Transcript: Seth Klarman, The Baupost Group
The transcript from this week’s MiB: Seth Klarman, The Baupost Group, is below.
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MASTERS IN BUSINESS
Guest: Seth Klarman, CEO and Portfolio Manager, The Baupost Group
Host: Barry Ritholtz
[07:14] BARRY RITHOLTZ: This week on the podcast, I’m not fooling around when I say an extra special guest. Seth Klarman is CEO and portfolio manager at the Baupost Group, a Boston-based private investing firm founded in 1982 with only $27 million in client monies. Over the past four decades that has grown to $22 billion. Seth is known for his patient, risk-averse, and contrarian approach to finding deeply discounted securities in all sorts of areas — equities, distressed debt, real estate, wherever. He authored the book Margin of Safety, a highly sought-after and rare 1991 publication, as well as editing the seventh edition of Security Analysis. Seth Klarman, welcome to Bloomberg.
[09:05] SETH KLARMAN: It’s so great to be here. Thank you, Barry. Thank you so much. I’ve been looking forward to this forever.
[09:12] BARRY RITHOLTZ: 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?
[09:30] 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. Of course I had no idea what I was doing, but I was paying attention from quite an early age. I didn’t really ever develop a career plan, but I was drawn to the stock market. I’m drawn to puzzles, Barry. I like doing word puzzles every day, solving math puzzles. I still subscribe to something called a math puzzle book published by Dell. And the stock market — it’s a big puzzle. The financial markets are a big puzzle. How does it all work? How does the performance of the companies get reflected in stock prices? And how can an investor outperform everybody else? All of that is a piece of what drew me in.
[10:31] 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 Johns Hopkins. Was it just simply thumbing through the sports pages, literally to the next set of pages where the stock pages were?
[10:59] SETH KLARMAN: That’s literally it — the numbers on the page attracted my attention. I think my origin story is a lot like other people who ended up in the investing business, like Warren Buffett, like Todd Combs, like many others. Drawn to small businesses, wanted to make money. I was delivering a newspaper route for the Baltimore Sun papers. I had a snow cone stand in my driveway one summer. I mowed lawns, I raked leaves, I shoveled snow. I did little carnivals for the neighborhood kids. I sold candy at religious school on Tuesdays and Thursdays because the kids were starving after school. 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 the stock market. My first stock was some bar mitzvah money when I was around 10 years old.
[12:03] BARRY RITHOLTZ: Well, it can’t have been bar mitzvah money.
[12:05] SETH KLARMAN: It wasn’t bar mitzvah money then, it was a present, but then bar mitzvah money continued to be. So really, 10 years old, and about a share of Johnson & Johnson.
[12:14] BARRY RITHOLTZ: Still have it?
[12:15] SETH KLARMAN: Do not still have it. It’s split three for one, but ultimately I presumably have traded that in for something else that I like better.
[12:23] BARRY RITHOLTZ: So let’s fast forward a little bit to the Baupost origin story, which isn’t that far ahead. You’re only 25. The urban legend is you co-founded Baupost, but in reality you were brought in to manage money for the four founding families — still at 25. That’s a kind of shocking thing: “Oh, we have all this wealth, let’s bring in this kid to run our portfolio.”
[12:51] SETH KLARMAN: Right. And I would say the same thing. If I were in their seats, I would wonder, how does this kid know how to do that? 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 who were already in the business of making investments. They wanted to build kind of an institutional structure, a 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, real economic uncertainty, stagflation at some point and getting worse, Treasury bond yields getting higher and higher. So it was a really fraught moment. They wanted to make sure that the money they had not only was kept intact but was accounted for — clip the coupons, 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 Poorvu, the P-O of Baupost, was my real estate professor. He and some friends were selling Channel 5 — he was a big investor in that, the 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 of 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 some more things to do with the money.”
[14:46] BARRY RITHOLTZ: So eventually you become the lead partner there.
[14:50] SETH KLARMAN: I don’t know if CEO is right, Tom. 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, 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.
[15:16] BARRY RITHOLTZ: You ended up with over half. That’s amazing, 40-something years later.
[15:20] SETH KLARMAN: Now much less, because I’m a big believer in sharing the pie with my team.
[15:25] BARRY RITHOLTZ: It 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 did the markets look and feel like in ’82, when, I imagine, most people were still pretty bearish?
[16:03] SETH KLARMAN: So I think Malcolm Gladwell would look and say 1982 was an interesting time to start an investment firm — that was certainly a wind at your back in terms of being successful. But, and you know this, how it works in the markets is you had no idea you were at the beginning of a long bull market. What you felt was the market hadn’t done that well for a long period of time and people were very skeptical about it. And this is probably a valuable insight: you could 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 layup hand. But what ended up happening was, we tried to make money apart from the market. We weren’t buying an index — indexes weren’t big then anyway. We were buying idiosyncratic situations, looking for bottom-up mispricing, and that led to a building 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.
[17:13] BARRY RITHOLTZ: Really interesting. So given you were 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?
[17:45] SETH KLARMAN: I would tell you, I think every investor needs to be a student of history. It may not repeat exactly, but it certainly rhymes, and it is very valuable to understand — especially financial history for an investor. What were the worst moments? How did we go through a market crash in 1929 to 1933 and a Great Depression that lasted close to a decade? What must that have been like for the people at the time? How would one handle oneself if you were going into a period like that, when we know that even the greatest acclaimed value investor of all time, Benjamin Graham, went broke twice during that era? So it’s 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, from time to time. Today we have a backdrop of an expensive market and a bit of euphoric conditions. Is that dangerous? Dangerous. But we’re also at the cusp of maybe a groundbreaking new technology. So over the 40 years it’s always been some of both — 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. You might have a top-down view, you might say, yeah, it 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. 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.
[19:47] 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 Heine. Who affected you the most over the years? Who still affects you?
[20:08] SETH KLARMAN: Reading Ben Graham was certainly a major influence on me, as he has been on essentially everybody in the value investing community. And then Warren Buffett, the real-life practitioner of Graham. 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 on individual companies and not worry so much about the overall market, the willingness to hold cash, and concurrently 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. To watch Warren Buffett do that — I’ve realized now that Warren probably had a certainty of the idea that he would compound capital over a long period of time. And I think that is something that Graham gave Warren, and 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 not be on the playing field. And that’s a huge advantage. So Graham and Dodd is kind of a North Star, a place where you can stay focused on what something’s worth. You can ignore the herd. You can ignore the siren song of growth at any price, of exciting new technologies and exciting IPOs. You can 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. That’s the underpinning that lets you follow a value investment strategy.
[22:11] BARRY RITHOLTZ: So you mentioned downside risk, and you referred to before, you began in 1982. Less than a decade later you publish Margin of Safety, 1991. What led 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?
[22:44] SETH KLARMAN: 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 & Row, maybe, before Harper Collins. She had seen some of my client letters and said, you seem like you’d be a good writer, and you’re a smart guy, maybe you’ll have something to tell the audience. What I really thought was, I’m just updating The Intelligent Investor for modern examples and a contemporary market, decades since that book was written. 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 didn’t think I would make money from writing the book — as you, as an author, know, we get like a buck fifty an hour. But it’s a great feeling, and it’s a ton of work, but 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.
[23:59] BARRY RITHOLTZ: 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?
[24:16] SETH KLARMAN: It’s somewhere in between. What happened first was 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. It had maybe a very tiny second printing — I think they printed 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, is it was bought significantly by competitors who used it to train their teams. And that was also — is that what I wrote it for? I don’t mind, but the starting goal, 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. 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. Because it didn’t get republished, it developed a bit of a cult following, and that’s kind of amusing and interesting to me. 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.
[25:47] 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 re-jiggered. How different is this version than Graham’s? Obviously the market’s changed, the economy — it’s so much different than when he was writing. How did you approach this?
[26:13] 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 edit on my own. As editor, we didn’t follow the process you might follow, because we kind of thought of Security Analysis as the Bible, and we thought we should leave it alone. What we should do is have modern-day expert investors write commentary about the different chapters and sections of the book. So that’s what we did. 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. 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. So I felt like we were moving Graham and Dodd into a different era. The thing that’s beautiful about Graham and Dodd is it was written a hundred years ago, give or take, and it was written during the Depression. Things that made sense in a depression haven’t made sense every day since then, because we haven’t been in a 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 to the modern day. We expanded it to cover some topics that weren’t covered. It certainly has more international investing, which wasn’t really focused on by Graham. It talks about some private investments, some of the changes in financial markets, the latest manias and fads and all of that, but also the changes in market structure, changes in asset classes that have come into existence. All of that 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 it wouldn’t be very useful to people.
[28:20] BARRY RITHOLTZ: Really, really interesting. 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.
[SEGMENT BREAK]
[29:10] BARRY RITHOLTZ: My extra special guest this week is Seth Klarman. He’s CEO and portfolio manager at the Baupost 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 ’08-’09 financial crisis, you raised about $4 billion, and the research I read had you 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?
[29:57] 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. 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 uncertainty of an economic decline that could have pretty epic proportions. As it turned out, it certainly was the worst decline since the Great Depression, and it stands out as 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.
[30:49] BARRY RITHOLTZ: So Bear Stearns, if I’m remembering correctly, was spring of 2008, Lehman was September of ’08. That’s not a lot of time from there until March ’09, when everything really bottoms. 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.
[31:20] SETH KLARMAN: The team worked heroically, and we were able to raise very significant capital within a quarter.
[31:29] 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 were their marching orders? How did everybody operate in that period of absolute turmoil and mayhem?
[31:47] SETH KLARMAN: So we were already an established firm. We’d been up and running for a couple of decades by then. So I had a team in place, and they were deeply knowledgeable — experienced distressed-asset expertise in the group. Not everybody on the team has that, but a very high percentage of the team has that. People within Baupost are like versatile athletes. We’re nimble, we’re agile, and we cross-train — 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. The same with us: 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 in to work on a distressed credit.
[32:42] BARRY RITHOLTZ: So a big chunk of capital, very aggressively deployed, in a moment in time when so many people seemed 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?
[33:01] 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. It wasn’t like that at all. It was the same cerebral, methodical, painstaking environment that we have every day. We see things trading at lower prices, and we notice that, and we look at the fundamentals. Everything we do at Baupost 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. People are worried maybe it could have a blip or a problem for a while, but people aren’t really doubting that there’s something there. As the economy got worse, people may have started to doubt more and more, and prices come in more and more. So we were literally able to buy mortgage securities, residential mortgage securities; we were able to buy corporate debt, especially the auto finance companies, the financial arms of General Motors and Chrysler and Ford. And when Lehman goes broke, that had pieces within its capital structure that got very interesting. So we were seeing all kinds of things, and we were kind of kids in a candy store. Sadly — right, it’s a tough time, people are hurting — but also, as an investor, you’re a fiduciary and you’ve got to put money to work to benefit your clients. So in every case we were stress-testing: hey, if the world got even worse, if this turned out to be 1933, will this investment be okay? That’s the only place where we’re making decisions — 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, for everybody, is you want to make sure that 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 make sure you’ll have capacity to buy when the best opportunities become available and your competitors are sidelined. That’s the moment 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, 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, you did it in a little bigger size.
[35:45] BARRY RITHOLTZ: So I’m kind of fascinated by the dynamic tension between fundamental bottoms-up research on a credit-by-credit or equity-by-equity basis versus the top-down. 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, was either responding or over-responding to the top-down environment. How do you look at that sort of environment?
[36:21] SETH KLARMAN: There are several layers to that. First of all, 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 it wasn’t just nervousness 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 it. So you have forced selling all over the place. And forced selling — 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. I’m not a mountain climber or a big hiker, but if you’re going to climb a mountain, you want to look bottom-up: is this the right trail, is it safe, do I have my equipment, am I prepared? And then you also want to have the top-down view — what’s the weather? What if it suddenly gets snowy up there, if the wind’s 60 miles an hour, how am I going to handle that? So you kind of want to have in your head the weather forecast. 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 unprecedented technology, 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 you still need your eye on the weather in the financial markets. That means, where’s GDP going, what’s the national debt, where’s inflation going to take us? I always have an eye on that stuff, but 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.
[38:36] 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?
[39:06] SETH KLARMAN: You’re nailing it with your question. You’ve covered all the parts of holding cash. Cash can be valuable optionality. Just imagine you have a reasonably concentrated portfolio, and a large position or two comes off the books. Should you put it to work in a nanosecond? Or can you wait until something really interesting comes along? That’s the origin of us holding cash — positions would come off and we’d hold some cash until something great came along. But not just a couple of percent. 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. That said, I would accept that I almost certainly made a mistake in holding cash to that extent. There were times when we were 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 in a period of suppression of interest rates and the Fed printing a lot of money in the U.S., running large deficits, where we really haven’t had a serious downturn in almost two decades. So that amount of cash became painful. The argument for holding cash, when the 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 $1 billion 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 opportunity that shows up.
[41:21] BARRY RITHOLTZ: A lot of larger equity funds, when they’re sitting in cash, use the SPDR ETFs, rolling 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 cash risk?
[41:46] 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. The market’s going to do what it does — and especially a market this concentrated in a handful of names, which it’s really been for a number of years, with the big names that carry the market often, not always, but often expensive, overpriced. We just think that’s not the right way to think about it. We want to earn 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.
[42:28] 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, other private investments. How do you think about capital allocation across these buckets? Are you using percentage terms, or are you just purely opportunistic?
[42:50] SETH KLARMAN: So we came about these through our experiences. We didn’t just wake up one day and say, let’s be in four different areas. Rather, we noticed that over the transom, interesting private investments were coming into the portfolio. We were getting phone calls: hey, would you inject capital into this business? Would you buy this portfolio of venture investments from a failed company that needed to sell them? Would you buy 22% of a company owned largely, 78%, by a large Middle Eastern company, with 22% up for sale? 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. One of our specialties 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. In all of our areas, we built teams of versatile people, so that our team is basically a generalist team, and the same person can work on a private investment, a credit investment, 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. The bottom-up approach to opportunity lets us allocate capital better than if we were doing it top-down. A lot of people will look at historic returns and say the expected return for owning private equity will be mid-teens or upper-teens, the expected return for venture capital will be better than that. We don’t do that. We really don’t know what asset class is going to do, because we think that’s very time-specific and very valuation-dependent. Rather, we see what’s available right this second. 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. People started working from home and that hasn’t fully returned, and in certain markets especially there’s too much space. A lot of people that have been in real estate have not done that well — a lot of people got in at a 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 that competition is hardly looking. So we think there are opportunities right now, for example in assisted living. The population is aging. You can make a very strong case for fundamentals. Rents haven’t moved up in years, and there’s probably pent-up growth in rents to come. 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. 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 an 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. 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 submarkets within real estate. Real estate, as you know, is a giant market — it’s probably got a market cap around as big as the public equity market — but it has a very different capital structure in terms of who the players are and how much capital they can tap, and the opportunity set. So real estate’s interesting. We like looking at it, and we have a team that’s agile and could 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 about — 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. We’re in a bit of an economic boom, possibly an inflationary boom. Who knows what’s going to happen with the Strait of Hormuz, and the result of that. And the demand for AI 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. 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 on AI right now.
[48:27] BARRY RITHOLTZ: 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?
[48:58] SETH KLARMAN: You’re asking about 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. When we lay out a thesis in an investment conversation, it’s very clear not just how undervalued it is, but why is this going to work? What’s going to drive it? If we can’t make an argument for why it’s turned 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. Our time horizon is not that long. We can’t just hold things that don’t perform for five or ten years. Very few people can do it today, and that’s not holding our feet to the fire. All organizations need to demand accountability from the teams. So we always are asking ourselves a different question about what is going to drive the success of this investment, rather than just letting cheap be enough. It’s not enough.
[50:18] BARRY RITHOLTZ: Very interesting. Coming up, we continue our conversation with Seth Klarman, CEO and portfolio manager at the Baupost Group, discussing the state of investing in today’s environment. I’m Barry Ritholtz, you’re listening to Masters in Business on Bloomberg Radio.
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[51:12] BARRY RITHOLTZ: My extra special guest today is Seth Klarman. He is the CEO and portfolio manager of value investing legend the Baupost Group. The firm manages about $22 billion in client assets. So we’ve touched briefly on things affecting today’s environment — the price of oil and 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? Or do you just look at it as yet another input into fundamental values?
[52:10] SETH KLARMAN: So I think AI is a sea change. I’m not a tech guy, and I’m not a personal user at the cutting edge of technology, but I’ve spent a huge amount of time — the advent of AI has forced me, and probably everyone, to just add more time to their day to stay current. 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. I’m consumed, because even though I don’t think Baupost, as a value firm, is going to find too many ways to get long AI exposure, we don’t want to be behind the curve. We don’t want to not know what we don’t know. 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. 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 what the right long-term cap rate is, but we think owning it 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 found something that the 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, like most investors, 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 stock volatility is unbelievable. 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. So the individual stock dispersion is very high, while the overall market volatility is actually quite low.
[55:06] BARRY RITHOLTZ: Really interesting. Let’s talk about another distraction and what it might mean. We’re recording this a couple of days before the SpaceX IPO. It’ll broadcast a couple of days after the SpaceX 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 indexes. How do you look at an event like this in terms of the overall gestalt of the market? 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?
[55:56] SETH KLARMAN: So my compliance team is very clear that I can’t talk about an individual security, and we own no SpaceX, privately or in any other form. What I would say to you is, I share your sense 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. We both read in the paper this morning that Goldman estimates what growth would have to be in some parts of their business — like 100x — to justify the current price for a long period of time. And those projections have a way of not happening. It’s not impossible, but it’s hard. 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’ portfolios that they’d love to get off at any point. 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 SpaceX. 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 a bank deposit. 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 OpenAI and Anthropic need more money, and utilities need more money for power, and chip companies need to build new factories in America. There’s so much demand for money. I think we’re in a vulnerable place, where ultimately supply and demand for money determines the cost of capital. That’s true in the bond market, and it’s in effect in the stock market. So we might be looking at some supply-demand excess where prices soften just because there’s so much supply of securities and the need to monetize is so great by these private companies.
[58:18] BARRY RITHOLTZ: So let’s talk about another imbalance between supply and demand through history, 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 ZIRP, 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 screaming from one crisis to another? Or do things eventually sort of moderate, do we learn from these experiences? What’s the same, what’s different?
[59:11] SETH KLARMAN: I think all investors should be students of history, as we talked about. Over the course of history, there are cycles. 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. You have those similar cycles whether it’s government spending, inflation and deflation, that sort of thing. Even the nature of debt — debt feels great when nobody’s asking you to pay it back, or interest rates are low. At some point that becomes pernicious and a giant problem. So we’re likely to always see those cycles, at least as long as humans are in charge of markets. How do you navigate it? 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 seems to be true today for all time probably won’t be true for all time, and you 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 know exactly how. So 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 do prepare appropriately for stormy days, not just in the mountains but in the financial markets. And look on the downside as best 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 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. So we’re buying macro protection when vols are low and people think nothing bad is going to happen, so we can sell that at a gain — both because the price moved, and because vol moved up during a stormier moment in the markets.
[61:38] BARRY RITHOLTZ: So we now have a new Fed chair, and that’s a great leaping-off point. There’s 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 behavior? And are we at a point now where rates are more or less normalized? How do you look at the present environment?
[62:07] 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, for egregious speculation, and for over-leverage. So I kind of hated that the Fed took rates — 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 incentivized speculation and maybe disincentivized responsibility. We saw that firsthand in 2022, when the market had gone higher and higher and you had those SPACs and all kinds of garbage-y 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%. That’s what happens when you get that kind of unregulated speculation. I think today we are back speculating, 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, or whether 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 who are not — the K-shaped economy. That’s a real source of concern. So there’s always going to be that kind of uncertainty. I think what we should agree on 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 ten years. And the dilemma with that is, people are paying very high prices as if the future is extremely predictable and clear, when obviously, given what’s going on, it is anything but that.
[64:22] BARRY RITHOLTZ: So before I get to my favorite questions, I just have two or three other questions I have to ask you that are a little more personal, starting with: 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 publicly stoic?
[64:54] SETH KLARMAN: So I’m probably a little bit more the introvert. I’m 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. 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’re not a recluse. Everybody knows where we are, everybody knows members of our team, we’re 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.
[65:38] 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’s going to these causes is being well spent?
[66:00] 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 are 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 a privilege and a responsibility to give back. You can’t take it with you, and you probably don’t want to. It’s not a good look to spend it all ostentatiously in your lifetime — that’s not my nature. So I’ve always been working to make money to give away, and it’s what keeps me focused today. I love investing as a puzzle, but I love knowing that if we do it well, we serve our clients, and 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. This is a broken world. There are all kinds of problems, from climate change to a poor education system to challenges to democracy, the threat in America to the way you and I have known it our whole lives, the country that I want — you probably want — future generations to grow up in. America has 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, and 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 the system holds; some in healthcare; 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 things we do is a musical 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 to 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. It just feels great to know that the people in Pittsfield will have as good a library as the people in Boston.
[69:16] BARRY RITHOLTZ: Really interesting. So there’s a question I want to end with before we do our final wrap-up, but there’s a question I want to ask, and we’ll just move it back a couple of beats, because that’s a tough answer to follow — and it’s just Boston sports. I feel obligated to ask during the finals. 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 go as far as some people thought. We’re now down two to one in the finals. How are you looking at basketball? What do you like in sports these days?
[70:06] SETH KLARMAN: So my two biggest sports passions are baseball — I’m a small owner in the Red Sox — and horse racing. I’ve been fortunate to have some really high-quality thoroughbreds over the years. 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. 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 had been introducing younger players into the mix, 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 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 accepts winning but also accepts 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 can unite a city.
[71:32] BARRY RITHOLTZ: 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?
[71:48] SETH KLARMAN: Yeah, I think it is partly small numbers, that we’ve only played 60 or 65 or 70 games, so still a lot of season to go. But statistics, you know, things can mean-revert, eventually catch up.
[72:06] BARRY RITHOLTZ: Is that the same way that — all of us have to decide whether we believe in hot streaks or not, right? It looks like a thing, but in fact, is there really a shooting streak, or is it simply…?
[72:19] SETH KLARMAN: And to every good shooter — you get a little overconfident and start taking worse shots. It’s when you take high-percentage shots and you take them consistently. So I think baseball will always surprise you. It’s a perplexing game, where what you draw up on paper doesn’t happen. And it also doesn’t happen in the locker room, where the players can’t understand, “I could hit last year and now I can’t hit.” Part of it is that the opponents adjust. If you’re a rookie like Roman Anthony, and you come up and you hit .300 for two months — he’s hurt now, but the pitching figures out your weak spots and they make you look bad, and then you adjust and you make the pitchers look bad. So 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.
[73:18] 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?
[73:27] 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. I stayed in close relationship with them over the years — they’ve been great friends and mentors to me. Warren Buffett, who I didn’t know until later in my career, but reading about Warren, reading his annual reports and his old shareholder letters, was very inspiring, and also reminded me of the idea of quality companies, which was not something that Graham and Dodd talked about that much, but was something that Warren taught us all about. So they were the people I would list as mentors. And then I also developed mentors who were kind of peers. 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 who ran other funds. Some of those people you probably know — somebody like Richard Perry, or somebody like Frank Brosens, or somebody like Paul Singer — have all been mentors in various ways over the years, in a way that hopefully I’ve provided something to them as well. Finding kindred spirits out there makes all of us both enriched by the experience, but also wiser.
[74:45] BARRY RITHOLTZ: 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?
[74:53] SETH KLARMAN: So right now I’m finishing Lloyd Blankfein’s memoir. I’m also reading Michael Pollan’s latest book about consciousness, which is really interesting. It combines some things I’m intrigued by, including the idea of what plants are 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, evolutionary biology. I’m a pretty good reader of fiction as well — biography, memoir, across the board.
[75:42] BARRY RITHOLTZ: You mentioned podcasts. What are you listening to? Or what are you watching and streaming these days?
[75:47] SETH KLARMAN: My favorite streaming — I think this may be a golden age of TV streaming. We loved The Pitt, the Pittsburgh general hospital emergency room. It’s just a remarkable series. Noah Wyle, but also a great surrounding cast, just off the charts. We also love Shrinking.
[76:10] 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?
[76:21] SETH KLARMAN: 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. Two years ago, you would have asked me, and I would have said, well, biotech is hitting lows every day, as though there’s never going to be any new drug discovered or anything good happening in that sector. I would have said, take a close look. Now it’s on fire — a lot of takeovers, a lot of people are doing really well. I think 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.
[77:08] BARRY RITHOLTZ: Final question. What do you know about the world of markets, risk, and investing today that would have been useful to know 40-plus years ago, when you were first getting started?
[77:21] SETH KLARMAN: I’ve thought about that. It’s a really good and hard question. 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 that are threatening our democracy. The ability to try and fail, the ability to innovate, the desire to innovate, the startups that unleash the passion of brilliant, hardworking people who want to cause their dream to happen — 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. It 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 institutional portfolios diversify into at least a piece. Now, venture capital is the last thing a value person is going to say is 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.
[78:58] BARRY RITHOLTZ: Fascinating. Seth, thank you for being so generous with your time. We have been speaking with Seth Klarman, CEO and portfolio manager of the Baupost Group. If you enjoyed 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.
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