During his recent interview with Grant’s Current Yield Podcast, Seth Klarman discussed risk, and the scary notion that exists today that risk is a good thing. Here’s an excerpt from the interview:
Klarman: I think that along with the everything bubble has been pretty much a draining out from the entire system of the idea that risk is there, that risk can’t be controlled, that we haven’t permanently seen, and it created an era where there’ll just always be less risk, less volatility.
That risk inherently exists in human affairs. It exists in terms of Mother Nature, it exists in terms of the business cycle, it exists in terms of humans over leveraging and overreaching. Risk is always with us. And I think one of the most important things is that Security Analysis talks about risk.
It talks about risk being how much you can lose and whether you’re likely to lose it. And I think we’ve gotten away from that. That the academic definition of risk, which has been around for decades now, is risk is measured by volatility. And I dispute that.
I think volatility can be a value investor’s friend. Volatility can drive undervaluation and make a small mispricing into an even more egregious mispricing leading to great opportunity.
And of course, volatility is not a natural phenomenon. That itself is based on what humans do, the human response to news and business developments. And there’s a really scary notion out there now which is that risk is actually a good thing and that for an investor to prosper, they need to go and seek risk because the only way to get return is by assuming risk and that if you don’t assume risk, you can’t get return.
My career and Graham and Dodd’s careers were staked on the idea that the opposite is true, that the way to get return is by avoiding and shunning risk and hedging risk and protecting against risk. And so I think the world is kind of upside down in the sense of the idea of a margin of safety, the idea of what risk is and how to think about it as an investor.
People have joked with me over the years that my book would have sold better had I called it The Safety of Margin.
While I never seriously considered that, I do think that the world has turned on its head a little bit and that investors should once again actually think really hard about risk.
Think about not only return on capital, but return of capital in the investments they make, that this too will turn out to be cyclical, and that we know that the best periods to invest are the ones where you enter at a low valuation, and the worst periods for future returns are where you enter at a high valuation.
You can listen to the entire discussion here:
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