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- [00:01]
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- [00:35]
Seth Klarman
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- [01:39]
Seth Klarman
this is Masters in Business
- [01:41]
Global Payments / Chase Sapphire Reserve Advertiser
with Barry Ritholtz on Bloomberg Radio.
- [01:45]
Barry Ritholtz
What can I tell you about this week's banger? Seth Klarman, legendary value investor out of Boston at the Bow Post 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.
- [02:31]
Seth Klarman
So great to be here. Thank you Barry.
- [02:33]
Barry Ritholtz
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?
- [02:56]
Seth Klarman
So I was always drawn to investing. Even when I was a very young kid, I was interested in the 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 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.
- [03:56]
Barry Ritholtz
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 John Hopkins and nyu. Was it just simply thumbing through the sports pages literally to the next set of pages were the stock pages.
- [04:25]
Seth Klarman
That's literally the numbers on the page attracted my attention. I would say. 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 route for the Baltimore sun papers. I had a snow cone stand in my driveway 1 summ. 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 stock market. I bought my first stock with some bar mitzvah money when I was around 10 years old.
- [05:29]
Barry Ritholtz
Well it couldn't have been bar mitzvah money.
- [05:31]
Seth Klarman
It wasn't bar mitzvah money then it was a present. But then bar mitzvah money continued to be piled in.
- [05:36]
Barry Ritholtz
10 years old and I bought, I
- [05:38]
Seth Klarman
bought a share of Johnson and Johnson.
- [05:40]
Barry Ritholtz
Uh huh. Still have it.
- [05:41]
Seth Klarman
Do not still have it. It split three for one. But ultimately I presumably have traded that in for something else that I that I like better.
- [05:49]
Barry Ritholtz
So, so let's fast forward a little bit to the Bell Post origin story, which isn't that far ahead. You're only 25. The urban legend is you co found Bell Post. But reality, you were brought in to manage money for the four founding families. Still at 25, that, that's a kind of shocking thing. Oh, we have all this wealth. Let's bring in this kid to run our portfolio, right?
- [06:17]
Seth Klarman
And I would say the same thing if I were. If I were in their seats, I would wonder, how does this kid know how to do that? So I, 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 and 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 Porvoo, the PO of Balpost, was my real estate professor. And he and some friends were selling Channel 5. He was a big investor in that. The Metromedia largest sale at the time of a TV station to Metromedia. 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.
- [08:12]
Barry Ritholtz
So eventually you become the lead partner there. I don't know if CEO is the right term.
- [08:19]
Seth Klarman
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.
- [08:41]
Barry Ritholtz
Ended up with over half. That's amazing. 40 something years later, now, much less.
- [08:47]
Seth Klarman
Because I'm a big believer in sharing the pie with my team.
- [08:51]
Barry Ritholtz
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 were you, what did the markets look and feel like in 82 when I imagine most people were still pretty bearish.
- [09:28]
Seth Klarman
Yeah. So 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 success. The challenges, 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 very, you know, 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 lay up hand. But what, what ended up happening was, you know, 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 situation bottom up by 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.
- [10:39]
Barry Ritholtz
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 under 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?
- [11:10]
Seth Klarman
I would tell you I think every investor needs to be a student of history that 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 1929-1933 and a great Depression that lasted close to a decade. What, what must that have been like for the people at the time? How would one handle oneself if you're going into a period like that, that we know that even the greatest acclaim value investor of all time, Benjamin Graham, nearly went broke twice during that era. So it's I think 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 price 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 today, we have a backdrop of very expensive market and a bit of euphoric conditions. And 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 yes, 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.
- [13:12]
Barry Ritholtz
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 Hein. Who affected you the most over the years, who still affects you.
- [13:30]
Seth Klarman
Right. So I think reading Ben Graham was certainly a major influence on me. I think as he, 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 like 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, that Warren probably had a certainty of the idea that he would compound capital over a long period of time. And I think that that is something that Graham probably gave Warren 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 be not on the playing field. And that's a huge advantage. So I think that Grand Dot is kind of a North Star. It kind of is a place where you can stay focused on what's something 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 could 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 that's an underpinning that lets you follow a value investment strategy.
- [15:36]
Barry Ritholtz
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, 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?
- [16:07]
Seth Klarman
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. I. What I really thought was, I'm just updating Intelligent Investor for modern examples and 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. 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.
- [17:24]
Barry Ritholtz
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? And a handful of value geeks bought it, but no one else.
- [17:42]
Seth Klarman
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 my maybe 7,000 copies. I ended up buying a bunch of them back from HarperCollins 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's 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.
- [19:13]
Barry Ritholtz
So in 2023, the seventh edition of Security Analysis, Ben Graham's Framework for Investing, was edited by you, and in a lot of ways, substantially rejiggered. How different is this version than Ben Graham's? I mean, obviously markets change the economy so much is different than when he was writing. How did you approach this?
- [19:39]
Seth Klarman
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 you know, 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 making we're moving Grandma Dodd into a different era. The thing that's beautiful about Grandma Dodd, it was written 100 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 were uncovered. 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, 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.
- [21:46]
Barry Ritholtz
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.
- [22:10]
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- [23:42]
Barry Ritholtz
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 Bow Post 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 0809 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?
- [24:32]
Seth Klarman
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 the uncertainty of an economic decline that could have pretty epic proportions. As it turned out, it probably was. 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 hundred 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.
- [25:24]
Barry Ritholtz
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.
- [25:55]
Seth Klarman
The team worked heroically and we were able to raise about. We were able to raise very significant capital within a quarter.
- [26:04]
Barry Ritholtz
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?
- [26:22]
Seth Klarman
So we already were an established firm. We'd been up and running for, for, you know, a couple of decades by then. So I had a team in place and they were deeply knowledgeable, experienced distressed
- [26:37]
Barry Ritholtz
asset expertise in the group.
- [26:40]
Seth Klarman
We, not everybody on the team has that, but a very high percentage of the team has that. And people at Bell Post 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 in the private investments especially love when we're super busy in the public markets and we call them into work on a distressed credit.
- [27:18]
Barry Ritholtz
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?
- [27:36]
Seth Klarman
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 battlepost 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 fincos, the financial arm of General Motors and Chrysler and Ford, and that 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 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, you know, 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.
- [30:20]
Barry Ritholtz
So I'm kind of fascinated by the dynamic tension between fundamental bottoms up research on a creditor equity by creditor 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?
- [30:56]
Seth Klarman
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 for selling is 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 like, and I'm not a mountain climber or you know, 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 know that. 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 incredibly, 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, 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.
- [33:11]
Barry Ritholtz
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?
- [33:41]
Seth Klarman
So you're nailing it with your question. You've covered all the parts of holding cash. I think that cash can be valuable optionality especially just imagine you have a reasonably concentrated portfolio. A large position or two comes off the books. Should you put it to work in a nanosecond or can you wait till something really interesting comes along? So that's the origin of us holding cash. Positions would come off and we'd hold some cash until something great came along.
- [34:07]
Barry Ritholtz
But not just a couple of percent you've throughout history.
- [34:11]
Seth Klarman
But with concentrated positions, we have 5 and 10% positions in the portfolio. When two or three of them come off, cash goes from next to nothing to 15 or 20%. So that's the origin. That's how we got started with the idea that we would hold some cash from time to time. I think though I would accept that I almost certainly made a mistake in that holding cash to that extent. There were times when we 30% cash and even higher and I viewed it as valuable optionality. The problem is the optionality didn't pay off very well for big swaths of time, especially since 08 that with suppression of interest rates and the Fed printing a lot of money in the US running large deficits, that we really haven't had a serious downturn in almost two decades. And so that amount of cash became painful. I think that the argument for holding cash, when a client says I'm not paying you to hold cash, my answer would be I'm not getting paid to hold cash. I'm getting paid to use my judgment on when to deploy the money and in what to deploy it. So I feel like that's right. But I felt like I was not optimizing for our clients in an environment that stopped being as volatile as the one I'd grown up in. So we changed our strategy somewhat. We made our liquid books more liquid, especially our public equity book where we used to own companies with, you know, 500 million or billion dollar market cap. Now we own much bigger market cap holdings on average. That liquidity in the public equity book has made us feel better that we can pivot on a dime with a large percentage of our book. So we don't need as much cash to be able to take advantage of a sudden an opportunity that shows up
- [35:56]
Barry Ritholtz
a lot of larger equity funds when they're sitting in cash, they use the spider etf. So roll into spy so they're not falling behind a benchmark and then it's deep and liquid. If they want to deploy that in a momentum market, is that a bad strategy or are you just adding risk to avoid the. The cash risk?
- [36:21]
Seth Klarman
We think about our benchmark as an absolute return, not a relative return. So we're not very interested in keeping up with the market. Market's going to do what it does. And especially a market this concentrated in a handful of names. And it's really been that way for a number of years with the bank stocks and the handful of names that carry the market often, not always, but often are expensive, overpriced. So we just think that's not the right way to think about it. We want to earn an absolute return. We want to beat inflation by hundreds of basis points. And if we're doing that, we're not going to worry about whether that's ahead of the market or behind. I think over the fullness of time, a good absolute return strategy is going to beat the market, too.
- [37:03]
Barry Ritholtz
So let's talk about some of the opportunity sets that you look at. You mentioned equities. We talked about distressed debt. You also make real estate investments. Investments, other private investments. How do you think about capital allocation across these buckets? Are you using percentage terms or are you just purely opportunistic?
- [37:25]
Seth Klarman
So we came about these through our experiences. We didn't just wake up one day and said, let's be in four different areas. Rather, we noticed that over the transom, interesting private investments were coming into the portfolio. We're getting phone calls. Hey, would you ever. Would you inject capital into this business? Or would you buy this portfolio of venture investments from a failed company that needed to sell them? Or would you buy 22% of a company owned by largely 78% by a large Middle Eastern company and 22% up for sale? Would you buy that? Well, at three times EBITDA, maybe you would. So literally, by seeing examples one at a time, bottom up, we started to figure out that there were more things to focus on than just the public equity markets. And so we got drawn. One of our specialties, I think, is distressed credit. And we became really good at it. We've got smart people. We're very patient. Sometimes there's nothing to do, there's nothing distressed. Other times there's an avalanche of opportunity. And so we wait patiently in all of our areas. We build teams of versatile people so that our team is basically a generalist team. And the same person can work on a private investment, can work on a credit investment, can work on an equity investment. Real estate is a bit more specialized than that. But even within real estate, many people have a land person and a hotel person. We don't do that. Everybody works on everything. So we have the team in place and we're able to respond bottom up. That the bottom up approach to opportunity I think lets us allocate capital better than if we were doing a top down that I think a lot of people will look at historic returns. We'll say the expected return from owning private equity will be mid teens or upper teens. The expected return from venture capital will be better than that. And we don't do that. We really don't know what an asset class is going to do because we think that's very time specific and very valuation dependent. Rather we see, we see what's available right this second. And by looking bottom up, opportunity after opportunity, I think we can paint a really clear picture. So right this second, real estate's been in tough shape since COVID especially commercial office and people started working from home and that hasn't fully returned. And in certain markets especially there's, there's too much space and a lot of people that have been in real estate have not done that well. A lot of people got in at the wrong vintage and a lot of properties have become structurally obsolete. So that sounds like a mess. Why would you touch it? But it also means the competition is hardly looking. And so we think there are opportunities right now. For example, in assisted living, which is population is aging, you can make a very strong case for fundamentals. Rents haven't moved up in years and I think there's probably pent up growth in rents to come. And Covid was obviously a giant problem because any facility tended to empty out as people pulled their relatives out to save their lives during COVID understandably. And a lot of newly built facilities from that era from 2021, 2022 never got filled and a lot of them have run into bankruptcy or financial distress. So it's been an opportunity to build a position in area with strong fundamentals. The past is the past. But moving forward it looks like they're going to have real ramp for rents and for occupancy. And we're seeing opportunity here and there to add to a portfolio of assisted living. Similarly, we like certain parts of the real estate office market, especially some outside the major cities, in a few select markets though, and we're seeing more in other sub markets within real Estate. Real estate is, as you know, is a giant market. It's probably got a market cap around as big as the public equity market and so but, but it has a very different capital structure in terms of who are the players and how much capital can they tap and the opportunity set. So real estate's interesting. We like looking at it and we have a team that's agile and can deploy capital quickly when something comes along in private investments, it's opportunistic and there have been some things to do lately as capital's pulled back from private investments, for example in energy and midstream that's led to some things that have trickled down to us that we've been very excited, very high return and well hedged. So downside protected. So we're just opportunistic investors. I would say though using my top down lens that you mentioned, we are certainly nervous. It's. We're in a bit of an economic boom, possibly an inflationary boom. Who knows what's going to happen with the strait of hormones moves and the end result of that and the demand for AI is and AI related investments is so all encompassing. It's almost as if the market has said we want the AI winners. We're going to dump anything that looks like an AI loser and maybe we'll throw out some babies with the bathwater and we don't care. And AI agnostic, we're not looking at that either. So we think there's opportunity even in some larger cap high quality equities that are being thrown out as people want to make the high returns from speculating in AI.
- [43:01]
Barry Ritholtz
Right now we're going to talk a little bit about the current environment in greater detail shortly. I just have to ask one more question about contrarian approaches and opportunity for value investors. The risk is always a value trap. Sometimes the market's negative judgment is actually right. How do you prevent something that's cheap from suckering you into something that's on the way to becoming much, much cheaper?
- [43:33]
Seth Klarman
Yeah, you're asking something that we've had a bit of a painful lesson in over time which is cheap is not really a strategy. We tend to look at our investments not as are they at a discount from what we think they could be worth, but rather what is our expected go forward return from here. And we tend to also ask that our investments have catalysts and that when we lay out a thesis in an investment conversation it's very clear. Not, not just how undervalued is it, but why is this going to work, what's going to drive it and if we can't make an argument for why it should turn around in the next year or two, it might be nice that it's trading at a five year low, but that doesn't mean it's not going to be at a seven year low and a ten year low. And so our time horizon is not that long. We can't just hold things that don't perform for five or 10 years. I think very, very few people can do it today and we think that's not holding our feet to the fire. All organizations need to demand accountability from their teams. So we always are asking ourselves and really I think changed our approach a little bit where we're asking a different question about what is going to drive this, the success of this investment rather than just letting cheap being enough, it's not enough.
- [44:52]
Barry Ritholtz
Very, very interesting. Coming up, we continue our conversation with Seth Klarman, CEO and Portfolio Manager at the Bao Post Group, discussing the state of investing in today's environment. I'm Barry Richard Halts. You're listening to Masters in Business on Bloomberg Radio.
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- [46:22]
Seth Klarman
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- [46:30]
Seth Klarman
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- [46:54]
Barry Ritholtz
I'm Barry Ritholtz. You're listening to Masters in Business on Bloomberg Radio. My extra special guest today is Seth Klarman. He is the CEO and Portfolio manager of Value Investing. Really Legend. The Balpost Group. The Firm manages about $22 billion in client assets. We've touched briefly on things affecting today's environment. Price of oil, inflation. We have a Middle east war. We're still dealing with a new set of tariffs. It seems like every week there's a different macro headache. How do you think about the current environment? Is it something that has to be dealt with but sort of compartmentalized? Is something that has to be dealt with and compartmentalized or do you just look at it as yet another input into fundamental values?
- [47:53]
Seth Klarman
So I think AI is a sea change and that I'm not a tech guy and I not a personal user at the cutting edge of technology, but I've spent a huge amount of time, I think that the advent of AI has forced me and probably everyone to just add more time to their day to stay current that I've never seen a technology with this kind of importance and potential game changing magnitude. So I read everything I get my hands on. I listen to a lot of podcasts as well. I read a lot of books and magazine articles as well. I'm consumed because even though I don't think Baupost as a value firm is going to find too many ways to to get long AI exposure, I think that we don't want to not, we don't want to be behind the curve. We don't want to not know what we don't know. And so the team is doing a fabulous job thinking about AI, thinking about ways to incorporate it into our processes, but also especially thinking about the implications of AI on our portfolio companies. So I think we have found ways to have a little bit of long exposure in things, for example, like data centers where we own a few private investments at what we think is a very considerable discount to where data centers tend to trade. We're not sure what the right discount is or we're not really sure what the right long term cap rate is, but we think owning at a significant discount is a Good thing. So we have some exposure. But mostly we're trying to own a portfolio where we have avoided AI losers and maybe occasionally we found something that market thinks is an AI loser that we think isn't. And to otherwise have things with ancillary exposure to AI where we can turn into AI winners but not pay much for the privilege. So it's a piece of what we do in the meantime. Obviously you referred to tariffs and the volatility of the President and this administration. There are things coming out of left field all the time. Some of it is policy, some of it is distraction. I think maybe deliberate distraction. And it's very hard to deal with that. I think most investors, and I too have said I need to make a mental note of it. I need to think about who I want to vote for next time there's an election. But I also need to not get distracted by this. And most of it doesn't end up mattering on an investment by investment basis. So it is a time of tremendous change. High degrees of volatility. And you see the volatility, the stock by stock volatility is unbelievable that when they love a stock they can't get enough of it and it goes through the roof. And when they turn on a stock, it gets clobbered. And so the individual stock dispersion is very high while the overall market volatility is actually quite low.
- [50:50]
Barry Ritholtz
Really, really interesting. Let's talk about another distraction and what it might mean. We're recording this a couple of days before the Space X ipo. It'll broadcast a couple of days after the Space X ipo. This is not only a giant trillion dollar valuation, but it's got a lot of hair on the deal with this tiny float and the NASDAQ waving the rules to put it into the queues. How do you look at an event like this in terms of the overall gestalt of the market is. I know the old line is they don't ring a bell at the top, but at a certain point, how do you perceive something like this? Does it trouble you?
- [51:40]
Seth Klarman
So my compliance team is very clear that I can't talk about individual securities. And we own, we own no Space X privately or in any other form. What I would say to you is I share your sense of that. This is the kind of bell that might ring at the top. It is an unprofitable company. In aggregate, it is an enormous valuation. I think we all, we both read in the paper this morning the Goldman estimates of what growth would have to be in Some parts of their business like 100x in order to justify the current price. Long period of time for a long period of time. And those projections have a way of not happening. It is, it's not impossible, but it's hard. I think that, that it is. The. I think investors might be missing just how much money is being sucked out of the system between large IPOs. This won't be the last one. OpenAI and Anthropic are coming and there's a ton of other IPOs that are stuck in institutional investors portfolio portfolios that also they'd love if they could get them off at any point then the float might be tiny today, but you have a large number of shareholders private investments. We read again this morning that 10 or 15% of some endowments, entire endowment is in the one name, Space X. So they're going to want to sell, employees are going to want to monetize and go from being wealthy on paper to wealthy in in a bank deposit. And so that's a lot of stock for sale and we have to sell that stock. While apparently Google and Facebook need more money and where OpenAI and Anthropic need more money and utilities need more money to power and chip companies need to build new factories in America there's so much demand for money. And I think we're in a vulnerable place where ultimately supply and demand for money determines the cost of capital. And that's true in a bond market and it's in effect true in the stock market. So we might be looking at some supply, demand, excess where prices soften just because there's so much supplier of securities and the need to monetize is so great by these private companies.
- [54:02]
Barry Ritholtz
So let's talk about another imbalance between supply and demand through history. But because Baupost has been around for over four decades, you've traded and invested through and survived all sorts of different market regimes. Inflation, disinflation, the dot com bubble, the financial crisis, QE and ZURP Covid and more recently the return to, let's just call it normalized interest rates. Has anything changed since 1982? Is it just the same careening from one crisis to another? Or do things eventually sort of moderate, sort of. Do we learn from these experiences what's the same, what's different?
- [54:54]
Seth Klarman
I think that all investors should be students of history as we talked about. And I think we know that over the course of history there are cycles that you're going to have a cycle where you're at war and then another cycle where people are tired of war and you have peace for a while. At some point you have peace long enough that people forget how bad war is and you end up in another war. And you have those similar cycles, whether it's the government spending and inflation and deflation, that sort of thing, even the nature of debt. That debt feels great when nobody's asking you to pay it back. And when interest rates are low, at some point debt becomes pernicious and a giant problem. So I think we're likely to always see those cycles at least as long as humans are in charge of markets. How do you navigate it? I think you navigate it by realizing that you may not see the cycle with clarity while you're in it. But you know there are cycles. You know that what is seems to be true today for all time probably won't be true for all time and hold on to that. So again, it goes to the idea of holding inconsistent ideas in your head. At the same time, this is both true and likely at some point to become less true or untrue. And you don't, you don't know exactly how. So how do you, how do you hold the portfolio? You diversify when things are up a lot and become more expensive and the go forward return is low. You take profits, you trade out when things are out of favor so badly that the returns look high. Maybe there's a time to step in and buy during a period when others are dumping. So I think it's that stay focused on the bottom up. Remember broadly the weather. So when you go camping you don't not prepare appropriately for stormy days, not just in the mountains but in the financial markets. And look outpost protects on the downside as best we we can by doing deep fundamental analysis, by knowing our names unbelievably well, by not being afraid to sell them when the price is up and the same way same as we buy more when the price is down by finding securities that are maybe more senior in nature, whether in public or private markets and by macro hedging the portfolio to an extent because we know that those rainy days are going to happen. And so we're buying macro protection when vols are low and people, people think nothing bad is going to happen. So we can sell that at a gain both because the price moved and because volume moved up during a stormier moment in the markets.
- [57:22]
Barry Ritholtz
So we now have a new Fed chair and that's a great leaping off point to talk about a lot of skepticism broadly, but you've been pretty skeptical about Fed policy since the financial crisis. How do you think rates have affected investors? What's been the impact on. On behavior? And are we at a point now where rates have more or less normalized? How do you look at the present environment?
- [57:51]
Seth Klarman
You know, I believe in people taking responsibility for their actions. I believe that we are a healthier system when there's a reckoning for excess and for, you know, egregious speculation and for over leverage. So I kind of hated that the Fed took rate. I totally understood why the Fed took rates down to zero after the great financial crisis and that it was really the only way to hold things together, give time to heal. But by leaving rates there for an extra decade after there was no crisis, I think we stoked a problem. We sort of incented speculation and maybe disincentivized responsibility. And so we got some of that. We saw that firsthand in 2022 when the market had gone higher and higher and higher. You had those SPACs and all kinds of garbagey companies trading at very high prices, the meme stocks. And then it blew up in 2022. A lot of stocks down, you know, 50, 70, 80, 90, 95%. And that's what happens when you get that kind of unregulated speculation. I think today we are back speculating. We're speculating in an era that in an area that feels more legitimate, it's hard to say exactly what's going to happen with the continued development of AI, with the possibility of AGI coming and what that will mean. We don't know whether it's going to lead to massive unemployment, when it's going to lead to incredible prosperity, or whether it's going to create even more dispersion in the economy between the people who are doing well and the people are not doing well. The K shaped economy. And that's a real source of concern. So there's always going to be that kind of uncertainty. I think what we should agree is that there's going to be a path that Nobody today in 2026 could say with any precision what things are going to look like in two or four or 10 years. And the dilemma with that is people are paying very high prices as though the future is extremely predictable and clear when obviously, given what's going on, it is anything but that.
- [60:05]
Barry Ritholtz
So you're a big Boston guy and you mentioned you were a big fan of the sports pages and all the statistics. What do you think of what's going on in sports these days? The Celtics didn't, didn't go as far as some people thought we're now knicks are up 2:1 in the finals. How are you looking at basketball? What do you like in sports these days?
- [60:30]
Seth Klarman
So my two biggest sports passions are baseball and I'm a small owner in the Red Sox and horse racing. And I've been fortunate to have some really high quality thoroughbreds over the years. And we won a few races Belmont Stakes weekend, not the Belmont, but a few other stakes races this past weekend. So those are my favorite sports. I thought the Celtics season was disappointing. They played so well the first three quarters of the season and sadly, when their superstar Jayson Tatum came back, I think it got them out of their game where they were introducing younger players into the mix. They were passing the ball a lot and really winning in an exciting way. So maybe the chemistry just didn't go as well as they had hoped. And then when Tatum got hurt right at the end of the playoffs, we bowed out. I think sports is great. It's a place where Americans, of blue Americans and independent Americans and red Americans can all root for the same team and can be excited about a sport and can do it in a way that's gracious and accept winning, but also accept losing. Sports is a great equalizer and a great unifier. So I love sports. It serves a lot of positive purposes in a society. It's a little crazy because we're rooting for strangers we've never met who represent our city. But it is a powerful way that I think also can unite a city.
- [61:57]
Barry Ritholtz
So. So baseball this year just seems to be so odd. The Mets are having a hard time. The Red Sox, I have no idea what's going to happen with them this year. What do you think about what's happening in baseball in 2026?
- [62:13]
Seth Klarman
Yeah, I think that it is partly as small numbers that we've only played 60 or 65 or 70 games. So there's still a lot of season season to go.
- [62:23]
Barry Ritholtz
But that. That's a third of a season.
- [62:24]
Seth Klarman
It's a third of a season. But statistics, you know, it.
- [62:27]
Barry Ritholtz
Things can mean reversion will eventually catch up.
- [62:30]
Seth Klarman
Is that in the same way that, I mean, all of us have to decide whether we believe on hot streaks or not? Right. It looks like a thing, but in fact, is there really a shooting streak or is it simply. And. And to every good shooter, you. You get a little overconfident, start taking worse shots. It's when.
- [62:49]
Barry Ritholtz
And then the defense collapses when you
- [62:50]
Seth Klarman
take high points percentage shots and you've taken them consistently. So I, I think that, that baseball will always Surprise you. It's a perplexing game that what you drew up on paper doesn't happen, but it's. It also doesn't happen in the locker room that the players can't understand. I could hit last year and now I can't hit. And part of it is that the opponents adjust, that if you're a rookie and you're Roman Anthony and you come up and you hit.300 for two months, he's hurt, but the pitching figures out your weak spots and they make you look bad. And then you. You adjust and you make the pitchers look bad. So I think there's that perpetual back and forth between defense adjusting and then offense adjusting, and where it ends up determines who goes in the hall of Fame.
- [63:41]
Barry Ritholtz
Really, really interesting. You very famously kept a low profile in a business that has historically rewarded publicity. Was that a conscious decision? Was that a strategic approach? And why be a little more public these days?
- [64:07]
Seth Klarman
So I'm probably a little bit more introvert than extrovert. So I not looking to be on TV or in the papers. I also think a lot of the work we do is better off when everybody isn't looking to copy our investments, that if you want to accumulate a stock, you're better off. If everybody doesn't know that you're trying to do that, you're going to get a better price, like in any business transaction. That said, we've never been. We're not a recluse. You know, everybody knows where we are. Everybody knows members of our team. We're very, very well known on the street. You just don't see me on TV talking about it all the time. I don't know why that's a bad thing. It feels to me like a good thing.
- [64:47]
Barry Ritholtz
And beyond investing, you and your wife have been very active philanthropists. The Klarman Sell Observatory. There's been just a run of different things. How do you think about philanthropy? How do you think about capital allocation? And how do you make sure that the money that are going to these causes is being well spent?
- [65:09]
Seth Klarman
On our third date, my wife and I were taking a walk on Cape Cod on the beach, and she said we were just getting to know each other, obviously. Third date, she said, what do you hope for in your life? I said, I hope that if I'm able to provide for my family and there's still resources beyond that, I want to give back. And that just comes from my fundamental view. I guess it's how I was raised, that some of us are going to be fortunate and be in that position at a time when not everybody is. And it's both. It's both a privilege and a responsibility to give back. It's. It's. You can't take it with you, and you probably don't want to. I mean, it's not a good look to spend it all ostentatiously in your lifetime. That's not my nature. So I've always, I think, been working to make money to give away, and it's what keeps me focused today that I love investing as a puzzle, but I love knowing that if we do it well, we serve our clients, I'm going to have money that I'm going to be able to add to what we give to charity. Charity is a calling. It feels very, very important to me personally. I think this is a broken world. There are all kinds of problems from. From climate change to poor education system to challenges to democracy that threaten America the way you and I have known it our whole lives. And the country that I want, you probably want future generations to grow up. And America's been amazing for me. I have been such a beneficiary of growing up in this country and having unprecedented opportunities that if I was in another country, I wouldn't have had. So I'm grateful for that. I want to make sure everybody has the same chance. But we also have to be realistic. The American dream is broken for a lot of people. People are less likely today to be able to say that their kids and grandkids will be able to eclipse them. And I think we need to restore that, and we have a lot of hard work to do. So our philanthropy goes into many different areas. Some, as you said in science, some in terms of thinking about democracy and making sure that the system holds. Some in terms of health care, some to the universities that were good to me and my wife. We spread it pretty well because we believe that a lot of causes will come together to be able to lift up people throughout the country. One of the. One of the things we do is a music instrument fund because our son is extremely musical. And it reminded us that every kid that is passionate about music should have a chance to have an instrument. We also do capital gifts in institutions throughout Massachusetts. In some of the harder hit towns during COVID or just economically depressed areas, there's just not a lot of money there. So kind of as a value investor, I'm seeing an opportunity to refurbish the civic center or this library in a small town in Massachusetts. And it just feels great to know that the people in Pittsfield will have as good a library as the people in Boston.
- [68:26]
Barry Ritholtz
Really interesting. All right, let's jump to our favorite questions we ask all our guests, starting with, who are your mentors who helped shape your career?
- [68:37]
Seth Klarman
So I worked for Max Heine and Michael Price at Mutual Shares right out of college, and that was an incredible couple of years. And they. And I stayed in close relationship with them over the years. They've been great friends and mentors to me. I think Warren Buffett, who I didn't know until later in my career, but reading about Warren, reading his annual reports, and reading his old shareholder letter was very inspiring and also reminded me of the idea of quality companies, which was not something that Grandma Dodd talked that much about, but was something that Warren taught us all about, I think. So they were the people I would list as mentors. And then I also developed mentors who were kind of peers that I had a tiny firm. I didn't get trained officially at any big Wall street firm, but I was able to form friendships with people that ran other funds. And some of those people, probably, you know, all of them, but somebody like Richard Perry or somebody like Frank Rosens or somebody like Paul Singer have all been mentors in various ways over the years in a way that, you know, hopefully I've provided something to them as well. But I think finding kindred spirits out there makes all of us both enriched by the experience, but also wiser along the way.
- [69:54]
Barry Ritholtz
Good. Good answer. Let's talk about books. You mentioned you're a big reader. What are you reading now? What are some of your favorites?
- [70:02]
Seth Klarman
So right now I'm finishing Lloyd Blankfein's memoir. I'm also reading Michael Poland's latest book about consciousness, which is really interesting. It's. It's combined some things I'm intrigued by, including the idea of what plants are doing up to. Plants turn out to be a lot more conscious and a lot more aware of their environment than you might think when you just walk by them and think of it as lawn. There's a lot more going on with plants. I love history. My favorite is probably Battle Cry of Freedom, about the Civil War. I read a fair amount of everything. I love the Red Queen and Evolutionary Biology. I'm a pretty good reader of fiction as well. Biography, memoir, across the board.
- [70:50]
Barry Ritholtz
You mentioned podcasts. What are you listening to or what are you watching and streaming these days?
- [70:56]
Seth Klarman
My favorite streaming, I think this was. This is maybe a golden age of TV streaming. We loved Pitt on the Pittsburgh General Hospital Emergency Room. And it's just A remarkable series. Noah Wiley, but also a great surrounding cast is just off the charts. We also loved shrinking.
- [71:18]
Barry Ritholtz
Yep, that was a lot of fun. Final two questions. What sort of advice would you give to a recent college grad interested in a career in investing?
- [71:29]
Seth Klarman
Yeah, first of all, go somewhere that you would want your capital invested if you wouldn't put your money there, don't go there and don't be afraid to go somewhere out of favor. If two years ago you would ask me, I would have said, well, biotech is hitting lows every day as though there's never going to be any new drugs discovered or anything good happening in that sector. I would have said, I'm not sure, I'm not an expert on that stuff, but take a close look now it's on fire. A lot of takeovers, a lot of people are doing really well. I think, think that it pays to be a little contrarian and go somewhere where they're going to be mentors to you, where they're willing to be patient with you, where they're not going to just expect you to make money the first six months you're there. That's where you're going to be able to build a career and learn a lot.
- [72:17]
Barry Ritholtz
Final question. What do you know about the world of markets? Risk investing today would have been useful to know 40 plus years ago when you were first getting started.
- [72:29]
Seth Klarman
Yeah, I've thought about that. It's a really good and hard question. And what I think is I wish I knew the importance of the economic engine that Silicon Valley is, that American creativity and ingenuity is. It's why I worry so much about the bad things happening in our country like, like that are threatening our democracy. The ability to try and fail, the ability to innovate, the desire to innovate. These startups unleash the passion of brilliant, hardworking people who want to cause their dream to happen. And that is the driver of this economic engine that keeps not only winning but keeps outpacing everywhere else in the world. Israel has maybe a mini version of that, but it hardly exists in the rest of the world. Certainly doesn't exist in Europe much. And it's really sad because the opportunity that is present for young Americans to help, to dream and to start something is just an amazing engine for their lives, for their communities, for future philanthropy, for tax receipts. It's across the board. And I wish I'd understood it better. I would have owned some venture capital in my foundation. I would have been recommending that, that institutional portfolios diversify into at least a piece now. Venture capital is the last thing a value person is going to say. It's a bargain. You should go long. But I do think that as a value investor, maybe too much paint by numbers. I wasn't focused enough on the engine that is venture capital.
- [74:07]
Barry Ritholtz
Fascinating. Seth, thank you for being so generous with your time. We have been speaking with Seth Klarman. If you enjoy this conversation, well, be sure and check out any of the 651 we've done over the previous 12 years. You can find those at Apple, iTunes, Spotify, Bloomberg, YouTube, wherever you get your favorite podcasts. I would be remiss if I didn't thank the crack team that helps me put these conversations together each and every week. Alexis Noriega is my video producer. Sean Russo is my researcher. Anna Luke is my podcast producer. I'm Barry Ritholtz. You've been listening to Masters in Business on Bloomberg Radio.
- [74:57]
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