Baupost Year-End Letter Cliffs Notes: Klarman Channels Dalio, Interior Decorating, Hot Nerd Burns

Now That's What We Call An Investor Letter! Vol. 1!
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By Hedge Funds [CC BY 3.0], via Wikimedia Commons

By Hedge Funds [CC BY 3.0], via Wikimedia Commons

Earlier this week, Andrew Ross Sorkin offered us a peek at what Baupost Group chief Seth Klarman is thinking these days. In short, he’s thinking that President Trump is going to be a disaster, that his fellow investors are burying their heads in the sand about this, and that passive investing is just the latest thing to prove efficient markets theory will never be borne out by inefficient realities.

Oh, but there’s more. So much more. Nineteen long, dense pages of it, in which Seth Explains It All. Without further ado, a taste:

Last Year Made No Sense

Sayeth Klarman: 2016 was a tale of two years. Neither of them made sense.

As of mid-August, $13.4 trillion of debt worldwide (largely sovereign) traded at negative interest rates, a mystifying and unprecedented circumstance in which bondholders willingly obligate themselves to pay interest to issuers for the privilege of tying up their capital for a significant interval while still bearing the risk of default…

Investors were willing to overlook political uncertainty and a slow-motion banking crisis in Italy, including the real prospect of a Euro-skeptic political party taking control. Days later, tranches of Saudi Arabian debt, including a 30-year offering at 4.5%, were even more oversubscribed, despite an oil price slump that has devastated the Saudi economy and upended its fiscal situation. And the following week, Austria (Austria!) floated a 70-year issue that was gobbled up despite paying a paltry 1.5% coupon….

Anyone who bet on “lower for longer” will have locked in “inadequate for longer,” an insufficient return not just for a while but for a career, for a lifetime.

Things did not get better in 2016: Part Deux.

The market’s post-election gyrations are emblematic of what markets do: they attempt to forecast the future and reflect it in daily securities prices. But markets are hardly efficient; they frequently overshoot. As Barron’s columnist Kopin Tan pointed out in late November, “the stock market is behaving as it Trump will fulfill only the campaign promises it likes but conveniently break all those promises it doesn’t like.”

Seth Klarman Really, Really Doesn’t Like Donald Trump

Incredibly, calling the president “shockingly unpredictable” and dedicated to pursuing policies that history has already taught us don’t work isn’t the half of Klarman’s take down of the man who will lead us for the next three years, 11 months and one week. The normally media-shy Klarman made a point of coming out against Trump publicly back in August, and “nothing he has done or said since then has changed my mind.”

On November 8, the U.S. electorate basically gave the middle finger to the establishment and the status quo by narrowly electing Donald J. Trump to the presidency of the United States….

As a student of history, I know that democracies are fragile and cannot be taken for granted. Democratic norms are crucial for the perpetuation of democracy. Political stability depends on the rule of law and adherence to precedent….

A good leader demonstrates intelligence, curiosity, patience, self-discipline, consistency, humility, and self-awareness. He or she displays an abiding respect for facts, maintains a nuanced view of issues, and forms judgments based on a careful assessment of the whole picture. He readily acknowledges mistakes and strives to learn from them. A strong leader is measured; she offers a clear and consistent message and says the same thing again and again, both in public and in private, in every form of communication, to every constituency. If new facts or a considered reassessment of a situation causes her to change her mind, she communicates this, too, and explains her revised thinking. She isn’t focused on winning at all costs while crushing her opponents; she seeks win-win outcomes and common ground. She meets her obligations and commitments; her word is gold. The erratic tendencies and overconfidence in his own wisdom and judgment that Donald Trump has demonstrated to date are inconsistent with strong leadership and sound decision-making.

That’s pretty bad, but Seth Klarman, he’s not done with the leader of the free world just yet.

No matter how well he may perform as president, I know I won’t forget the hate-filled rants, threats to democracy, and simple lack of decency that accompanied his campaign. The end – even winning the presidency – does not justify those means….

Strikingly, the tweeting has continued, including patently false claims and personal attacks that have no place in a serious administrator. We know from the seminal work of behavioral psychologist Daniel Kahneman, author of “Thinking, Fast and Slow,” that when addressing a problem, the first thought that comes into our minds is often not the best answer we will ultimately arrive at. Our “fast” brain comes up with its best approximation of the answer to a problem, but our “slow” brain often has the last laugh. This raises the question of whether it makes sense to tweet… anything. Especially for a president.

Oh Yeah: Seth Klarman Doesn’t Like The Travel Ban Anymore Than The Ninth Circuit, Either

We are proud to have a diverse workforce where we all come together to serve our clients. In the face of growing intolerance during and after the recent presidential campaign, we will stand with every Baupost employee who faces discrimination or hostility.

Seth Klarman Has Been Reading Ray Dalio’s ‘Principles’

You wouldn’t think that the Oracle of Boston and the Hyena of Westport have much in common. At least, you wouldn’t after reading Klarman’s savaging of the kind of macro investing that Dalio specializes in.

Macro investing is really hard…. The difficulty of top-down investing is nicely illustrated by the stock market’s response to the 2016 election result. Before Election Day, the markets generally rallied when polls were strong for Clinton, and fell when Trump’s chances seemed to improve. Thus, those who forecast a Trump win could reasonably have expected an accompanying market sell-off. But a sharp rally ensued instead. In macro investing, investors must be correct not only about the anticipated event, but also about now the market will react to it.

But then, I mean, just look at these meditations.

At Baupost, we practice humility and moderation, aware of how much we don’t and can’t know…. We watch our competitors’ actions in order to learn. It would be foolishly arrogant to always assume that we’re right and they’re wrong. We strive to build self-awareness, the ability to recognize both our own skills as well as our limitations. We consistently attempt to learn from our mistakes and draw enduring lessons…. An investment firm must create an environment of debate and truth-seeking…. At Baupost, all ideas go through the same meat-grinder of process.

Baupost Is Both Not A Hedge Fund And Is The Best Hedge Fund

While we think of ourselves as a value-oriented investment partnership, our primary competitors are hedge funds, a category we sometimes get lumped into…. We believe we have real edges as a firm, such as our truly long-term focus and flexible investment mandate (including the ability to hold significant cash balances.)…. Most of our competitors feel intense pressure from their clients to generate short-term performance and have trouble maintaining a truly long-term perspective….

Some Further Uncharitable Thoughts On Efficient Markets Theory

The emotional swings of human nature virtually ensure that markets will always be inefficient. The efficient market hypothesis has always appealed to academics, but it has never described the real world…. The more others believe in market efficiency, the more inefficient the markets will eventually become.

In Which Seth Klarman Gingerly Brings Up The Topic of Succession

Klarman assures his investors that he intends “to continue to lead Baupost and oversee its investments for a long time to come.” Alas, he is mortal, and after 34 years of running the place he’s got to start thinking about the future. To that end, he’s designating a number two: public investment group head Jim Mooney.

I have asked Jim Mooney to take on the role of president of Baupost…. Sharing the load will undoubtedly enable me to extend my tenure…. We have also established a position of authority separate from mine that will advance Baupost on its path toward long-term organizational progression and permanence.

Baupost 4eva!

A Visit to the Baupost Cafeteria

In early December, we again held a company breakfast to honor those employees who have achieved milestone anniversaries. For each employee who reaches his or her 10th anniversary with Baupost, we commission a professionally drawn caricature to display on the wall of our lunchroom here in Boston. This year, we added seven new caricatures, bringing the total on the wall to 40; five of these veterans have clocked more than 20 years at Baupost!

I don’t know about you, but I think I’m going out for lunch today.

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