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$30 Billion Value Investor Seth Klarman (STRATEGY & PORTFOLIO) - YouTube
Channel: The Swedish Investor
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We have all heard about
the âOracle from Omahaâ,
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but what about the âOracle from Bostonâ?
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According to famed professor Bruce
Greenwald at Columbia Business School,
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Warren Buffett once said that
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he would only invest with
three outside managers
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if he ever decided to retire and
stop managing money
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on behalf of Berkshire Hathaway.
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One of them was Seth Klarman
from the Baupost Group.
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In this video, you will learn the key
components of Seth Klarman's investing,
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which has allowed him to turn $30Â million
from 1983 into $30 billion today.
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You will also learn what his current portfolio
looks like, and about his biggest holding.
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Hereâs a hint:
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Itâs an online marketplace.
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This is the Swedish Investor,
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bringing you the best tips and tools
for reaching financial freedom,
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through stock market investing!
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The âOracle from Bostonâ, president
of The Baupost Group,
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is pretty much unknown for most people
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but Klarman's overall track record
speaks for itself.
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He's become a billionaire through
investing in a Warren Buffett-way,
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and his firm, the Baupost Group
has grown to manage
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more than $30 billion in assets after
starting with less than $30 million.
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The 63-year-old investor,
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with a reported net worth
of 1.5 billion dollars,
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and an alumni of Harvard Business School,
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also has a stake in the Boston Red Sox
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and owns various racing horses!
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After graduating, Klarman worked for
Mutual Shares Corporation,
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which was run by value
investing guru, Max Heine.
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Later in his career,
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Klarman was recruited by
Adjunct Professor Bill Poorvu
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to help him manage a pool of
capital just south of $30 million.
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The company was named Baupost.
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As you know now,
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this turned out to be the ride of a lifetime.
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Headquartered away from the
noise of Wall Street, in Boston,
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his firm has averaged an annual return
of nearly 20% since launching in 1983,
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despite holding a large
portion of its assets in cash.
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So how do we put that
track-record in perspective?
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Well, the rule of 72 says that 20% means that assets double every 3,6 years.
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(72/20)
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And since that is 37 years ago,
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that means about 10 doublings (37/3,6).
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10 000 dollars invested in 1983Â would
become around 8.5 million dollars today.
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That`s what compounding looks like,
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and more importantly,
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that is the importance of not losing money,
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the mantra of Warren Buffett.
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You may see glimpses sometimes of Seth
Klarmanâs sought after letters to investors,
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but if they ever appear online,
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Klarman and his lawyers at Baupost have
them taken down in a matter of minutes.
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The only public material out there
is a book he wrote in 1991, called
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"Margin of Safety: Risk-averse Value Investing Strategies for the Thoughtful Investor,"
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which is out-of-print
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and reads more like an academic text
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than a New York Times bestseller.
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It has been circulated online
in pdf form for some time
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and has also been reported to sell for
thousands of dollars on various platforms.
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There are essentially 5 underlying pillars
to Klarman`s investment approach:
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1. The margin of safety
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The title for his now out-of-print book
was not chosen randomly.
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It also happens to be the
mantra of Warren Buffett,
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his would-be client if he ever retired from
managing money on behalf of Berkshire.
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Warren Buffett said,
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âThe three most important words in
investing are margin of safety.â
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That means to buy stuff on sale.
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That means paying less than
what itâs worth.
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That means buying 10 dollar
bills for 5 dollars.
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Thatâs the whole secret
to great investing.
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Buffett, as we all know,
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found his mentor in Benjamin
Graham and in his book,
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The intelligent investor.
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In chapter 20 âMargin of Safetyâ
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Graham wrote:
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âThe function of the margin
of safety is, in essence,
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that of rendering unnecessary
an accurate estimate of the future.
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If the margin is a large one,
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then it is enough to assume that
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future earnings will not fall far below
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those of the past
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for an investor to feel sufficiently
protected against the vicissitudes of time.â
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Buffett once used an analogy including
a bridge to describe what he means:
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âIf you understood a business perfectly
and the future of the business,
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you would need very little in
the way of a margin of safety.
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So, the more vulnerable the business is,
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assuming you still want to invest in it,
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the larger margin of safety youâd need.â
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âIf youâre driving a truck across a bridge
that says it holds 10,000 pounds
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and youâve got a 9,800-pound vehicle,
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if the bridge is 6 inches above
the crevice it covers,
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you may feel okay;
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but if itâs over the Grand Canyon,
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you may feel you want a little
larger margin of safetyâŠâ
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Klarman defined it as:
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âA margin of safety is achieved
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when securities are purchased
at prices sufficiently
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below underlying value
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to allow for human error,
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bad luck, or extreme volatility
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in a complex, unpredictable
and rapidly changing world.â
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He goes on telling that it
can also be achieved by:
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â⊠always buying at a significant
discount to underlying business value,
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and giving preference to tangible
assets over intangibles.â
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Moreover:
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âSince investors cannot predict
when values will rise or fall,
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valuation should always be
performed conservatively,
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giving considerable weight to worst-case
liquidation value as well as to other methods.â
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2. Flexibility
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What makes Klarman special is that he has
essentially applied value investing principles
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across the entire capital structure
of both public and private businesses.
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He once said that
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âIt doesnât matter if an investment is a public or
private, fractional or full ownership, or in debt,
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preferred shares, or common equity.â
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In other words, favor substance over form.
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The mantra of Baupost and Klarman
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has always been to go
where there is inefficiency
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and where there is less competition.
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That`s why Baupost spends most of
its time in complex securities
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which doesnât receive much attention
from other market participants.
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In a lecture held at Columbia
Business School in 2006
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he summarized their approach by saying:
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âif you had to use one
word for our approach,
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it would be either mispricingss
or perhaps overreactions.
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Situations when the market
gets something wrong.â
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It`s fair to say that Baupost prefers
MESSY/ICKY situations
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which are too complex for most
people to get involved in,
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and thus leads to favorable prices
and a margin of safety.
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Here is an example from
the financial crises:
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Klarman once said that
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âWhatever investment success we achieve
will take place against a troubled backdropâ.
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This was clearly shown during
the financial crises back in 2008-2009
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when Klarman and his team deployed
around 10% of their portfolio
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into auto finance companies like
Ford Motor, Chrysler Finance, and GMAC.
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They invested around $1.8 billion
and made around $1.2 billion in profits.
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Ford Motor credit bonds were bought
at 40 cents on the dollar
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when, in a depression, they estimated
getting 60 cents on the dollar.
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Here is that margin of safety again.
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Klarman and his team at
Baupost modeled that
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they would make money even
if their worst-case assumptions happened.
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They were able to make
this investment because
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a) they were ready with cash
when other people HAD to sell
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b) they were the first people to receive a call
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when Goldman Sachs had
clients needing to sell in a hurry,
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and c) they were able to assess the odds
of not losing money in a relatively short time.
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3. Long-term orientation
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A key pillar of Bauposts strategy
is a long-term orientation.
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All else equal, if you own a stock of a company
producing high returns on capital
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which is also able to reinvest
that capital at high returns,
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you want to own that company
for as long as possible.
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Let`s say a business generates free cash
flow of 1 million dollars every year,
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to keep it simple.
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It`s return on capital is 20%
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and the business has the opportunity to
reinvest annualy at the same rate of return.
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After 10 years, the combined cash
generation and reinvestment
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amounts to over a six-fold
increase in free cash flow.
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Being able to structure one's
investment approach
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in a way to fully reap the rewards
just described, is incredibly important.
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However, many funds have
constraints in some shape or form.
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This also holds true
when it comes to clients.
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There are many investment managers out
there who own businesses for the long-term,
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but unfortunately have clients
with a short-term horizon.
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This mismatch creates subpar performance.
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Bauposts clients are mainly comprised
of endowments and foundations
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which are long-term entities in nature.
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After generating world-class returns
to their investors for long periods,
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they get goodwill from clients
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but, more importantly,
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Baupost can choose which
investors they let in the door!
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This can be a key competitive advantage
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and partly explains why Baupost
has been able to produce
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fantastic returns for their clients
for such a long period.
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4. Focus on business risk
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Risk, according to Klarman, is not
measured as âBetaâ
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like many people in academia and
Wall Street wants you to believe.
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Risk according to Klarman,
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is described by both the probability and
the potential amount of loss.
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This mindset is the same applied
in assessing credit risk
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and how a bank man would calculate
expected loss on a given exposure.
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It`s common to overemphasize on
the probability of loss
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but the amount you lose is also important.
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Thatâs why a credit mindset
applied to investing
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is much better than thinking
in terms of Beta and volatility.
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This also goes back to how
a value investor looks at a stock.
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As a value investor, you are buying
a piece of a business
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and you are trying to pay a price
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which is less than the sum of
the cash flow the business produces,
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adjusted for alternatives.
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If the volatility of returns of the stock
relative to the market increases,
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the beta increases,
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and hence the riskiness, also increases.
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But does this mean that the risk for
you as a shareholder has increased?
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According to Klarman`s way of thinking,
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increased volatility creates more opportunities
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for a long-term investor whose focus is
on the fundamentals of the business.
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Did the cash flow and value
of the business change
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and are the price changes
justified as a result?
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As we know, this may not
always be the case.
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It`s all a matter of looking
at the business for yourself.
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5. Absolute orientation
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Most mutual funds are primarily focused
on accumulating assets under management.
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The reason for this is that investment
funds earn management fees
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as a percentage of the assets they manage.
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The bigger the pie, the larger the fees!
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Most funds also charge additional fees
based on the performance of the fund
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relative to a benchmark.
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Underperforming your benchmark
means clients leaving out the door.
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Clients leaving means fewer
assets and hence fewer fees.
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This is the reason why many
funds chase relative performance,
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and investment managers are
afraid of investing in anything
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that might have a different return
than their benchmark indices,
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even in a single quarter!
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Trick question:
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How can âactiveâ managers overperform for
their clients, meaning after fees,
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if they invest very similar to an index?
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Less tricky answer:
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They canât.
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Baupost takes the opposite approach.
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Klarman and his team only
focus on absolute returns,
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which means that they
don`t care if they might be
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underperforming a benchmark
in the short term.
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What`s important for Klarman
is that they can make good investments,
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even if the big payoff may lie
many years into the future.
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Again, this approach is only possible
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because clients trust Baupost
to do a good job,
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it`s all about the track record!
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Seth Klarman and his team at Baupost are always extremely secretive
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when it comes to what
they are buying and selling
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but they are required by law
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to report quarterly to the Securities
and Exchange commission
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what they own in the USÂ in
terms of public equities.
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This means that few people know
what their actual portfolio looks like
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when it comes to debt instruments,
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real estate, and all other non-US
or nonpublic holdings.
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What we do know is that disclosed
equity holdings in listed companies
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were around 8 billion
dollars as of June 2020,
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which is the latest reporting
date to the SEC.
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Having assets under management
of around 30 billion dollars
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results in a portfolio of 27% listed equity
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if we only account for
the US public holdings.
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The top equity positions as
of June 2020 were
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eBay, Liberty Global, Fox, and Viasat.
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An interesting pattern looking
at the US listed holdings,
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is the notable exposure within
telecommunication
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and media including Liberty Global (controlled by John Malone, the legendary
outsider investor),
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Fox, Viasat and Viacom.
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Benjamin Graham was the inventor
of the margin of safety concept,
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and as such,
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he has had a major influence
on Seth Klarman's investment style.
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If you want to hear more about
this mentor of Klarman,
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who is often referred to as
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âThe Father of Value Investingâ,
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head over to my summary
of his magnum opus
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âSecurity Analysisâ.
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Incidentally, Seth Klarman wrote the
foreword to the 6th edition of this book,
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so I think it is fair to say that
it gets his recommendation.
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Cheers guys!
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