The new Warren Buffett

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Published: 03rd April 2015
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Margin of Safety – now there’s an ironic title for an out-of-print book that is so sought after that rare second-hand copies sell for £1,330 on Amazon. Ironic because there is clearly no margin of safety for anyone who pays that price. After all, it’s not the secrets of the text that generates the value. That can’t be, since a PDF of the book is available as a free download. And it’s doubly ironic because Margin of Safety, the book, is an investment text with the core message that much of the time investors forget all about margin of safety, the concept, when they buy and sell stocks and bonds.

The book in question is written by Seth Klarman, a 56-year-old US fund manager, who is often dubbed “the new Warren Buffett”. That’s partly because of his investment principles and partly because of his success. More about his principles in a moment. As to his success, Mr Klarman runs Baupost, a fund management company that he launched in 1982 with a pool of $30m (£18.6m) mostly provided by staff at Harvard Business School, where he had just finished an MBA. Today, Baupost manages $29bn and, along the way, has added $16bn in value, making it the fourth most successful hedge fund ever, according to LCH Investments, which monitors these things.

Now, how can we conflate Warren Buffett with a guy who apparently runs a hedge fund, vehicles that are the antithesis of Mr Buffett’s ‘value-investing’ approach? First, because real hedge funds stick to Mr Buffett’s – and Mr Klarman’s – prime rules of investing: the first rule is not to lose money and the second rule is not to forget the first. And that’s consistent with the idea that a proper hedge fund is also an absolute-return vehicle, which much prefers the strong likelihood of a small return to the slim possibility of a fat return. The preference for such caution owes much to the fact that both Mr Buffett and Mr Klarman started out looking after the wealth of families who valued the preservation of capital above all else.

Second, because they seem alike in manner and style. Mr Buffett, who works out of Omaha, Nebraska, because it’s his home town and it keeps him well away from the distracting hurly-burly of Wall Street, is famous for his avuncular style and folksy aphorisms. Ditto Mr Klarman – well, almost. He was born and raised in Baltimore, where, as a boy – and like Mr Buffett – he developed a keen interest in horse racing. Now he is based in Boston, where he lives in its most affluent suburb (close to John W Henry, the owner of Liverpool football club) and has an office that sounds much like Mr Buffett’s: “I don’t have a Bloomberg terminal on my desk and I don’t care. There’s just giant piles of paper that are in danger of falling on me; oh, and several bottles of water, always well hidden.” (With Mr Buffett, it’s cherry-flavoured Coke.)

Third – and more serious – even before either started managing money, both had a great grounding in the principles of value investing. Mr Buffett cut his teeth in the early 1950s at Graham-Newman, the fund management firm run by Benjamin Graham, the British-born New Yorker who is caricatured as ‘the founding father of investment analysis’. Mr Klarman could not start at such rarefied levels (Graham died in 1976), but before Harvard he worked for two years at Mutual Shares, a value-orientated unit trust run by Max Heine, who had been much influenced by Graham. Mr Klarman says that what he learnt at Mutual Shares (code: TESIX), which, incidentally, is now owned by Franklin Templeton Investments and has a continuous record since 1949, eclipsed what he learnt at Harvard.
Small wonder then that he chose ‘margin of safety’ as the title of his book. It’s borrowed from the title of the final chapter of probably the best known – and arguably the best – investment text of all time: The Intelligent Investor, Graham’s accessible work on investing, which in its most recent – and still available – 1973 edition was updated by Mr Buffett. In it, Graham said: “When confronted with a challenge to distil the secret of sound investment into three words, we would venture the motto, margin of safety.”
Another way of playing it is via distressed debt, an asset class that currently grips hedge-fund managers. You can see why. Banks the developed world over hold loans they don’t want either because they are going bad or because they want to shrink their balance sheets in order to contrive an improvement in their capital ratios. As a result, they sell packages of loans at deep discounts to their book value – quite possibly, too deep. Mr Klarman has been an expert in this field since the 198os. He spotted then profited from the flaws in the US junk-bond market in the late 198os and much more recently – 2011 – opened an office in London to capitalise on opportunities in European debt and real estate markets, which, he reckons, are trading at bargain levels. This is a more obscure market for UK private investors, but they could play the theme through shares in Investors Chronicle favourite Real Estate Credit Investments (RECI), which runs a portfolio of mortgage-backed securities.
Much rarer – though often lucrative – are opportunities in corporate spin-offs, when companies split themselves into two, distributing shares in the new companies pro-rata to shareholders. Often, what’s created is a glamorous side that investors want and a hum-drum side that they regard as peripheral. Chances are, it will be too much bother for institutional investors to assess the value of the peripheral side, so they will dump their shares, few questions asked. That’s where the possibility of value arises.

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To find out more about RECI Real Estate Credit Investment visit their website or to read the full article click here

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