A friend sent me a video of a speech given by Seth Klarman at the Columbia Business School.

Klarmans hedge fund the Baupost Group has done over 20 a year since he founded the firm in !"#$ %ith only one do%n year. Also& Seth Klarmans boo' (argin of Safety) *is'+Averse ,alue -nvesting Strategies for the .houghtful -nvestor is also one of the best boo's -ve read on value investing. -ts currently out of print and selling for about /!&000 but - got a copy through my librarys intra library loan program. 1f all the articles2speeches2intervie%s of value investment managers this is one of the best speeches -ve ever %atched. Klarman discusses ho% he made over 3 times his money investing in 4nron debt& %hat his investment principles are& his thoughts on the investment manegment industry& %hy he doesn5t go short and %hy he uses derivitives. .his speech is not posted any %here else on the internet. 6ere is my summary)

Thoughts on Investment Manegment Industry .he investment (anegment industry is not set up to achieve mar'et beating returns. -nstead they are incentivi7ed to get big and act li'e asset gatherers. At the same time there is little incentive to ta'e ris' and deviate from the mean because if they stri'e out and underperform for even a short period clients %ill be lost 8uic'ly. -ts an enforced mediocrity 9if you %ant to get big :ust do %hat everyone else is doing and settle for average results;. Klarman said he %ould rather hold treasury bills then invest in many of the hedge funds out there. -f stoc's do !0 going for%ard and a hedge fund that charges 2 and 20 ta'es $ of your money in fees youve only got < left& plus its leveraged& holds illi8uid securities& etc. 6e %ould much rather get =.3 ris' free.

.%eedy Bro%n is todays manifestation of Ben:amin Graham ,alue investing is ris' aversion Baupost charges a ! percent management fee plus 20 percent of profits.

How Baupost Invests *ule >!) ?ont lose money. *ule >2) @ever forgot *ule >!. Baupost al%ays loo's for catalysts in its investments. -f you find a stoc' trading for 30 of %hat you thin' its %orth you %ant there to be something that %ill trigger it to reach fair value. Baupost %ill al%ays sell an investment as soon as it near their estimate of fair value. Baupost has analysts focused around the type of opportunityA Baupost has a spinoff

analyst& indeB fund deletion analyst& post ban'ruptcy analyst& distressed debt analyst and an analyst loo'ing at companies that are depressed because of a bad earnings announcement;. Baupost invest in) Both public and private distressed debt& *eal estate 9Baupost has done over 200 real estate deals including biding on *.C auctions;& C.S. and foreign e8uities& DB1s and ?erivatives. .he portfolio is =3 cash& 20 e8uities& around !< distressed debt& !! real estate& < private investments 9distressed debt& small DB1s& financial restructurings;& 0 in South Korean e8uities and a small in hedges. Baupost loo's at every merger& rights offering& privati7ation of government business& spin off& ma:or share repurchase& dutch auction tender& thrift conversions or anything else that could cause mispricings. Eost ban'ruptcy situations are a good place to loo' for bargains because people avoid them and dont understand them. A lot of good things can happen in ban'ruptcy such as terminate overpriced contracts or leases& shed eBtraneous business units or& deal %ith union problems or settle contingent liabilitiesA all under the protection of ban'ruptcy court. .hen all the debt holders have e8uity and they %ill %ant to sell. Baupost opened over !&000 savings accounts across the country to ta'e advantage of thrift conversions Baupost doesnt go short because unli'e going long %hen you can ta'e advantage of a drop in the value of an undervalued security by :ust buying more& if your short even though you may be right that its %orth less then the trading price you can still go bro'e. -ts %ay more ris'y and you can lose infinity. .hin' tech stoc's if you shorted them in "<& "# or even "" you %ould have been 'illed. -t %or's for a %hile and then the mar'et goes berser' and you get 'illed.

Baupost uses hedges to reduce ris'. For eBample they use derivatives to hedge the interest rate ris' in their real estate holdings. .hey hold credit default s%aps on the government debt of countries they have investments in 9S. Korea;. .hey also hold credit default s%aps in a bunch of 4uropean countries not necessarily because they have holdings there but because it reduces ris' and they %ere very cheap 9/00& 000 a year for /!00 million in insurance;.

Baupost does best %hen there is high uncertainty and little information. Ghen they research a company they do %hat ever they can to find informationA they tal' to every one to get information including& manegment& industry people& former eBecutives&

customers& suppliers& they sometimes hire consultants and tal' to analysts on buy and sell side. .hey constantly reassess to find ne% information& if theyve overloo'ed something or if something has changed. 4mployees o%n second largest position in Baupost.

Bauposts 3 investment principles: !. Focus on ris' before return. .his is %hy Baupost has so much cash& currently =3 of the fund is in cash. -f they could find undervalued investments they %ould put all their money to %or' tomorro%. -f they had to they %ould have no problem holding !00 cash. Eeople fail to have sell discipline because they cant hold cash. 2. Focus on absolute returns. -nstitutions focus on relative returns but Baupost doesnt because Klarman cant imagine %riting a letter to clients saying H%e performed %ell during the year& the mar'et %as do%n 23 and %e %ere do%n only 20 H also clients %ill pull money out at the %rong time and it has a strong psychological effect.

$. 1nly focuses on bottom up investing. 6e has vie%s on the macro but doesnt thin' he has an edge in that type of investing. Klarman said that its really hard to turn a macro idea into an investment. Klarman's 5 old investment in !nron de"t Baupost invested in 4nrons senior debt and he said that %ould be an eBample of his favorite type of investment. .he situation had a lot of compleBity& hard to analy7e& a lot of litigation& uncertainty and no one %anted to be associated %ith anything 4nron creating a huge mispricing. Baupost bought the debt for !0+!3 cents on the dollar. -t comes do%n to assessing assets minus liabilities. After a fe% years most of 4nrons assets %ere cash /!0+!# billion but the liabilities %ere eBtremely complicated& %ith over !&000 subsidiaries. Baupost had one analyst focus solely on 4nron for over = years and try to figure out its liabilities and ho% much they %ould get bac' on the bonds. Baupost believed that the people li8uidating 4nron %ere lo% balling %hat they %ould get bac' on the bonds. .he people li8uidating 4nron %ere very pessimistic and they originally estimated that the bonds %ould get bac' !< cents on the dollar at the same time the debt traded for !=+!3 cents& Baupost estimated that the debt %ould recover $0+=0 cents and as of no% they believe it %ill be more then 30 cents.

-nvestments li'e 4nron debt are possible because the mar'et doesnt assess ris' correctly by relying on volatility 9beta;.