Seth Klarman, Baupost – CFA Annual Conference Notes (5/18/2010)

Tuesday, May 25th, 2010

This article is a guest contribution by Cameron Wright.

I have found other peoples notes from events such as the Berkshire Hathaway Annual Meeting and the Value Investing Congress very useful and wanted to share something of my own. I took these notes by hand and tried transcribing my scribbles. I do not believe I have made any mistakes, but if I did, I apologize in advance.

Cameron Wright

Cameron@wrightmgt.com

Seth Klarman Discussion with Jason Zweig of The Wall St. Journal At the CFA Institute Annual Conference, 5/18/2010

JZ: How have you followed Graham and Dodd, and how have you deviated?

SK: Graham and Dodd is really a way to think about investing, think about bargains and where they come from. Our search process is definitely based on G&D. We deviate by investing in instruments that didn’t exist then, and the business is more competitive than it was then. Also, what is on the books is not as reliable, we don’t trust the numbers, we look behind them.

JZ: What lessons did you learn from Mutual Shares working with Mike Price and Max Heine?

SK: From Mike Price, endless desire to get into and seek out value. Mike once found a mining stock he thought was undervalued and drew up a map of interlocking ownership structures and found about 10 securities he could buy that owned part of this company. From Max Heine: While he was a great analyst, he was a better man. He was very kind to everyone, from the receptionist on up, I learned how to treat people well.

JZ: What went wrong in 2008, and how did so many Value Investors get hammered? SK: Value investing doesn’t work all the time, you need to expect periods of underperformance. In the Pre 08 period, the world was valued on an invisible LBO Model. Stocks were not allowed to get cheap because of an underlying expected LBO bid. But when the model got fragmented, the template no longer made sense. So in order to do well, equity minded investors needed to be more agile in 07/08 and have an opinion on subprime mortgages and the ripple effect. Bank stocks looked cheap unless you thought their capital would be destroyed. Also the modern day pressure to be fully invested and on short term performance didn’t help.

JZ: In Michael Lewis’s book The Big Short, Mike Burry finds himself in the situation in 2007 of defending himself to his investors at the precise moment that he’s doubting himself. How is Baupost organized to avoid this?

SK: Having great clients is the key to investment success. We have emphasized very sophisticated families and Institutions as our clients, who had the ability to see through the financial crisis as opposed to many individuals who felt as if they were staring into the abyss.

JZ: Any advice on how to raise the quality of your clients?

SK: Avoid Fund of Funds since you don’t see the actual client, they are at the mercy of their clients and don’t have staying power. Our ideal client has two characteristics: 1.) If we feel we have had a good year, they agree, regardless of relative performance and 2.) when we call, asking them to consider adding new capital, they a.) appreciate the call and b.) add new capital. It’s not only actual withdrawals that matter but the fear of redemptions as well.

JZ: Baupost is organized for the long term, but can be opportunistic in the short term, such as in 2008 when Mortgage Backed Securities went from 0% to 30% of the fund…

SK: And got as high as 50% in early 2009. I have incredible partners, with common investment approaches. We have a non conventional approach to organizing our analysts. We don’t have Pharma or Oil/Gas analysts, but they’re organized by opportunity: Spinoffs, Bankruptcy, Legal, etc. They don’t waste their time keeping up on latest quarterly earnings from companies we will never invest in, but spend their time looking for irrational sellers.

JZ: In 1932, Benjamin Graham wrote in Forbes, “Those with the enterprise lack the money and those with the money lack the enterprise to buy stocks when they are cheap.” How did you have the courage, was it easy to step up and buy in the fall of 2008?

SK: “Yes, it was easy.” The critical thing to understand is that securities are not pieces of paper that fluctuate in price tick by tick like Cramer says on TV, instead they are in fact claims on earnings or assets of businesses. If you are afraid a security will go lower then you worry about what clients, or partners, will think. If you have conviction in your analysis, you will hold and buy more. So what do we do to give us conviction? 1.) Find compelling bargains, not slight bargains. 2.) Test everything with sensitivity analyses. 3.) Prepare to be wrong. It’s not courage, it’s Arrogance, when you buy something, you’re saying you’re smarter than everyone else. We realize we have lots of smart competition and temper our arrogance with humility to realize that many things could go wrong. Our own confidence matters, and we’re highly disciplined buyers and sellers to avoid round trips and take advantage of short term sell offs.

Tags: Baupost, Berkshire Hathaway, Berkshire Hathaway Annual Meeting, Better Man, Cfa Institute, Cfa Notes, Commodities, Congress Notes, Dodd, Endless Desire, Gold, Jason Zweig, Jz, Lbo Model, Max Heine, Mike Price, Minded Investors, Model Stocks, Mutual Shares, Ownership Structures, Receptionist, Search Process, Seth Klarman, Value Investors
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