Seth Klarman: Value Investing In Bull MarketsThe Acquirer's Multiple
According to CNBC (August 22, 2018) we are currently in the midst of the longest bull market in history, since World War II:
- The current bull market rally, which started March 9, 2009, became the longest one on record since World War II on Wednesday by avoiding a 20 percent or more decline, according to S&P Dow Jones Indices.
- The market has risen more than 300 percent since its low nine years ago. It surpassed the rally from 1990 to early 2000, which totaled 3,452 days.
With this in mind, Seth Klarman’s 1997 Baupost Shareholder Letter provided some guidance for value investors in dealing with turbulent markets, and extended bull markets, like the one we’re seeing today. Klarman says:
“I must remind you that value investing is not designed to outperform in a bull market. In a bull market, anyone, with any investment strategy or none at all, can do well, often better than value investors.”
Here’s an excerpt from that letter:
Value Investing in a Turbulent Environment
The most favorable position going into a sudden downdraft (if you could correctly anticipate one) is to hold market hedges and/or cash (or better still, short positions, but short sellers have been aging in dog years for a long time). We hold both, although never enough in a downturn, because both are costly.
Hedges, like any insurance, involve paying a premium. Premiums have skyrocketed in lockstep with the market’s surge over the past two years, and have risen even more in the current volatile environment. Cash provides protection in a storm and ammunition to take advantage of newly created opportunities, but holding cash involves the considerable opportunity cost of foregoing presently attractive investments.
Given the choice between holding mostly cash awaiting the periodic market tumble or finding compelling investments which earn good returns over time but fluctuate to a certain extent with the market amidst turbulence, we choose the latter. Obviously, we could not have earned the returns we have from investing, without investing.
The upside of the recent market episode is that many good bargains have become even better ones, and numerous attractive new situations have surfaced. We are selectively deploying cash into what we believe are wonderful, long-term values, and are also repositioning ourselves, adding to some positions while reducing or deleting others, to take advantage of the lay of the present landscape. The opportunity to invest more money at lower prices will certainly be to our long-term financial benefit.
If the financial markets remain turbulent and retrace some of their decade-long gains, I believe we will be in a strong position. Despite delivering good investment performance over the Fund’s first seven years of operations, I must remind you that value investing is not designed to outperform in a bull market. In a bull market, anyone, with any investment strategy or none at all, can do well, often better than value investors. It is only in a bear market that the value investing discipline becomes especially important because value investing, virtually alone among strategies, gives you exposure to the upside with limited downside risk. In a stormy market, the value investing discipline becomes crucial, because it helps you find your bearings when reassuring landmarks are no longer visible.
In a market downturn, momentum investors cannot find momentum, growth investors worry about a slowdown, and technical analysts don’t like their charts. But the value investing discipline tells you exactly what to analyze, price versus value, and then what to do, buy at a considerable discount and sell near full value. And, because you cannot tell what the market is going to do, a value investment discipline is important because it is the only approach that produces consistently good investment results over a complete market cycle.
You can read a collection of Baupost’s 1995-2001 shareholder letters here.
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Article by The Acquirer's Multiple