A friend sent me a video of a speech given by Seth Klarman at the Columbia Business School.

Klarman’s hedge fund the Baupost Group has done over 20% a year since he founded the firm in 1983 with only one down year. Also, Seth Klarman’s book Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor is also one of the best books I’ve read on value investing. It’s currently out of print and selling for about $1,600 but I got a copy through my library’s intra library loan program. Of all the articles/speeches/interviews of value investment managers this is one of the best speeches I’ve ever watched. Klarman discusses how he made over 5 times his money investing in Enron debt, what his investment principles are, his thoughts on the investment manegment industry, why he doesn't go short and why he uses derivitives. This speech is not posted any where else on the internet. Here is my summary:

Thoughts on Investment Manegment Industry • The investment Manegment industry is not set up to achieve market beating returns. Instead they are incentivized to get big and act like asset gatherers. At the same time there is little incentive to take risk and deviate from the mean because if they strike out and underperform for even a short period clients will be lost quickly. It’s an enforced mediocrity (if you want to get big just do what everyone else is doing and settle for average results). Klarman said he would rather hold treasury bills then invest in many of the hedge funds out there. If stocks do 10% going forward and a hedge fund that charges 2 and 20 takes 3% of your money in fees you’ve only got 7% left, plus it’s leveraged, holds illiquid securities, etc. He would much rather get 4.5% risk free.

• • •

Tweedy Brown is today’s manifestation of Benjamin Graham Value investing is risk aversion Baupost charges a 1 percent management fee plus 20 percent of profits.

How Baupost Invests • • Rule #1: Don’t lose money. Rule #2: Never forgot Rule #1. Baupost always looks for catalysts in its investments. If you find a stock trading for 50% of what you think it’s worth you want there to be something that will trigger it to reach fair value. Baupost will always sell an investment as soon as it near their estimate of fair value. Baupost has analysts focused around the type of opportunity; Baupost has a spinoff

• Baupost does best when there is high uncertainty and little information. Baupost opened over 1. They hold credit default swaps on the government debt of countries they have investments in (S. if your short even though you may be right that it’s worth less then the trading price you can still go broke. spin off. all under the protection of bankruptcy court. small LBO’s. 7% private investments (distressed debt. U. manegment. 6% in South Korean equities and a small % in hedges. privatization of government business. deal with union problems or settle contingent liabilities. 11% real estate. thrift conversions or anything else that could cause mispricings. It’s way more risky and you can lose infinity. 98 or even 99 you would have been killed. 000 a year for $100 million in insurance). Baupost looks at every merger. dutch auction tender. rights offering.analyst. post bankruptcy analyst. LBO’s and Derivatives. financial restructurings). they talk to every one to get information including. shed extraneous business units or. Real estate (Baupost has done over 200 real estate deals including biding on RTC auctions). 20% equities. • Baupost invest in: Both public and private distressed debt.S. industry people. distressed debt analyst and an analyst looking at companies that are depressed because of a bad earnings announcement). When they research a company they do what ever they can to find information. index fund deletion analyst. major share repurchase. • • • • • • Baupost uses hedges to reduce risk. They also hold credit default swaps in a bunch of European countries not necessarily because they have holdings there but because it reduces risk and they were very cheap ($60. Then all the debt holders have equity and they will want to sell. The portfolio is 45% cash. Post bankruptcy situations are a good place to look for bargains because people avoid them and don’t understand them. around 17% distressed debt. Korea). For example they use derivatives to hedge the interest rate risk in their real estate holdings. Think tech stocks if you shorted them in 97. It works for a while and then the market goes berserk and you get killed.000 savings accounts across the country to take advantage of thrift conversions Baupost doesn’t go short because unlike going long when you can take advantage of a drop in the value of an undervalued security by just buying more. and foreign equities. former executives. A lot of good things can happen in bankruptcy such as terminate overpriced contracts or leases. .

People fail to have sell discipline because they can’t hold cash. This is why Baupost has so much cash. If they had to they would have no problem holding 100% cash. Focus on absolute returns. if they’ve overlooked something or if something has changed. The people liquidating Enron were very pessimistic and they originally estimated that the bonds would get back 17 cents on the dollar at the same time the debt traded for 14-15 cents. The situation had a lot of complexity. 2.000 subsidiaries. Focus on risk before return. . with over 1. After a few years most of Enron’s assets were cash $16-18 billion but the liabilities were extremely complicated. a lot of litigation. the market was down 25% and we were down only 20%" also clients will pull money out at the wrong time and it has a strong psychological effect. 3. Baupost bought the debt for 10-15 cents on the dollar. They constantly reassess to find new information. • Investments like Enron debt are possible because the market doesn’t assess risk correctly by relying on volatility (beta). Klarman said that it’s really hard to turn a macro idea into an investment. they sometimes hire consultants and talk to analysts on buy and sell side. 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. suppliers. Baupost estimated that the debt would recover 30-40 cents and as of now they believe it will be more then 50 cents. He has views on the macro but doesn’t think he has an edge in that type of investing. Institutions focus on relative returns but Baupost doesn’t because Klarman can’t imagine writing a letter to clients saying "we performed well during the year. Baupost believed that the people liquidating Enron were low balling what they would get back on the bonds. • Baupost’s 3 investment principles: 1. If they could find undervalued investments they would put all their money to work tomorrow. Klarman's 5 fold investment in Enron debt • Baupost invested in Enron’s senior debt and he said that would be an example of his favorite type of investment.• customers. hard to analyze. uncertainty and no one wanted to be associated with anything Enron creating a huge mispricing. Only focuses on bottom up investing. It comes down to assessing assets minus liabilities. currently 45% of the fund is in cash. Employees own second largest position in Baupost.

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