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From: Sent: To: Subject: Joshua Tucker <firstname.lastname@example.org> 04 May 2013 18:20 Joshua.R.A.Tucker@gmail.com Distressed Debt Investing: Wisdom from Seth Klarman - Part 3
Distressed Debt Investing
If you remember, in the beginning of August, we grabbed some quotes from the Baupost letter from 2005. We continue with that same letter, as it provided a number of fantastic investing gems. "...Investors operate within what is for the most part a zerosum game. While it is true that the value of all companies usually increases over time with economic growth, market out performance by one investor is necessarily offset by another's under performance. Consequently, you keenly watch your competitors to see not only what they are doing right, but what they are doing wrong. You observe carefully to identify their investment constraints and limitations, their time horizon and liquidity requirements, areas that they ignore and areas that they avoid. It is in these areas that opportunity is often greatest; that is where bargains regularly surface, with your best competitors not only failing to compete but sometimes serving as the seller. It is here, where others panic, sell mindlessly, neglect, or fear to tread that investors have a chance to develop and sustain an edge." From a speech that Seth Klarman gave to a group of Professor Greenwald's Value Investing Class, we know that he has analysts that just focus on spin offs, changes in indexing, bankruptcy etc. These create vacuums where force sellers rule the day due to investment constraints. In the example of an index fund trade, imagine a somewhat illiquid stock dropping from an index. Index funds across the board need to sell the holding to maintain their index match which creates a situation of uneconomic selling which in turn may create a dispersion between price and intrinsic value. It is also rumored that Baupost's investments in MLPs in late 2008/early 2009 stemmed from the fact that Lehman
but I remember hearing a quote: "You deserve the capital you attract. but the idea was kibashed. an advantage of Baupost is how sticky the capital is as opposed to a number of other funds that have had to put the gates up. but by no means without risk. Further. is that this quote somewhat ties in with the previous two.brothers held 20% of the float of the companies and were forced sellers as their prop desk unwound. Many analysts reading the blog today will have experienced a situation where an investment looks particularly compelling. a strategy that might also be labeled "return control"." It is a sad. In a world where performance comparisons are made not only annually and quarterly but even monthly and daily. I do not know who said it. or sold early. or was painting the monthly numbers. In order to avoid a mismatch between the time horizon of the investments and that of the investors. Having a large diversified book helps when capital it quick to exit. it is more crucial that ever to take the long view. any capital is good to get the ball rolling. have different investment and liquidity time constraints. a massive position in two or three stocks when limited partners are redeeming can cause returns to become even worse as you put pressure on the stock. Ours do. We work exceptionally hard to ensure that our largest positions are indeed our most worthwhile opportunities on a risk-adjusted basis. for a small manager. because the portfolio manager had to raise cash. one's clients must share this orientation. "We are able and willing to concentrate our capital into our best ideas. other investors' idea of "risk control" is to own literally hundreds of small positions while making no size able bets. But 2 . specifically in the context of a hedge fund. to be able to concentrate our exposures. It is clearly an advantage. These days." What is interesting." Unfortunately. "The single greatest edge an investor can have is a long-term orientation. And that creates a mismatch which is one of the fundamental flaws of this business. Despite their obviously strong investment skills. The opportunistic investors should see this and buy the stock you are selling (uneconomically I might add) on the cheap. but true fact in the investment industry that limited partners and general partners.
This is where people discuss the Kelly Formula. but there will be times (like Enron for example) where a 10% position makes sense. the modified Kelly Formula. With massive trade imbalances and huge U. I think this makes sense.they will wait until you are fully out. but at the same time placing your bets in a way to maximize risk return. rising inflation. and many are leveraged. further depressing returns. government budget deficits. Sent from my iPad 3 . " Take about having a crystal ball. there appears to be little. Klarman wrote these words in early 2006: "The world could well be setting up for considerable upheaval and with it an avalanche of opportunity. a housing bubble that is starting to burst. margin of safety in the global financial system. Stay tuned for the next part of the Seth Klarman series where we dig into the 2006 Baupost annual letter. and record and unprecedented low quality junk bond issuance. if any. As we have said. Managing the book to allow for sufficient liquidity in case of redemptions. nearly ever investment professional is fully invested. Monish Pabrai moved his allocations to 10% per position to a smaller number.. As has been reported in many places. This is where portfolio management becomes so important.or better yet. tremendous leverage everywhere you look.S. still low interest rates. massive and unanalyzable exposures to untested products like credit derivatives. and inciting more limited partners to redeem. Now remember..