Seth Klarman is nobody's idea of a fast-buck, quick-change investor. Since helping to found Boston-based Baupost Group in 1982 with $27 million pooled from four families, he has emulated prototypical value-investment role models like Warren Buffett and the late Benjamin Graham. He buys underpriced equities and securities of bankrupt or distressed companies and usually steers clear of leverage and shorting, though last year he made very profitable investments in credit protection and recorded his best-ever annual return (52 percent). Klarman credits his "very strong team" and stresses that he doesn't even consider himself a hedge fund manager in the traditional sense (though he accepts only legally qualified investors and charges a 20 percent performance fee). Yet his nearly 20 percent annualized returns rival those of larger peers who take more risks. A professorial 51-year-old who manages $12 billion today, Klarman has an economics degree from Cornell University and an MBA from Harvard Business School but traces much of his success to two Wall Street mentors, Max Heine and Michael Price.
How did you decide value investing was for you?
I was fortunate enough when I was a junior in college — and then when I graduated from college — to work for Max Heine and Michael Price at Mutual Shares [a mutual fund founded in 1949]. Their value philosophy is very similar to the value philosophy we follow at Baupost. So I learned the business from two of the best, which was better than anything you could ever get from a textbook or a classroom. Warren Buffett once wrote that the concept of value investing is like an inoculation- — it either takes or it doesn't — and when you explain to somebody what it is and how it works and why it works and show them the returns, either they get it or they don't. Ultimately, it needs to fit your character. If you have a need for action, if you want to be involved in the new and exciting technological breakthroughs of our time, that's great, but you're not a value investor and you shouldn't be one. If you are predisposed to be patient and disciplined, and you psychologically like the idea of buying bargains, then you're likely to be good at it.
What traits in Heine and Price influenced you?
Max Heine was great at not looking at what something was called, what its label was. He looked at what it actually was. For example, back in the late '70s, Mutual Shares was buying the bonds of bankrupt railroads, and I think a lot of people would have said, "They're bankrupt," and "Who needs railroads?" Max and one of his partners knew how many miles of track the railroad had, what the scrap steel on the track could have been sold for and which railroads might have wanted pieces of those networks. They also knew what the real estate rights above the terminals were worth.
Michael Price was fabulous at pulling threads. He would notice something, and then he would get curious and ask questions. And one thing would lead to another thing, and that would lead to another thing. I remember a chart that Michael made of interlocking ownership of mining companies that was an extension of a thought where one good idea led to another and had the potential to lead to many more if the threads kept being pulled. That was a great lesson — to never be satisfied. Always be curious.