Last week @NeckarValue tweeted a link to a great interview with Seth Klarman at Barron’s titled – “Value Hunter in a Sky-High Market”. The article provided a number of great value investing insights by Klarman and how he implements his value investing strategy differently to a lot of other value investors.
Here’s an excerpt from that article:
Q: You talk about value investing. Which can mean almost anything. And what it has meant in recent years for most people is a lack of return. How do you define value investing?
A: I was waiting for you to ask.
Q: This is known as a soft-hanging-curve-ball question.
A: Atlanta could have used one Sunday night. We define value investing as buying dollars for 50 cents, somewhat like Mike Price’s definition.
Q: Or everybody else’s.
A: That is a favorite phrase. We certainly don’t stick to it rigidly. We will buy dollars for 40 cents or dollars for 60 cents when they are attractive dollars to buy. I think that we implement it a fair bit differently than many value investors, or many so-called value investors who frankly I’m not sure are buying good value at all.
Value to some extent is in the eye of the beholder. It is very hard to pin down what the value of a future set of cash flows from a business, be it cable TV or biotechnology, is going to be. Some are easier to predict than others. But it is very hard to predict what those future cash flows are going to be. And it is very hard to ascertain the correct discount rate to bring them back to the present with.
Q: Fine, but tell us not how difficult it is to define, but what you consider value?
A: When we look at value, we tend to look at it on a very conservative basis—not making optimistic forecasts many years into the future, not assuming growth, not assuming favorable cost savings, not assuming anything like that.
Rather looking at what is there right now, looking backwards and saying. Is that the kind of thing the company has been able to do repeatedly? Or is this a uniquely good year, and is it unlikely to be repeated? We tend to look at hard assets as much as possible.
Q: Like . . .
A: For instance, cash is something we understand. When a company has cash on the books, or marketable securities cease to exist, they will probably distribute the funds and go out of business. Already, we see many of the arbitrageurs from the ‘Eighties disappear and go into new lines of business like distressed securities. As you mentioned, short sellers have started to disappear.
Q: How do you get your ideas?
A: We originate, I would guess, half or so internally. That would mean reading the newspapers, looking at periodicals, looking at Barron’s, for instance.
Q: Flattery will get you everything. Does it help on that score that you have businessmen as partners? Do they suggest things because of their knowledge of their particular businesses?
A: We have had some suggestions from clients. But I don’t believe that any have translated into actual investments. I would describe it this way: When you have been doing this for a while, you start to become more proficient about where to look, which rocks to look under. The rocks we look under tend to have a few things in common.
Q: We’re afraid to ask, but go ahead.
A: One thing we want to look for is perhaps a market inefficiency or imperfection. And often these are caused by what we would call institutional constraints. The institutions, first of all, because of their tremendous size, and second of all, because many have gotten away from fundamental investing, tend to be prolific creators of opportunities. An example of this would be when a large company spins off a much smaller subsidiary and distributes the stock free to shareholders. The institutions tend to be natural sellers of the spinoffs.
Q: Why is that?
A: Either they would have to buy an enormous amount to justify a large position, or they sell. And they sell regardless of fundamentals, regardless of the price compared to the value. So we tend to look at spinoffs as one category. That would be a type of rock that we look under. So when in the newspaper it mentions that such and such a company is considering a spinoff, we will follow the progress of that and look at the registration statement when it becomes available for a possible investment.
There are, of course, now people who follow spinoffs, including an analyst at one major firm. So even in that area there might be fewer opportunities than before. Although every so often one slips through the cracks, or one is written up but ignored by most of Wall Street. We do find some opportunities even in overpopulated areas.
Q: How about another type of rock?
A: Another type of rock we would look under would be when securities get downgraded from investment grade to below investment grade, i.e., distressed. In particular, many funds that own these are not permitted to own other than investment-grade securities. So when the downgrade happens, they have to sell, they have no choice, given the rules that they operate under. That may create a short-term supply/demand imbalance. Another opportunity created by selling that is not dictated by fundamentals.
Q: We guess we have a reasonable knowledge of how you work and reason. So why don’t we switch to the way you view the economy and the market?
A: One thing I want to emphasize is that, like any human being, we can discuss our view of the economy and the market. Fortunately for our clients, we don’t tend to operate based on the view. Our investment strategy is to invest bottom up, one stock at a time, based on price compared to value. And while we may have a macro view that things aren’t very good right now—which in fact we feel very strongly—we will put money to work regardless of that macro view if we find bargains. So tomorrow, if we found half a dozen bargains, we would invest all our cash.
Here’s the tweet by @NeckarValue:
Seth Klarman interview with Barron's in November 1991, at the beginning of the 90's bull market
"Value Hunter in a Sky-High Market"
Baupost: three wealthy families pool their money
Of course at $400m AUM he wanted to stay small 🙂
— NeckarCap (@NeckarValue) July 4, 2018
You can find the entire interview here.
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