Notes from Seth Klarman's Youtube Videos

I came across some videos of successful money manager Seth Klarman of the Baupost Group. Klarman is the author of the $900 book, Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor. When I was watching I was blown away with the rapid-fire investment truisms. So I decided to jot them down:

• value investing is a risk averse approach - focus on risk before return
• Ben Graham's net working capital test - if you can buy a stock for less than 2/3 its networking capital (working capital - all liabilities) then that's a bargain. You are buying a company for less than you could liquidate the business for.
• three underlying pillars:
• Focus on risk before return. Focus on multiple scenarios, i.e. what can go wrong, what's the worst thing that can happen. Create a range of possible outcomes, don't rely on single point estimates. Volatility isn't risk, volatility creates opportunities.
• The world is oriented toward relative performance. People who are risk averse should be focused on absolute returns. If you are focused on absolute returns, the idea of losing other people's money is abhorent. If you're focused on relative performance then you're OK with that.
• The importance of being bottom-up and not top-down. Interest rate and the stock market direction forecasting are incredibly difficult to perform well.
• Baupost. When they set it up they wanted to have flexibility - a wide mandate - in order to have as large an opportunity set as possible. The more weapons available in your mandate  the better chances you will have to take chances of mispricings. They also set it up to have capital alongside their clients. They don't allow people to have significant holdings outside the firm. The firm is highly collaborative; people are able to make an impact even at a junior level. Capital isn't siloed or allocated to specific people; it is able to move to different opportunities as they arise. Baupost's edge is in complicated situations.
• To invest in something you need an edge. They need to have a reason that they will outperform. The biggest edge someone can have is a long-term orientation. It's easy to say you do, but harder to implement it. Also, you need a catalyst: what is going to cause a mispricing to correct itself. Or a supply/demand imbalance like distressed debt where, as a bond is down-graded, there is forced selling.
• Spin-offs and index inclusion/exclusion are both good sources for deals.
• Relationships are important. They work hard to have the best clients and the best brokers. Trust. The team has worked together for a long time.
• Pharmaceutical company that invented a number of drugs - PDL Biopharma 30% IRR on the likely collections from drug patents.
• Risk vs. Return:
• Intensive sensitivity analyses on everything they do. A whole variety of assumptions. E.g. what if defaults are 5%, 10%. If a security, even with Depression-like scenarios, passes these tests then it is a good buy.
• Easy to find things that aren't efficiently priced.
• Baupost never uses modern finance, i.e. WACC or ROIC. Instead, use a range of values.
• Often the greatest opportunities are around the peripheries of things. If people are looking at
  the S&P 500, you should look at the 501st company. Where do we earn enough to buy and hold this entire company?
• Which value managers do you admire?
  Buffett and Munger for one.
  FPA Crescent team. Southeastern Asset Management. Tweedy Brown.
  Paul Singer. David Abrams. Perry Capital. Jeff Hallis. Michael Lowenstein. Steve Mandel.
• Looking for egregious mispricings. Looking for low-risk, high-return situations.
• Never believe that something will go well beyond fair value. We don't hold on for the last nickel. Don't fall in love with a stock because it acts well.
• One of the biggest mistakes that investors make is overdiversification. This presupposes that losses will be one-off events rather than the entire market moving against you. This limits your return and doesn't really limit your risk that much.
• You need to be able to tell a great idea from a good idea.