Seth Klarman’s investment principles

Superinvestor Seth Klarman, sometimes called the ‘Oracle of Boston’, has made billions by following the “margin of safety” principle and never taking shortcuts.

Klarman is the founder and CEO of the Baupost Group, one of the largest hedge funds in the world. 

He is a titan in the world of finance, renowned for his disciplined and risk-averse investment approach.

Born in 1957, Klarman discovered his passion for investing at a young age, developing his skills at Cornell University and later earning an MBA from Harvard Business School. 

In 1982, at just 25, he founded the Baupost Group, a hedge fund that has consistently outperformed the market with an average annual return of 15% over four decades.

Like many great investors, including Oracle of Omaha Warren Buffett, Klarman is a dedicated value investor, drawing inspiration from Benjamin Graham, the father of value investing. 

However, Klarman did not only follow in the footsteps of the great value investors who came before him but also cemented his own legacy.

His 1991 book, Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor, has become a cult classic in the investment world. The book is so highly regarded that rare copies sell for thousands of dollars. 

Klarman’s knack for investing can also be seen in his company’s performance. 

Under his leadership, Baupost has grown to manage approximately $25 billion in assets, with a reputation for investing in distressed debt, real estate, and other unconventional assets. 

Beyond finance, Klarman is known as a committed philanthropist. Through the Klarman Family Foundation, he has supported causes such as education, health care, and cultural preservation. 

The foundation managed nearly $709 million in assets as of 2020.

Klarman’s contrarian investment strategies have earned him widespread respect. 

Daily Investor compiled some of Klarman’s best insights and principles for investing, which can be seen below.

‘The margin of safety’

A concept first coined in the 1940s by authors Benjamin Graham and David Dodd, it has since become one of Klarman’s cornerstone principles.

The “margin” refers to the difference between the intrinsic value of a stock and its market price.

Therefore, this principle emphasises investing only when the market price of an asset is significantly below its intrinsic value. 

This “margin” protects against potential valuation errors or unexpected market changes, reducing the risk of substantial losses. 

This principle also underscores Klarman’s emphasis on preserving capital rather than chasing speculative gains.

Intrinsic value over market hype

Following from his “margin of safety” principle, for Klarman, intrinsic value is the true worth of an asset based on its fundamentals, independent of market sentiment. 

He has repeatedly warned against following market trends blindly and encouraged investors to focus on businesses with strong financial health and sustainable long-term growth prospects.

Patience and discipline

Klarman believes successful investing requires resisting the crowd and staying disciplined during market exuberance or panic. 

He often holds unconventional positions, prioritising long-term opportunities over short-term profits. 

For example, Klarman is known for expressing his distrust of indexing – one of the most popular investment strategies in the world.

One reason for this distrust is his belief that few index fund managers have read the financial statements of the companies they invest in and, therefore, treat one stock as essentially similar to another.

This disciplined and often contrarian approach enabled Baupost to capitalise on distressed assets during crises, such as the 2008 financial downturn.

Klarman said many investors look to “investment formulas” and other shortcuts to base their decisions on.
However, “the financial markets are far too complex to be incorporated into a formula”, he explains. 

Therefore, Klarman encourages investors to look to the fundamental analysis of specific investment opportunities rather than look for shortcuts that do not exist.

Avoid speculation and emotional decisions

Klarman distinguishes between investing and speculation, criticising the latter for being driven by predictions of price movements rather than underlying fundamentals. 

Klarman believes that investors base their decisions on business and investment fundamentals, whereas speculators base theirs on a prediction of the behaviours of other people. 

In his book, he explains, “Investors believe that over the long run, security prices tend to reflect fundamental developments involving the underlying businesses.” 

“Speculators, by contrast, buy and sell securities based on whether they believe those securities will next rise or fall in price,” he says.

He also emphasises avoiding emotional decisions, which can lead to irrational investments and increased risk.

Contrarian thinking and market inefficiencies

Klarman thrives on market inefficiencies, often taking positions contrary to prevailing sentiment. 

He believes that inefficiencies are opportunities for disciplined investors conducting thorough research and analysis. 

His contrarian stance often appears “out of touch” in the short term but tends to be validated over time.

“Being a value investor usually means standing apart from the crowd, challenging conventional wisdom, and opposing the prevailing investment winds,” he said.

Klarman describes value investing as “the disciplined pursuit of bargains” and maintains that this discipline makes investing difficult but ultimately worthwhile.

He believes that, while value investors may sometimes experience poorer results than other types of investors, over the long run, the value approach is more successful.