penned by Seth Klarman. We continue our wisdom / quotes from the Baupost 2005 letter.First of all, they posted a return of 11.22% for the year, with 3.32% of the gain coming from"non-performing debt." Further this position represented ~15% of the NAV at year end.When the odds are in your favor, you bet big. Most people in the distressed debt can guesswhat this position is...My personal guess is Enron. There was a video floating around on theinterweb, where Seth Klarman gave a speech to Columbia business school students, wherehe mentions Enron. From Gurufocus (via Alex Bossert's Value Investing Blog):
"Baupost invested in Enron’s senior debt and he said that would be an example of hisfavorite type of investment. The situation had a lot of complexity, hard to analyze, a lot of litigation, uncertainty and no one wanted to be associated with anything Enron creating ahuge mispricing. Baupost bought the debt for 10-15 cents on the dollar. It comes down toassessing assets minus liabilities. After a few years most of Enron’s assets were cash $16-18billion but the liabilities were extremely complicated, with over 1,000 subsidiaries. Baupost had one analyst focus solely on Enron for over 4 years and try to figure out its liabilities and how much they would get back on the bonds. Baupost believed that the people liquidatingEnron were low balling what they would get back on the bonds. The people liquidating Enronwere very pessimistic and they originally estimated that the bonds would get back 17 centson the dollar at the same time the debt traded for 14-15 cents, Baupost estimated that thedebt would recover 30-40 cents and as of now they believe it will be more then 50 cents."
My old fund had a large position in Enron, in which I was the analyst, and the time framepretty much matches with the movements of the bonds. We owned the Class 4's with S (if you do not know what that means, don't worry about it). I do not know the exact vehicleBaupost would of invested, but it looked like they made a nice chunk of change (as manydistressed funds did).Back to the Baupost letter now.
"For most investments, much can go wrong, including numerous factors beyond aninvestor's control: the economy, the markets, interest rates, the dollar, war, politics, tax rates, new technology, labor problems, competition, litigation, natural disasters, fraud,dilution, accounting gimmicks, and corporate mismanagement. Some but not all of theserisks can be hedged, often only imprecisely and always at some cost. Other factors areunder an investor's control, but are not always controlled: discipline; consistency; remainingwithin your circle of competence; matched duration of client capital with underlyinginvestments; prudent diversification; reacting rationally to news or market developments;and of course, not overpaying"
One of the characteristics that has impressed from reading Klarman is how consistent heseems. He does not seem to waver from his strategy. I know he has used options and verytight CDS (specifically sovereigns) to hedge his portfolio. Those factors where hecommented that are under our control...well we should spend 90% of our time thinkingabout them and not worrying if the market will finish higher a month from now. For our nextquote, Klarman discusses Baupost's investment returns:
"Is or past success the result of skill or luck? Is it replicable, or merely a lengthy run of good fortune? We are confident that our success has not been the result of a favorable spin of aroulette wheel or a timely roll of the dice. It has been truncated, not heightened, risk. Our gains over the years have been earned, banked, redeployed into the next advantageousinvestment, and thereby compounded, again and again. With sound investment principles, acommitted and dedicated investment organization, a healthy and vigilant awareness of what can go wrong, and a strong sell discipline, investing is more akin to a high-yielding, periodically volatile, and non-guaranteed bank account than a game of chance. Can gains