Sunday, May 27, 2012

Thoughts from Seth Klarman, a Legendary Investor

In 1934 Benjamin Graham and David Dodd introduced the term “Margin of Safety” in their book "Security Analysis". Warren Buffet built an investment empire on these concepts and principles.

In 1991, Seth Klarman of Baupost Limited Partners wrote "Margin of Safety – Risk-Averse Value Investing Strategies for the Thoughtful Investor". The book became an investment classic and Mr. Klarman became an investment superstar.

The following excerpts from his book are worth considering during this period of economic uncertainty.
  • On Value Investing: “The most beneficial time to be a value investor is when the market is falling.” and ” Value investing is simple to understand but difficult to implement….The hard part is discipline, patience, and judgment. Investors need discipline to avoid the many unattractive pitches that are thrown, patience to wait for the right pitch, and judgment to know when it is time to swing.” 
  • On Inflation and Deflation: “ Value investing can work very well in an inflationary environment” but deflation is “a dagger to the heart of value investing”…”in a deflationary environment, if you cannot tell whether or when you will realize underlying value, you may not want to get involved at all.” 
  • On Diversification: “An investor is better off knowing a lot about a few investments than knowing only a little about each of a great many holdings” and suggests that as few as ten to fifteen different holdings should be suffice for diversification.
  • On Buy and Hold Investing: “Some investors buy and hold for the long term, stashing their securities in the proverbial vault for years. While such a strategy may have made sense at some time in the past, it seems misguided today” and “Given the geopolitical and macro-economic uncertainties we face in the early •1990s and are likely to continue to face in the future, why would abstaining from trading be better than periodically reviewing one's holdings?”
  • On Investment Fads: “All market fads come to an end” however “It is only fair to note that it is not easy to distinguish an investment fad from a real business trend” but “Investing is serious business, not entertainment”.  

Sunday, May 20, 2012

An Amazing Road Biking Tour Provides a Diversion from the Investment Process

This past Friday, I had the good fortune to participate in the Annual Carmel, CA to San Simeon, CA Century Bike ride for the first time. This informal one-day event started 41 years ago when a father and sons traveled this route by bicycle.   This year, 179 bikers joined the tour (the oldest rider is 78 years old) and enjoyed amazing views of the Pacific Ocean, traveling through the Big Sur area and several good climbs called “the whammies”.

Having toured across the U.S. by bicycle in the past, riding this route with many fellow bikers was an amazing experience.  Many thanks to all the bikers on the ride, to everyone that helps keep the Pacific Coast route in such great shape and to Jack McGlynn who coordinates the ride (this was his 35th year of riding the route as well!)

Sunday, May 13, 2012

A Trading Blow-up at JP Morgan Chase Highlights Their Risk Management Issues

A $2.3 billion trading loss announced by JPMorgan Chase on Thursday (with perhaps another $1bilion or more to come) has so far resulted in 1) a 9.3% decline in its stock on Friday, 2) a credit rating downgrade by Fitch Ratings  - citing concerns about the firm’s risk management, 3) Standard & Poor’s placing the firm’s rating on negative outlook - noting that the loss was “not consistent with what we have viewed as the company’s sound risk management practices” and 4)  increased scrutiny by a variety of government regulators.  CEO Jamie Dimon said the trading mishap was “flawed, complex, volatile, poorly reviewed and poorly monitored “and consisted of “many errors, sloppiness and bad judgment”.  Federal Reserve Bank of Dallas President Richard Fisher’s reaction to the incident was “At what point do you reach a size you don’t know what is going on beneath you?”

Many of the “too big to fail” banks, including JP Morgan, continue to struggle with lower trading volumes, contracting fees  and a lack of trust by many players outside of the world of finance. While this trade may not present “systemic risk” to the global financial system (although it reinforces the view that some bankers are gamblers rather than financiers), it decreases the confidence level in some of the system’s participants.