Klarman Held 50 Percent Cash Amid Scarce Value

Klarman Held 50 Percent Cash Amid Scarce Value

by Michael IdeJanuary 27, 2014, 12:20 pm

Investment funds are usually looking for cash, so it was something of a surprise (although not to ValueWalk readers) when Baupost Group LLC founder Seth Klarman announced that he was giving money back to his investors for the second time in just a few years. The problem is that, as a dedicated value investor, Klarman found himself holding onto cash and increasing exposure to gold because not much else looked attractive, according to several people who attended a recent speech given by Klarman.

Nearly half of Baupost’s AUM was cash

Before sending cash back to investors, Baupost nearly passed the $30 billion AUM mark this year, compared to just $27 million in 1982, and during that time Klarman has always made a point of focusing on long-term value creation. Sometimes that means holding onto cash so that he could seize opportunities as they arose.

“To assume the investment opportunity sets that are available to you today are as good (or better) than those that will present themselves next week, next month, next quarter is naive and you need to have cash to take advantage of those new investment opportunity sets,” said Klarman, according to Raymond James chief investment strategist Jeffrey D. Saut, who attended Klarman’s talk at the Grant’s Investment Conference.

So having cash on hand was not, by itself, a major problem. But Baupost had $14 billion in cash as of late October 2013, nearly half of its total portfolio, and Klarman didn’t expect to find enough interesting investment opportunities to put that money to work.

Klarman states that he “worries top-down but invests bottom-up” meaning that, while worrying about the economic environment in which his investments operate, he still selects his investments solely based on their own intrinsic value.

Gold as a hedge against inflation: Klarman

You might wonder why Klarman wouldn’t just look for equities that seem like they will keep going up in today’s bull market, but he tries to find unique investments that almost necessarily move differently than the market, which don’t need to be hedged because they are so fundamentally cheap. On top of that, he doesn’t trust that the QE experiment will end well.

“There will be a day when the world looks very different, so when we rack our brains – how we might protect ourselves – we’re looking for cheap optionality. Rates will be higher at some point,” he said, according to a transcript of the speech. “I don’t know where rates would be if not for all this QE and bond buying and expansion of the Fed balance sheet. So what we come up with over and over is gold, the one place you probably want exposure.”

Klarman notes that gold is a hard asset to own because it can be challenging to convince clients that. He acknowledges that he has had some spirited conversations with clients on this topic, but generally answers that he would feel stupider not owning it and subsequently needing it.

Klarman argued that it’s possible investors will lose interest in Treasury bonds with their low yields, and if they do dump Treasuries, gold will get a big boost. While this argument goes beyond using gold as a purely defensive measure, the fact that the supply of above-ground gold can only grow so fast is part of what makes this investment “the best hedge” against the worst-case scenarios of rising inflation and other fallout from tapering. However, his hedge fund is not obsessed with “hedging”, since Baupost’s investments are so cheap that hedging is unnecessary.

In terms of reform, Klarman regrets that little action was taken on this front. He stated, “It’s almost embarrassing that five years after the greatest credit bubble in history, that we recreated the exact same behavior through government and monetary policy…that we’ve made no progress whatsoever when we almost went down the tubes.”

Klarman advocated merciless repetition of the same idea to the point of boredom in order to get the message through. One can see that when one looks at other recent remarks by Klarman.

Finally, Klarman discussed his secret sauce. So what is it?  Klarman says there is no magic to what they do at his Baupost Group, simply a lot of common sense.