Distressed Debt Investing: Wisdom from Seth Klarman - Part 1

http://www.distressed-debt-investing.com/2009/07/wisdom-from-seth-klarman.html[1/4/2012 2:43:13 PM]

DISTRESSED DEBT INVESTINGThis blog will try to dissect distressed debt investing, up and down the capital structure. We will look at current distressed debtsituations, try to explain the ins and outs of how decisions are made in the distressed debt world, probably rant a few times aboutpositions that are working against me, and hopefully enlighten some readers.

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7.22.2009

Wisdom from Seth Klarman - Part 1

Seth Klarman and Baupost are in the news lately regarding the CIT bailout. While I donot want to delve into specifics, I will say that, outside the chance of fraudulent transfer/ conveyance / some other quirky bankruptcy ruling dealing with the rescue financing, Iwould buy the new L+1000 loan (3% floor) all day long...especially if I was getting a 5point advance fee. Currently in the grey market (when-issued) it is trading at 104-105without the fee.

As we have not discussed Klarman or Baupost in the past few months, I thought I wouldtake a few moments to pull out some of the more educational quotes from his fundletters through 2004-2007 (note: I do not have the fund letter from 2008...just theportions that were posted in a recent issue of Value Investor Insight).

Before I start pulling out some of my more favorite Seth Klarman quotes, I want to pointour reader to a post by Sivaram Velauthapillai, at his contrarian investment blog, wherehe discusses Seth Klarman's performance in relation to Warren Buffett (WEB). Nowadmittedly, Sivaram admits he does not know much about Seth Klarman, and really waspulling information from a document I alerted readers to a while back: old Seth KlarmanFund Letters. A few comments have already corrected him, but just to reiterate: As of theend of 2007, Klarman was CRUSHING the S&P since the inception of the fund. Thelowest return of the three classes of his funds, from inception, was 5903.7% cumulativereturn (10434.2% for the largest inception return). And no I did not place the decimal inthe wrong point. The S&P in the same period return came in at 1828.4%. So despitelagging the S&P in the go/go years of the 90s, he maintained his capital base when themarket gave a lot back in 2000-2002 and the rest is history. In 2008, press reportsstated that Klarman was down low double digits. I can neither confirm nor deny this.Nonetheless, the S&P was down ~38.5% ... further extending Baupost's lead.

In response to the blog post specificially: I understand the point about Klarman under-performing the S&P in the go-go years. I get it. But, the problem in looking at any one'srecord at any one point in time is that the past is the past. If you had looked at JohnPaulson's merger arbitrage flagship fund in the beginning of 2007 you may say toyourself: "Well, this fund...you know, it has been just doing OK" ... and then he goes outand throws a +50% net to investors year in 2007 versus a nearly flat market. On the flipside you could look to any number of funds that were putting up annualized returns inthe high 20s to low 30s up to 2008 and were down 50-60% last year bringing theircumulative returns to mere marginal levels.

Extending this to fundamental analysis, take a guess who's returns these are:

1991: 14.9%1992: 28.1%1993: 27.7%1994: 22.3%1995: 11.3%1996: 21.2%1997: 22.1%

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Distressed Debt Investing: Wisdom from Seth Klarman - Part 1

http://www.distressed-debt-investing.com/2009/07/wisdom-from-seth-klarman.html[1/4/2012 2:43:13 PM]

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1998: 19.2%1999: 16.1%2000: 15.9%2001: 11.7%2002: 15.7%2003: 17.7%2004: 17.0%2005: 15.2%2006: 18.3%2007: 1.8%

They are the reported return on equity of Bear Stearn (as reported fromBloomberg)...right up until the very end. As Seth Klarman writes in his 2004 letter,"While others attempt to win every lap around the track, it is crucial to remember that tosucceed at investing, you have to be around at the finish."

Now onto some more Seth Klarman wisdom. I am going to a few quotes from each letter(2004-2007) that I find particularly insightful regarding the investment and portfoliomanagement process.

From the Baupost 2004 letter:

"By holding expensive securities with low prospective returns,people choose to risk actual loss. We prefer the risk of lostopportunity to that of lost capital, and agree wholeheartedly withthe sentiment espoused by respected value investor Jean-MarieEveillard, when he said, "I would rather lose half ourshareholders...than lose half our shareholder's money..."

That is just a spectacular quote (both Klarman's and Eveillard's). It's also why, as myreaders are more than aware, I prefer current paying, senior-secured bank debt. Risk ofpermanent capital is low, I am getting paid to wait, there is a definite catalyst inemergence, and I have some control over the process. More quotes from the 2004 letter:

"We continue to adhere to a common-sense view of risk - how muchwe can lose and the probability of losing it. While this perspectivemay seem over simplistic or even hopelessly outdated, we believe itprovides a vital clarity about the true risks in investing."

Another great quote from Seth Klarman. Risk is not beta or standard deviation...it ishow much you can lose on an investment and what the chance is that "loss" scenario isgoing to play out.

And finally, from the 2004 letter (I am going to jump around on this one for full effect):

"Markets are inefficient because of human nature - innate, deep-rooted, permanent. People don't consciously choose to invest withemotion - they simply can't help it.

"So if the entire country became securities analysts, memorizedBenjamin Graham's Intelligent Investor and regularly attendedWarren Buffett's shareholder meetings, most people would,nevertheless, find themselves irresistibly drawn to hot initial publicofferings, momentum strategies and investment fads...People would,in short, still be attracted to short-term, get rich quick schemes.

"In short, we believe market efficiency is a fine academic theory thatis unlikely ever to bear meaningful resemblance to the real world ofinvesting."

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Distressed Debt Investing: Wisdom from Seth Klarman - Part 1

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Take that Burton Malkiel.

In the next few weeks, we will offer more wisdom from Seth Klarman, from both hisfund letters, and other public sources. Stay tuned.

Posted by Hunter

Labels: Seth Klarman

5 COMMENTS:

Anonymous, 7/23/2009

Hi,

Where did you find the Baupost letters from 2001 to 2007 ?

RegardsVishnu

Anonymous, 7/23/2009

Seth Klarman Compilationhttp://www.valuestockplus.net/seth-klarman

Lawrence D. Loeb, 7/23/2009

Klarman wrote a 28 page preface to the 6th edition (the current one) ofGraham & Dodd.

Anonymous, 7/23/2009

Can you please post the 2001 to 2007 letters here. I have only been able tofind the 1990 to 2001 letters. Thanks.

Anonymous, 7/27/2009

Problem was difficult to participate in the L+1000 loan if you were't a bigholder.

Where do you work?

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Distressed Debt Investing: Wisdom from Seth Klarman - Part 1

http://www.distressed-debt-investing.com/2009/07/wisdom-from-seth-klarman.html[1/4/2012 2:43:13 PM]

Disclaimer

This website is about distressed debt investing. Under no circumstances is this an offer to sell or a solicitation to buy securities discussed on this site. Any

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