How Seth Klarman Is Investing In 2022: Is Value Investing Still Alive?

How Seth Klarman Is Investing In 2022: Is Value Investing Still Alive?

Billionaire value investor Seth Klarman who runs the Baupost Group hedge fund has shared how he is investing in 2022 and a few warning signs that I’ll cover in today’s video!

I discuss the highlights of the Oracle of Boston’s recent shareholder letter and the Baupost Group’s 13F equity positions amounting to about $10 billion in Q4 2021.

Seth Klarman said that we are seeing deep complacency and stretched valuations in the stock market, as well as looming risks such as mounting inflation and rising interest rates. He wrote that “materially higher interest rates are posing a real danger to financial markets.” Yikes.

Seth is a 64 year old value investor who follows the investment philosophy of Benjamin Graham, the Columbia Business School professor who taught Warren Buffett.

Ben Graham is famous for his cigar butt style of investing, and this bargain hunting investing style strongly influenced how Seth invests. Seth tries to find deeply undervalued assets and buy they them with a margin of safety like Ben Graham and Warren Buffett do.

Most likely Klarman and Buffett have had to evolve some of their investing approaches since the days of Graham because now there are not as many net net type opportunities as when Graham was able to get one last puff of profits out of these kinds of companies.

Seth founded Baupost Group after getting his Harvard MBA in 1982 at the age of 25, and the fund has averaged around 19-20% annual return per year. Pretty impressive!

One of the reasons why Seth’s fund may not have performed as well as other funds in recent years is because he’s holding a lot of cash. Out of the $31 billion of assets under management at Baupost, about a third or $10 billion is cash, and with $10 billion in equities, the other $10 billion is deployed across a range of strategies.

While Seth is a renowned value investor, he does a bunch of investing strategies as part of the Baupost hedge fund such as commercial real estate, private equity, private credit financing, preferred stocks, and hedging.

Much like how Buffett is holding onto about $150 billion in cash at Berkshire Hathaway making up about 13% of the portfolio, Seth Klarman’s Baupost portfolio is 30% in cash.

Even though at face value we think Berkshire and Baupost have a lot of holdings, if you look at their top holdings of at least 2% or more, they are much more concentrated.

Based on Baupost’s Q4 2021 activities, he has been selling way more than buying equities, so maybe that’s foreshadowing what he thinks could happen. Bulk up on more cash now to buy companies on sale later.

It’s nothing new for Baupost to underperform the stock market for a long time before outperforming, but some allocators are walking away from Seth Klarman maybe at exactly the time when his value investing strategies will start to perform better. He goes against the grain of being fully invested by having so much cash on hand, waiting for more attractive investment opportunities.

I think what Seth Klarman said in 2020 is still relevant in 2022: “Unless the opportunities are truly and historically compelling, full exposure in this environment seems dangerous, given prevailing lofty valuations. Should corporate earnings weaken, record-high profit margins shrink, markets falter, or inflation pick up (driving central bankers to reverse current easy money policies), the downside from here could be quite significant.”

Among the highlights from Seth’s shareholder letter, he especially emphasized the importance of hedging to not achieve gains, but to protect the value of the assets you have. So he purchased hedges to protect the assets of Baupost Group.

He also issued a dire warning if the political strife in the US continues the way it has been. And to be illustrate what he thinks about stocks, he likened the speculation in the markets to roach motels that are easier to get into than get out of.

Seth wrote that “against a backdrop of relentless money printing, a very active Federal Reserve, and fiscal largesse, many investors have been lulled to sleep, unaware of and unfocused on risk.”

He doesn’t mind searching through the abandoned property bins of the market to find successful investments. This is what he thinks about current market conditions: “It is said that bull markets always climb a ‘wall of worry’ as the cautious are left behind while the intrepid get ahead and the reckless lead the pack. But the opposite may also be true – bear markets must inevitably descend a mountain of overconfidence and hubris.”

Since stock market volatility can create new investing opportunities, Seth believes that “volatility should more properly be considered a value investor’s best friend.”

And he warns “it only takes one moment of overconfidence, distraction, or sloppiness to undo a lifetime of painstaking compounding.”

Seth laments the ever-more polarized America in saying that democracy is a precious gift without instructions or a warranty. He cited a Ben Franklin quote “A Republic if you can keep it” since the future of the US may be in peril.

So some of what retail investors could do include potentially doing our own hedging strategies and learning more about Seth’s investing philosophy. If you’ve got the spare time and boatload of cash to spare, you could read Seth Klarman’s “Margin of Safety” book that came out in 1991 and currently costs thousands of dollars.

I think current stock market conditions are a lot like what Seth said in 2020, where he said that the low interest rate environment served as the rocket fuel for expanding valuations in stocks that aren’t sustainable. He likes to look for investments that are considered to be like “twisted apples,” which may lack broad appeal but can still deliver a sweet fruit taste. He thinks when the market corrects some of the mispricings we’re seeing in stocks, that it will be the “twisted fruits” that will prove to be the smartest investments.

Seth has borrowed from a Buffett quote in saying, “price may be what you pay, in other words, but value is what you get.”

If you’re interested in learning how to take control of your finances and start becoming an investor like Warren Buffett, check out my free PDF guide.

I look forward to making more investor friends! Add me on Instagram: michellemarki