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Circle Of Competence Issue #17

What are you reading this week? Drop me a line or tweet @competence_co. Have a great week!


This week, I thought I'd write a few thoughts on one of my favorite investors of all time, Seth Klarman. Klarman graduated with an economics degree from Cornell, and a few years later graduated with his MBA from Harvard Business School. While at Harvard, he met Professor William Poorvu and with a few partners, they seeded the Baupost Group with $27 million, allowing Klarman to run the money early on.

Although Klarman is known as reclusive and eschews the press, his investment philosophy is not as much a secret, because many investors carefully observe his filings and investment decisions. As I wrote in Issue #16 last week, his style is very similar to Michael Burry in the sense that he goes into any industry, any type of security (real estate, equities, debt, derivatives) at any time. He often prefers to buy what people are forced to sell - for example, he raised significant outside money in 2008 to begin buying distressed debt securities that were being liquidated due to margin calls and forced selling by other hedge funds. He tends to hold a decent percentage in cash when solid investment opportunities are scarce. In addition to higher cash balances when valuations are high, he uses index puts (derivatives betting on market declines) to hedge his portfolio against large systematic market declines. In fact, he only returned negative single digits in the financial crisis while other funds and the broader markets were down 30, 40, 50% due to his hedging and large cash balances prior to the real estate bubble collapse. He has been described as a Benjamin Graham deep value style investor due to buying securities that are distressed and fundamentally unwanted in nature.

To illustrate his idiosyncratic style relative to the rest of Wall Street, one can easily check out his equity holdings in his recent SEC 13F filing. As I look down the list of his holdings, I notice several trends:

- the top 10 holdings account for 76% of his equity holdings (very high concentration).

- Of $29 Billion in assets under management, only $10 billion was allocated to equities, representing ~34% of assets. That is a telling sign in a world where many funds (either by mandate or by choice) are fully invested in equities.

- They invest in stocks with: activists involved (LNG, the activist is Icahn), potential buyouts in the future (TWX buyout which is closing, FOX being pursued as I write this), dirt cheap stocks on a multiple basis (AGN cheap on free cash flow multiple), and convertible debt (Tesla and Theravance Biopharma convertible debt).

Finally, any summary of Seth Klarman's investment philosophy would be remiss without mentioning his book, "Margin