Seth Klarman on Long-Term Ownership

[07:14] BARRY RITHOLTZ: This week on the podcast, I’m not fooling around when I say an extra special guest. Seth Klarman is CEO and portfolio manager at the Baupost Group, a Boston-based private investing firm founded in 1982 with only $27 million in client monies. Over the past four decades that has grown to $22 billion. Seth is known for his patient, risk-averse, and contrarian approach to finding deeply discounted securities in all sorts of areas — equities, distressed debt, real estate, wherever. He authored the book Margin of Safety, a highly sought-after and rare 1991 publication, as well as editing the seventh edition of Security Analysis. Seth Klarman, welcome to Bloomberg. [09:05] SETH KLARMAN: It’s so great to be here. Thank you, Barry. Thank you so much. I’ve been looking forward to this forever. [09:12] BARRY RITHOLTZ: Before we get into your investment philosophy and the development of Baupost, I have to roll back a little bit to your early days — economics from Cornell, an MBA from Harvard. What was the original career plan? [09:30] SETH KLARMAN: So I was always drawn to investing. Even when I was a very young kid, I was interested in the baseball statistics. I became aware that there were these other columns of numbers in the newspaper and asked my neighbor what those were, and started to understand and follow the stock market a little bit. Of course I had no idea what I was doing, but I was paying attention from quite an early age.

You can ignore all that because you have a confidence that I own something that’s going to be worth more a year or two from now than it is today. That’s the underpinning that lets you follow a value investment strategy. [22:11] BARRY RITHOLTZ: So you mentioned downside risk, and you referred to before, you began in 1982. Less than a decade later you publish Margin of Safety, 1991. What led you, at the ripe old age of 34, to write a book on risk management? What was the motivation? How was it initially received — because it’s become so sought after these days. What was the initial reception like? [22:44] SETH KLARMAN: In retrospect that looks pretty darn presumptuous. I got asked to write it by a classmate from business school who worked at Harper Collins at the time — or Harper & Row, maybe, before Harper Collins. She had seen some of my client letters and said, you seem like you’d be a good writer, and you’re a smart guy, maybe you’ll have something to tell the audience. What I really thought was, I’m just updating The Intelligent Investor for modern examples and a contemporary market, decades since that book was written. I thought maybe I’d make it a little bit more accessible for the average Joe. I don’t know whether it accomplished that, but that’s what I was trying to do. I didn’t think I would make money from writing the book — as you, as an author, know, we get like a buck fifty an hour. But it’s a great feeling, and it’s a ton of work, but ultimately worth it.

[30:49] BARRY RITHOLTZ: So Bear Stearns, if I’m remembering correctly, was spring of 2008, Lehman was September of ’08. That’s not a lot of time from there until March ’09, when everything really bottoms. I have three questions about this. The first is, how quickly were you able to raise capital, get the docs signed, and be prepared to deploy that as opportunities arose? Doesn’t seem like there’s a lot of time. [31:20] SETH KLARMAN: The team worked heroically, and we were able to raise very significant capital within a quarter. [31:29] BARRY RITHOLTZ: Wow, that’s really quickly. Now you mentioned the team. I have heard some really interesting rumors and legends. How did you put this team together? What were their marching orders? How did everybody operate in that period of absolute turmoil and mayhem? [31:47] SETH KLARMAN: So we were already an established firm. We’d been up and running for a couple of decades by then. So I had a team in place, and they were deeply knowledgeable — experienced distressed-asset expertise in the group. Not everybody on the team has that, but a very high percentage of the team has that. People within Baupost are like versatile athletes. We’re nimble, we’re agile, and we cross-train — kind of like baseball teams are doing now in the minor leagues. They don’t want you to just be a third baseman, they also want you to play outfield and maybe second if need be.

The problem is the optionality didn’t pay off very well for big swaths of time — especially in a period of suppression of interest rates and the Fed printing a lot of money in the U.S., running large deficits, where we really haven’t had a serious downturn in almost two decades. So that amount of cash became painful. The argument for holding cash, when the client says “I’m not paying you to hold cash,” my answer would be, I’m not getting paid to hold cash, I’m getting paid to use my judgment on when to deploy the money and in what to deploy it. So I feel like that’s right, but I felt like I was not optimizing for our clients in an environment that stopped being as volatile as the one I’d grown up in. So we changed our strategy somewhat. We made our liquid books more liquid, especially our public equity book, where we used to own companies with, you know, $500 million or $1 billion market cap. Now we own much bigger market-cap holdings on average. That liquidity in the public equity book has made us feel better that we can pivot on a dime with a large percentage of our book. So we don’t need as much cash to be able to take advantage of a sudden opportunity that shows up. [41:21] BARRY RITHOLTZ: A lot of larger equity funds, when they’re sitting in cash, use the SPDR ETFs, rolling into SPY, so they’re not falling behind a benchmark, and then it’s deep and liquid if they want to deploy that.

We read again this morning that 10% or 15% of some endowments’ entire endowment is in the one name SpaceX. So they’re going to want to sell. Employees are going to want to monetize and go from being wealthy on paper to wealthy in a bank deposit. So that’s a lot of stock for sale. And we have to sell that stock while apparently Google and Facebook need more money, and OpenAI and Anthropic need more money, and utilities need more money for power, and chip companies need to build new factories in America. There’s so much demand for money. I think we’re in a vulnerable place, where ultimately supply and demand for money determines the cost of capital. That’s true in the bond market, and it’s in effect in the stock market. So we might be looking at some supply-demand excess where prices soften just because there’s so much supply of securities and the need to monetize is so great by these private companies. [58:18] BARRY RITHOLTZ: So let’s talk about another imbalance between supply and demand through history, because Baupost has been around for over four decades. You’ve traded and invested through and survived all sorts of different market regimes — inflation, disinflation, the dot-com bubble, the financial crisis, QE and ZIRP, COVID, and more recently the return to, let’s just call it, normalized interest rates. Has anything changed since 1982? Is it just the same screaming from one crisis to another? Or do things eventually sort of moderate, do we learn from these experiences?

Asked about the firm's holding periods, Klarman noted that Baupost's average position lasts several years, with some held for a decade or more. He framed this not as a stylistic preference but as the natural consequence of buying assets that are cheap relative to conservative value and waiting for the gap to close. He observed that the closing of the price-to-value gap is rarely a smooth process. Sometimes a catalyst appears - a takeover, a recapitalization, a reorganization. Often the catalyst is simply time, as the business generates cash that ultimately forces the market to re-rate it. The investor who demands a near-term catalyst before acting tends to miss the situations where the catalyst is simply patient compounding. The compounding implication is that the firm's returns are largely earned in the gaps between transactions. Baupost is not, by design, a high-turnover firm. Its edge is in identifying the gap, sizing into it, and waiting. The cost of this style is the years of relative underperformance during bull markets; the benefit is the avoidance of permanent loss during bear markets. Over a multi-decade horizon the compounding math has favored the style, but Klarman has been explicit that the style requires clients willing to accept multi-year stretches of looking wrong.

Klarman closed the Security Analysis discussion by emphasizing that the most important decision an investor makes is not which securities to buy but what kind of investor to be. He argued that the choice of philosophy - value, growth, macro, quantitative, thematic - is upstream of the security selection, and that the mistakes that destroy capital are usually philosophical in origin. He observed that investors who attempt to be all things - value when value is in favor, growth when growth is in favor - typically end up being neither. The philosophies imply different behaviors, different time horizons, and different definitions of risk. An investor who changes philosophies to fit the cycle has no fixed criterion by which to evaluate his own decisions, and therefore no way to learn from his errors. The implication is that the firm's identity as a value investor is not a marketing position but a discipline that constrains every other choice. Baupost's cash stance, its preference for distress, its willingness to abstain from popular themes, and its insistence on a margin of safety are all expressions of the same underlying commitment. The cost of that commitment is the years when the style is out of phase with the market; the benefit is a multi-decade record that has compounded through every kind of regime. In Klarman's framing, the philosophical choice is the binding one, and every other decision is a downstream expression of it.

Klarman frames Baupost's permanent-capital structure as a strategic advantage rather than a financial arrangement. Because the firm's capital is locked up for multi-year horizons, the portfolio can hold illiquid assets, ride out periods of marked-to-market pain, and wait years for a thesis to mature. The same edge is unavailable to funds whose investors can redeem quarterly. He emphasizes that the absence of redemption pressure changes not just the trade list but the kinds of opportunities that become investible. Real estate workouts, bankruptcy claims, private distressed debt, and certain international situations all require the willingness to commit capital for several years without interim liquidity. A fund whose investors require monthly liquidity cannot underwrite these even if its analysts are capable. The compounding implication is significant. In asset classes where returns accrue to whoever can wait, structural patience becomes a moat that scales. Klarman argues this is one of the few edges in investing that does not get competed away by information: knowing that a security will eventually be worth more is rarely enough; the firm that can sit through the noise until that resolution arrives is the one that captures the premium. Permanent capital, in his view, is the institutional expression of patience.