Several years ago Jason Zweig did a great interview with Seth Klarman titled – Opportunities for Patient Investors, which was published by the CFA Institute. While the entire interview provides a number of value investing insights, one answer in particular provides a unique insight into Klarman’s psychology towards investing saying:
“In investing, whenever you act, you are effectively saying, I know more than the market. I am going to buy when everybody else is selling. I am going to sell when everybody else is buying. That is arrogant, and we always need to temper it with the humility of knowing we could be wrong—that things can change—and acknowledging that we have a lot of smart competitors.”
Here is an excerpt from that interview:
Zweig: In a Forbes article in the summer of 1932, Benjamin Graham wrote, “Those with enterprise haven’t the money, and those with money haven’t the enterprise, to buy stocks when they are cheap.” Could you talk a little bit about courage? You make it sound easy. You have great clients and great partners. Was it easy to step up and buy in the fourth quarter of 2008 and the first quarter of 2009?
Klarman: You may be skeptical of my answer, but, yes, it was easy. It is critical for an investor to understand that securities aren’t what most people think they are. They aren’t pieces of paper that trade, blips on a screen up and down, ticker tapes that you follow on CNBC.
Investing is buying a fractional interest in a business and buying debt claims on a business. If you are afraid that a bond you bought at 60 might go to 50 or even 40, you may find it difficult to buy more; but if you know that the bond is covered, with extremely high likelihood, between 80 and par or even above par, the bond becomes more and more compelling as its price falls.
But you do have to worry about how a bond will trade and what your clients will think if you don’t have enough staying power to hold to maturity or even beyond maturity in the case of a bankruptcy.
But if you have the conviction of your analysis—are sure that your analysis wasn’t optimistic or flighty or based on a snapshot of an economic environment that cannot tolerate any stress—then you will not panic if the bond’s price starts to drop.
Our approach has always been to find compelling bargains. We are never fully invested if there is nothing great to do. We test all our assumptions with sensitivity analysis. Through stress testing, we gain a high degree of conviction that we are right. We are prepared for things to go slightly wrong because we adhere to a margin-of-safety principle that gives us the necessary courage to go against the tide.
Yet, we don’t actually think of it as courage, but more as arrogance. In investing, whenever you act, you are effectively saying, “I know more than the market. I am going to buy when everybody else is selling. I am going to sell when everybody else is buying.” That is arrogant, and we always need to temper it with the humility of knowing we could be wrong—that things can change—and acknowledging that we have a lot of smart competitors. Thus, in worrying about all the things that can go wrong, you can prepare, you can hedge—and you must remember to sell fully priced securities so that you are underexposed when things go badly. All these elements give us the courage to follow our convictions.
The last point I would make is that your psychology as an investor is always important. If you lose your confidence, if you’ve made too many mistakes, if you are down too much, it becomes very easy to say, “I can’t stand being down more than this.” Unless you have a bet-the-business mentality, you would worry about your business, about client redemptions, and about your own net worth in the business.
So, by being conservative all the time—by being both a highly disciplined buyer to ensure that you hold bargains and a highly disciplined seller to ensure that you don’t continue to own things at full price—you will be in the right frame of mind.
Avoiding round trips and short-term devastation enables you to be around for the long term.
You can read the entire interview here.
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