Bloomberg Audio Studios podcasts, radio, news. This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
What can I tell you about this week's banger, Seth Klarman, legendary value investor out of Boston at the Baupost Group. What a fascinating discussion about risk, about the current environment, about the Boston Red Sox, about just about anything that affects portfolios, distressed assets, stocks, bonds, real estate. I thought this was fascinating and I know you will also. With no further ado, my conversation with Seth Klarman.
Seth Klarman, welcome to Bloomberg.
It's so great to be here. Thank you, Barry.
Thank you so much. I've been looking forward to this for forever. 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?
So, I was always drawn to investing. Even when I was a very young kid, I was interested in 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. So, of course, I had no idea what I was doing, but I was paying attention from a quite early age. I didn't really ever develop a career plan, but I was drawn to the stock market. I think I'm drawn to puzzles, Barry. I like doing word puzzles every day. I like solving math puzzles. I subscribe still to something called a math puzzle book published by Dell. And the stock market's a big puzzle. The financial markets are a big puzzle. How does it all work? And how does the performance of the companies get reflected in stock prices? And how can an investor outperform everybody else? And so all of that is a piece of what drew me in.
So I'm interested in how you first found that beyond the newspaper stock price pages. You grew up in Baltimore. Your parents divorced when you were relatively young. Mom was an English teacher, later a psychiatric social worker. Dad was a health economist at Johns Hopkins and NYU. Was it just simply thumbing through the sports pages literally to the next set of pages where the stock pages?
That's literally the numbers on the page attracted my attention. I would say, you know, I think my origin story is a lot like other people who ended up in the investing business, like Warren Buffett, like I think Todd Combs, like many others, drawn to small businesses, wanted to make money. So, I was delivering newspaper routes for the Baltimore Sunpapers. I had a snow cone stand in my driveway one summer. I mowed lawns. I raked leaves. I shoveled snow. I did little carnivals for the neighborhood kids, whatever. I sold candy at religious school on Tuesdays and Thursdays because the kids were starving after school and I would buy it up over the weekend and bring it to school and sell it for an arbitrage profit. So it was just a pattern of being drawn to small business and making money. And over time that led to an interest in the stock market. I bought my first stock with some bar mitzvah money when I was around 10 years old.
Well, it couldn't have been bar mitzvah money if you were 10 years old.
It wasn't bar mitzvah money then. It was a present, but then bar mitzvah money continued to be piled in. I bought a share of Johnson and Johnson.
Do not still have it. It split three for one, but ultimately I presumably have traded that in for something else that I like better.
So let's fast forward a little bit to the Baupost origin story, which isn't that far ahead. You're only 25. The urban legend is you co-founded Baupost, but reality, you were brought in to manage money for the four founding families. Still at 25, that's a kind of shocking thing. Oh, we have all this wealth. Let's bring in this kid to run our portfolio, right?
And I would say the same thing if I were in their seats, I would wonder, well, how does this kid know how to do that? So I don't think people should generally be starting investment firms at age 25. And of course, I really didn't start the firm. The firm was in the process of being created. The four clients of the firm that came together, the founders had the idea that they would build a firm that might go and make investments itself, might hand money to others who were in the business already of making investments. So I think they wanted to build kind of an institutional structure or framework for how to make sure the money got managed well given what was then back in the early 80s a highly fraught time, as you know from history. The volatile markets, long history of underperformance of the stock market and real economic uncertainty, stagflation, at some point and getting worse. Treasury bond yields were getting higher and higher. So, it was a really fraught moment. And I think they wanted to make sure that the money they had not only was kept intact, but was accounted for, clip the coupons and collect the dividends and all of that. The founders were all selling businesses around that time. So the serendipity was I was a student at business school. Bill Poorvu, the P of Baupost, was my real estate professor and he and some friends were selling Channel 5. He was a big investor in that, the Metro Media largest sale at the time of a TV station to Metro Media. It was the ABC affiliate in Boston. A third friend had a computer publishing and consulting business. All that was getting sold. So they had this pile of $27 million. And the basic job offer I got wasn't come run a fund. It was come join us and let's figure out smart things to do with the money.
So eventually you become the lead partner there. I don't know if CEO is the right term.
I wasn't CEO for the first seven or so years and then I became CEO and effectively got control of the firm as sort of a handshake deal where we agreed that if I worked hard and did well for the clients that they would recognize that with a stake in the business. So I had no stake the day it was formed and ended up with over half.
Ended up with over half. That's amazing. 40 something years later...
And now much less because I'm a big believer in sharing the pie with my team.
Makes a lot of sense. Let's talk a little bit about the timing. You mentioned there was a lot of turmoil and stagflation. The previous 16 years I want to say the inflation adjusted returns were something like down 75%, 66 to 82 something along those lines. 82 was the beginning of a historic bull market. How did that affect how you thought about risk? How you thought about opportunities? What did the markets look and feel like in '82 when I imagine most people were still pretty bearish?
Yeah. So, right, I think Malcolm Gladwell would look and say 1982, what an interesting time to start an investment firm. That certainly was a wind at your back in terms of being successful. The challenge is, and you know this, how it works in the markets, is you had no idea that you were at the beginning of a long bull market. What you felt was the market hasn't done that well for a long period of time and people were very skeptical about it and you could always point to, I think this is probably valuable insight, is you can always point to things at any moment that don't add up, that seem overvalued, that seem risky, and yet we get through most of those things. So at the time it didn't feel like a gimme, it didn't feel like a layup hand. But what ended up happening was we tried to make money apart from the market. We weren't buying an index. Indexes weren't big then anyway. We weren't buying the market. We were buying idiosyncratic situations looking for bottom-up mispricings and that led to us building a record. So while it looks just okay compared to the market over that period of time, I think we would have done okay whether the market had been up, down, or sideways.
Really, really interesting. So given you're coming off of what was an epic bear market and just a whole lot of cross currents, stagflation, super high rates, Volcker, you're not that far away in '82 from the end of Vietnam, Watergate, all that malaise. How did that environment affect you as a professional investor? How did that change how you looked at the world and what lessons did you take from it?
I would tell you I think every investor needs to be a student of history. It may not repeat exactly but it certainly rhymes and it is very valuable to understand, and I think especially financial history for an investor. So what are the worst moments? How did we go through a market crash in 1929 to 1933 and a great depression that lasted close to a decade? What must that have been like for the people at the time? How would one handle oneself if you were going into a period like that? That we know that even the greatest acclaimed value investor of all time, Benjamin Graham, nearly went broke twice during that era. So, I think it's incumbent on all investors to be thinking and maybe holding multiple inconsistent thoughts in their head at the same time, that I found this interesting opportunity today, this bargain-priced stock, for whatever reason it's out of favor, they cut their dividend, it's a spin-off, it's a bankrupt security that's converting into a new equity. These things tend to get mispriced. But you've got a backdrop of, from time to time as we do today, a backdrop of very expensive market and a bit of euphoric conditions. Is that dangerous? It's dangerous, but we're also at the cusp of maybe a groundbreaking new technology. So I think over the 40 years it's always been some of both, that you've got a backdrop of something, sometimes very depressed, sometimes very optimistic, but you've also got individual securities that are fluctuating around maybe creating bottom-up opportunity. What I deeply believe is that value investors make money staying in the bottom up. That you might have a top down view. You might say yeah this could be a bubble, it could be a problem. But bottom up is where you're going to devote your time. It keeps you anchored. That if you have a portfolio of bargains, you're probably going to do okay if you've stress tested them and if you've been intellectually honest about them and they really are bargains.
So, you mentioned Ben Graham. I'm curious as to who else were important influences on the development of your investment philosophy. I've read about Michael Price and Max Heine who affected you the most over the years, who still affects you.
Right. So I think reading Ben Graham was certainly a major influence on me, I think as he has been on essentially everybody in the value investing community. And then Warren Buffett, the real life practitioner of Graham as well. And it was always heartening to know that somebody like Buffett who seemed to think similarly to how I thought, thought about downside risk, thought about the need to stay focused in individual companies and not worry so much about the overall market, the willingness to hold cash, and concurrently, the willingness to not have an opinion on everything. I have a lot of ideas and I end up with no opinion, no position. But once in a while we find something that seems way off the beaten path that's really interesting. So to watch Warren Buffett do that, I've realized now that Warren probably had a certainty of the idea that he would compound capital over a long period of time. And I think that is something that Graham probably gave Warren and gave me as well. The idea that if you protect on the downside, if you don't find yourself getting margin calls, frozen in place because you're too exposed, or getting massive redemptions because you're down so much, if you can position yourself that way, it can leave you in a position to play offense when even your best competitors might not be on the playing field. And that's a huge advantage. So, I think that Graham is kind of a north star. It kind of is a place where you can stay focused on what something's worth. You can ignore the herd. You can ignore the siren song of growth at any price and of exciting new technologies and exciting IPOs. And 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. And that's I think the underpinning that lets you follow a value investment strategy.
So you mentioned downside risk and that we referred to before you began in 1982. Less than a decade later you publish Margin of Safety in 1991. What led to 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?
Yeah. So, I think 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 and Row maybe before Harper Collins. And she had seen some of my client letters. She said, you know, 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 with modern examples and a contemporary market that's decades since that book was written. And 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 had no idea. I didn't think I would make money from writing the book. I mean, as an author, you know, we get like a buck fifty an hour, but it's a great feeling and it's a ton of work, but I think ultimately worth it. And you get smarter from the act of writing about what you do. You can do what you do all day long without maybe fully forming the philosophy, but if you want to share it with anybody else, it makes you think more clearly about what you do.
Yeah. The former librarian of Congress, Daniel Boorstin, used to say, I write to figure out what I think. And there's a lot of truth to that. What was the initial reception like? Did people respond or did it kind of land in a handful of value geeks bought it, but no one else?
So, it's somewhere in between. What happened first was I think my editor got fired three different times. So, I kept getting new editors. They had promised to back the book with advertising and they didn't. So, the book landed with a bit of a thud. I think it had maybe a very tiny second printing. So, I think they printed maybe 7,000 copies. I ended up buying a bunch of them back from Harper Collins by the time they took it off the market and the rights somehow reverted back to me. What it did do though, it was bought I think significantly by competitors who used it to train their teams. And that was also like, is that what I wrote it for? Because I don't mind. But it wasn't maybe the starting goal. The starting goal was, if you go back to the book, the first half of it was about the street and about how they treat the average investor and maybe the challenge of whether the investor is getting a good deal. And the second half is maybe an investment approach, a value-oriented approach, and how an investor might think about doing that even if they're not a professional investor. So, it was successful. In a weird way, it's sort of because it didn't get republished, it developed a bit of a cult following, and that's kind of amusing and interesting to me. And of course, we've reprinted some on our own. So, we've made it available to our clients and to summer interns and to anybody that's connected to the firm.
So in 2023, the seventh edition of Security Analysis, Benjamin Graham's framework for investing, was edited by you and in a lot of ways substantially rejiggered. How different is this version than Benjamin Graham's? I mean obviously the markets changed, the economy, so much is different than when he was writing. How did you approach this?
So the earlier edition, the sixth edition, I was co-editor with Jim Grant and Bruce Greenwald and the seventh edition they asked me to just edit that one as editor. We didn't follow the process that you might follow because we kind of thought of Security Analysis as the Bible and we thought we should leave it alone and what we should do is have modern-day expert investors write commentary about the different chapters, different sections of the book. So that's what we did. So I think the sixth edition and the seventh both have some really great selections by investors, some of whom are well known, but some of whom aren't known at all. And my former colleague David Abrams is one of them. David's contribution in the sixth edition is one of the most brilliant things I've ever read. And so I felt like we were moving Graham into a different era. The thing that's beautiful about Graham, it was written a hundred years ago give or take and it was written during the depression and things that made sense in a depression haven't made sense every day since then because we haven't been in depression most of the time since then if at all. So it was an update taking what's valuable, why people revere the book as a Bible, but also making it more accessible and more relevant modern day. We expanded it to cover some topics that weren't covered. It certainly has more international investing which wasn't really focused on by Graham. It talks about some other private investments. It talks about some of the changes in financial markets, the latest manias and fads and all of that, but also the changes in market structure, the changes in asset classes that have come into existence. And all of that, I think, is a valuable updating of the literature and helps keep something relevant that deserves to be relevant while updated, because in its original Graham and Dodd 1934 form wouldn't be very useful to people.
Coming up, we continue our conversation with Seth Klarman, CEO and portfolio manager at the Baupost Group, discussing the firm's evolution and philosophy. I'm Barry Ritholtz. You're listening to Masters in Business on Bloomberg Radio.
I'm Barry Ritholtz. You're listening to Masters in Business on Bloomberg Radio. Our extra special guest this week is Seth Klarman. He's CEO and portfolio manager at the Baupost Group, a legendary value and distressed investment shop out of Boston running over $22 billion in assets. So, let's talk a little bit about the way you think of opportunities and risks. During the '08-'09 financial crisis, you raised about $4 billion and the research I read, you were deploying $100 million a day into distressed assets. That seems like a big chunk of money. First of all, are those numbers remotely accurate? Is that ballpark?
It's ballpark. What I would tell you first of all is we had been closed for new clients much of our history, but we kept a list in case. And so when the market started to fall apart after Bear Stearns and then after Lehman, there were all kinds of things going on and people were in great stress as we entered the uncertainty of an economic decline that could have pretty epic proportions. As it turned out, it certainly was the worst decline since the Great Depression and it stands out as kind of the mother of all bear markets for anybody in the last 100 years. So the challenge was maybe it's time to take some capital and the odds are increasing every day that we're going to be able to deploy it fruitfully. So what you said is about right. So Bear Stearns, if I'm remembering correctly, was spring of 2007. Lehman was September of '08.
That's not a lot of time from there until March '09 when everything really bottomed. 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.
The team worked heroically and we were able to raise very significant capital within a quarter.
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 was their marching orders? How did everybody operate in that period of absolute turmoil and mayhem?
So we already were 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. And people at Baupost like being versatile athletes. So, we're nimble, we're agile, and we cross-train. Just 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. And so, the same with us that we have people that sit in four different groups as you mentioned. But all of them can work on distressed situations and people on the private investments especially love when we're super busy in the public markets and we call them in to work on distressed credit.
So big chunk of capital very aggressively deployed in a moment in time when so many people seem to be just paralyzed and frozen with fear. Was it just the value analytical framework or was it a little broader and deeper than that?
Yeah, I think Barry that the way you're conveying it probably comes across as we come in with giant satchels of money and hand over fist deploy it. It wasn't like that at all. It was the same cerebral, methodical, painstaking environment that we do every day. So, we see things trading at lower prices and we notice that and we look at the fundamentals and everything we do at Baupost is bottom up. Nothing's top down. We're not saying probably a good time to be a contrarian. None of that. We're saying, oh, I can buy this bond at 70 that I think is covered at par. I think people are worried maybe it could have a blip or have a problem for a while, but people aren't really doubting that there's something there. I think as the economy got worse, people may have started to doubt more and more. Prices come in more and more. And so we're literally able to buy mortgage securities, residential mortgage securities. We're able to buy corporate debt, especially of the auto financiers, the financial arm of General Motors and Chrysler and Ford. And Lehman goes broke and that had pieces within its capital structure that got very interesting. So, we're seeing all kinds of things and we're kind of kids in a candy store. Sadly, right, it's a tough time. People are hurting, but also as an investor, you're a fiduciary and you've got to put money to work where you're going to benefit your clients. So we're in every case stress testing, hey, if the world got even worse, hey, if this turned out to be 1933, will this investment be okay? And that's the only place where we're making decisions, is if the downside is protected and if we can see lots of paths to winning, then we're very interested. So we found a lot to do in distressed. We also owned equities. We also found private investments. And there were just all kinds of things worth doing in that era. The challenge in investing I think for everybody is you want to make sure that you know those environments are going to happen once in a while and you need to make sure you don't blow up during them and if possible you need to make sure that you'll have capacity to buy when the best opportunities become available and maybe your competitors are sidelined. And so that's the moment that I think investors need to at least have in their heads. How are you going to handle that environment? Because if you're too exposed, if you're getting margin calls, if you're getting massively redeemed because you took the wrong clients and they're short-term oriented, then you're going to be out of commission on that day. So to be around on that day and be able to do what we do, we just did the same thing we do every day. We did a little bigger size.
So I'm kind of fascinated by the dynamic tension between fundamental bottoms-up research on a credit or equity by credit or equity basis versus the top down. I know you've said that you really don't think about markets or investing from a top-down perspective, but it seems that everybody who panicked, everybody who helped create those distressed assets were either responding or over-responding to the top down environment. How do you look at that sort of environment?
Yeah, there are several layers to that. First of all, I think people were responding to all kinds of things. They were responding to redemption requests by their mutual fund shareholders. They were responding to credit downgrades so that it wasn't just I'm nervous that things are going to be bad. This bond is no longer investment grade and maybe my mandate is I can only own investment grade bonds or this bond has defaulted and I can no longer hold this bond. So you have forced selling all over the place and forced selling is a, you never want to be a forced seller and you especially want to be able to buy from forced sellers in any asset class if that comes along. What I would say is I think that, and I'm not a mountain climber or big hiker, but if you're going to climb a mountain you want to look bottom up. You want to understand is this the right trail? Is this safe? Do I have my equipment? Am I prepared? And then you also want to have the top down view. What's the weather? And what if it suddenly gets snowy up there? If the wind's 60 miles an hour, how am I going to handle that? And so you kind of want to have in your head the weather forecast. And I think I'm always thinking about is this environment safe? In today's market, it feels stretched, but it also feels like we're on the brink of an unprecedented technology and an era that might be one of very substantial prosperity, but also one of risk to society and great change. So, bottom up still feels like the right way to invest, but it feels like you still need your eye on the weather in the financial markets. That means where's the GDP going and what's the national debt and where's inflation going to take us. So I always have an eye on that stuff but we're not investing our portfolio based on that. The same way we don't invest based on a macro view that this country would be a good place to invest in. Rather we notice a security bottom up and say wow that seems egregiously mispriced. I wonder if there are more mispricings. Maybe we should look at that market a little bit closer.
So let's talk a little bit about cash. I think a lot of investors look at cash as a drag on their performance. The net return is usually zero or close to zero relative to inflation. How do you think of cash? It's always been such a historically important part of your toolkit. What sort of optionality does it create versus the career pressure of staying fully invested at all times?
