Seth Klarman’s Six warnings

Livewire Exclusive

Livewire Markets

The iconic value investor, and CEO of $27 billion hedge fund Baupost, Seth Klarman, has lived and breathed markets for 35 years. Today he’s nervous. Here are 6 warnings from him that you should keep in mind when investing today. 

Wait for the volatility

“Trump is high volatility, and investors generally abhor volatility and shun uncertainty. Not only is Trump shockingly unpredictable, he’s apparently deliberately so; he says its part of his plan. He’s also, at times, contradictory, giving one the perpetual feeling that just about anything could happen. Predictability in government policies, like predictability in business results, is important to investors. Amidst rapid-fire and tumultuous change, it’s going to be that much harder for investors to make assumptions, model business performance, and reach intelligent decisions.”

“We benefit from volatility. We provide liquidity when people want to sell something in a hurry. We buy something when the markets down, we sell something when the market’s up.” 

Watch the corporate insiders

Klarman says that CEOs and corporate insiders have been big sellers of their own shares. That’s “a sign that those who know their companies the best believe valuations have become full or excessive.” 

Leverage is rising

Klarman has also recently highlighted to investors that margin debt hit a record $528 Billion in February 2017.

“While some value-oriented hedge funds and even endowments use leverage to enhance their returns, I side with those who are unwilling to incur the added risks that come with margin debt. Just as leverage enhances the return of successful investments, it magnifies the losses from unsuccessful ones. More importantly, non-recourse (margin) debt raises risk to unacceptable levels because it places one’s staying power in jeopardy.”

“Almost every financial blow up is because of leverage.” 

The world is unpredictable so don’t buy expensive stocks

"The future is unpredictable. No one knows whether the economy will shrink or grow (or how fast), what the rate of inflation will be, and whether interest rates and share prices will rise or fall. Investors intent on avoiding loss consequently must position themselves to survey and even prosper under any circumstances. Bad luck can befall you; mistakes happen. The river may overflow its banks only once or twice in a century, but you still buy flood insurance on your house each year. Similarly we may only have one or two economic depressions or financial panics in a century, but the prudent, farsighted investor manages his of her portfolio with the knowledge that financial catastrophes can and do occur. Investors must be willing to forego some near-term return, if necessary, as an insurance premium against unexpected and unpredictable adversity."

“When share prices are low, as they were in the fall of 2008 into early 2009, actual risk is usually quite muted while perception of risk is very high. By contrast, when securities prices are high, as they are today, the perception of risk is muted, but the risks to investors are quite elevated.” Needless to say, Baupost was a net seller during Q1 2017. 

Deeply understand your investments

“Investors should pay attention not only to whether, but also to why, current holdings are undervalued. It is critical to know why you have made an investment and to sell when the reason for owning it no longer applies. Look for investments with catalysts that may assist directly in the realisation of underlying value. Give preference to companies having good management with a personal financial stake in the business.” 

Make sure you have the right mindset

“You need to balance arrogance and humility. When you buy anything it's an arrogant act. You're saying markets are gyrating and somebody wants to sell this to me and I know more than everyone else so I'm going to stand here and buy it. That's arrogant. You need humility to say 'I might be wrong.”

“Successful investors tend to be unemotional, allowing the greed and fear of others to play into their hands. By having confidence in their own analysis and judgement, they respond to market forces not with blind emotion but with calculated reason. Successful investors, for example, demonstrate caution in frothy markets and steadfast conviction in panicky ones. Indeed, the very way an investor views the market and its price fluctuations is a key factor in his or her ultimate investment success or failure.” 

To receive more expert insights to your inbox register to Livewire for free today. (VIEW LINK)


Livewire Exclusive brings you exclusive content from a wide range of leading fund managers and investment professionals.

I would like to

Only to be used for sending genuine email enquiries to the Contributor. Livewire Markets Pty Ltd reserves its right to take any legal or other appropriate action in relation to misuse of this service.

Personal Information Collection Statement
Your personal information will be passed to the Contributor and/or its authorised service provider to assist the Contributor to contact you about your investment enquiry. They are required not to use your information for any other purpose. Our privacy policy explains how we store personal information and how you may access, correct or complain about the handling of personal information.