Superinvestor Seth Klarman’s investment principles

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

Klarman is a well-known value investor who has amassed a personal net worth of $1.5 billion by buying undervalued stocks and keeping them for the long term. 

He started investing at a young age and founded Baupost in 1982 when he was only 25.

The fund has generated an annual average return of 15% over the past 40 years and has $30 billion in assets under management. 

Klarman is a known follower of the father of value investing, Benjamin Graham, who inspired other billionaire investors like Warren Buffett.

Klarman is risk-averse and emphasises the importance of a margin of safety.

He authored a book on this subject in 1991, titled “Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor”.

This book has grown in popularity since it was initially published and is now considered a cult classic among value investors, including successful investors like Buffett. 

There were only a limited number of copies published, which increased the price of the book from its initial $25 price tag to more than $1,000.

Klarman is also well-known for his philanthropy through the Klarman Family Foundation, a non-profit organisation that had $708,987,241 in assets in 2020. 

Here are five of the principles that have underlined Klarman’s approach to his investment success:

• You need a margin of safety: A “margin of safety” is the difference between the market price of a security and your estimation of its intrinsic value when the market price is significantly below that value estimation. Klarman explains that this margin is necessary because “valuation is an imprecise art, the future is unpredictable, and investors are human and do make mistakes”. He adds, “it is adherence to the concept of a margin of safety that best distinguishes value investors from all others, who are not as concerned about loss”. This margin of safety protects value investors from large losses in declining markets. 

• Index funds are “mindless investing”: Klarman is known for expressing his distrust of indexing as an investment strategy. One of the reasons 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. “Although indexing is predicated on efficient markets, the higher the percentage of all investors who index, the more inefficient the markets become as fewer and fewer investors would be performing research and fundamental analysis,” Klarman explains in his book.

• Invest like an investor, not a speculator: 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. He explains in his book, “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.

• Looking for shortcuts will only lead to disappointment: 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. Klarman encourages other investors to look to the fundamental analysis of specific investment opportunities rather than look for shortcuts that do not exist.

• Value investing takes discipline and thinking outside the box: Klarman describes value investing as “the disciplined pursuit of bargains”, and maintains that this discipline makes value investing difficult but, ultimately, worth it. “Being a value investor usually means standing apart from the crowd, challenging conventional wisdom, and opposing the prevailing investment winds,” he says. Klarman believes that, while value investors may sometimes experience poor results compared to other types of investors, over the long run, the value approach is more successful. 

Seth Klarman’s investment principles, according to ChatGPT

Daily Investor asked the chatbot ChatGPT about Klarman’s approach to investing.

ChatGPT is a chatbot launched by OpenAI in November 2022, which is built on top of OpenAI’s GPT-3 family of large language models.

ChatGPT said Seth Klarman is “known for his value-oriented investment style and has been a successful investor for several decades”.

 Here are some of his investment principles, according to ChatGPT:

• Value Investing: Klarman is a value investor and looks for undervalued companies that have strong fundamentals and a wide margin of safety.

• Patience: Klarman believes in taking a long-term approach to investing and being patient for the right opportunities to arise.

• Risk Management: Klarman places a strong emphasis on risk management and avoids taking on excessive risk. He believes in maintaining a diversified portfolio and avoiding over-concentration in any one stock or sector.

• Margin of Safety: Klarman believes in buying stocks at a discount to their intrinsic value to ensure a margin of safety.

• In-depth Research: Klarman conducts extensive research on companies and industries to understand their financials and future prospects. He believes that deep research is essential for making informed investment decisions.

• Contrarian Thinking: Klarman is a contrarian investor and often invests in industries or stocks that are out of favour with the market.

• Long-Term View: Klarman has a long-term investment horizon and believes in holding onto investments for the long term.