the probability of losing a certain amount of money. By contrast, volatility is the amount of fluctuation in share prices on a daily, or even hourly basis.Volatility can become a risk if you are forced to sell at a low point. However, if you have the ability to take long-term bets, it is actually the source of opportunities; if a good company is volatile and hence trading below intrinsic value, it could be a good investment.

4. Relative and Absolute returns

Relative returns are when you measure returns relative to or in comparison to the average, or someone else. By contrast, Absolute returns measure the percentage appreciation (or depreciation) in the value of the assets held. Absolute returns are better than relative returns. 

This is because relative returns breed mediocrity.They follow the principle of wanting to make a little more-or lose a little less-than your competitors. However, this means you are invariably close to the index, and cannot outperform the index.

Instead, Absolute returns encourage you to measure how much money you have made or lost. This makes the loss more significant, and encourages risk-aversion. It is based upon the idea of trying to make a lot of money in bad times, and making a decent return in good times. This metric is better, because in the real world, what affects your purchasing power is how much money you have, as opposed to how much you have relative to another individual.

5. Bottom up and Top down analysis

Top down analysis involves making macro-economic forecasts, determining the impacts on industries, and then determining who will win in the given industry. Bottom up investing is better than top down investing. In top down investing you must make consistently accurate macroeconomic forecasts. This is difficult! No one really knows what's going to happen. Instead, in bottom up investing, you 'simply' determine what something is worth, and buy it for less! Remember, however, that bottom up still considers the top. It's just that the top is considered later and is thought to be less important.

6. Edge

As an investor you need to look for your edge. You must ask yourself, "what do you know or have (e.g.: a lens or perspective), that others don't?". A significant edge is a long-term orientation. This is because it leads you to make more rational, well thought-through, long-term oriented decisions, instead of focusing primarily on short term growth. For this an investment fund needs to have capital belonging to like-minded people who have a similarly long-term orientation. A second edge, if you are an investment fund manager, is an open mandate. This is because this means that there are fewer restrictions, and that you can capitalise on the more interesting bargains, regardless of the asset class.

7. Forced sellers

Buying from a forced seller, or a seller who knows less than you is very, very desirable. This is because a forced seller does not have the option to determine whether an investment is good or bad. Thus, when there a large number of forced sellers, you can capitalise on the ensuing drop in asset price. Similarly, a seller who knows less than you do, cannot take a correct long term decision. As these groups are desperate to sell, you can buy assets at bargain prices. Conversely, you would not want to buy shares from a seller knowing more than you, because you have probably overlooked some risk.