Monday, June 14, 2010

Klarman Tops Griffin as Investors Hunt for ‘Margin of Safety’

By Charles Stein
June 11 (Bloomberg) -- Seth Klarman almost doubled his hedge fund’s assets to $22 billion in the past two years as the industry shrank by sticking with the off-the-beaten-path investments he’s pursued since starting out in 1983.
Unlike John Paulson, who made $15 billion by betting against home mortgages, Klarman didn’t see one big trade that would profit as markets began to collapse. The founder of Baupost Group LLC focused on corporate bonds he calculated would yield solid returns even if the economy got worse.
“We didn’t have the degree of conviction Paulson had,” said Klarman, whose views are so closely watched by investors that his out-of-print book, “The Margin of Safety,” is offered on for more than $1,700. “We don’t deal in absolutes. We deal in probabilities,” he said in an interview at his Boston office.
While Klarman didn’t post the gains that made Paulson famous, he was able to raise almost $4 billion in 2008 when firms including D.B. Zwirn & Co. and Peloton Partners LLP liquidated funds. Baupost was the ninth-largest hedge-fund firm as of Jan. 1, according to AR magazine, Pensions & Investments magazine and data compiled by Bloomberg. He oversees more money than better-known managers such as Ken Griffin and Steven Cohen.
A value investor who looks for securities he considers underpriced, Klarman, 53, said he’s best at “complicated” situations where fewer investors compete for assets. Over the years, Baupost has invested in Parisian office buildings, Russian oil companies and real estate that the U.S. government disposed of following the savings and loan crisis of the early 1990s, said Thomas Russo, a partner in the Lancaster, Pennsylvania-based investment firm of Gardner Russo and Gardner.
‘Complex Assets’
“He specializes in illiquid, complex assets,” said Russo, who has known Klarman since 1984.
Baupost gained an average of 17 percent annually in the 10 years ended in December, a period in which the Standard & Poor’s 500 Index fell 1 percent a year. The hedge fund has returned 19 percent a year since it was started, even as it held more than 40 percent of its assets in cash at times.
In February 2008, when Baupost accepted new investors after being closed for eight years, Klarman bought distressed corporate and mortgage debt. The fund lost 12 percent that year, its second annual decline since inception, because it bought some of the debt too early, Klarman said. It returned 23 percent in 2009 and was up 4.4 percent through April.
“It was a wonderful time to put money to work,” said Klarman.
Hedge funds on average lost 19 percent in 2008, gained 20 percent in 2009 and were up 3.6 percent through April, according to data from Chicago-based Hedge Fund Research Inc.
JPMorgan, CIT
Among the money-making bonds Baupost purchased, according to an October 2008 shareholder letter, was debt issued by Washington Mutual Inc., whose bank unit failed in 2008 and was bought by New York-based JPMorgan Chase & Co. Baupost also acquired bonds of CIT Group Inc., a New York-based lender that emerged from bankruptcy in 2009. The fund was part of a group of creditors that made a $3 billion loan to CIT in July 2009.
Klarman, in a May 18 talk to financial advisers in Boston, cited another Baupost purchase during the crisis to illustrate the way he thinks about investing. In a series of “what if” exercises, the firm calculated how much bonds of Ford Motor Credit Co. would be worth under different scenarios, including an economic depression in which loan defaults rose eightfold. The conclusion: the bonds, then selling for about 40 cents on a dollar, would still be worth 60 cents.
Real Estate
Ford Credit had net income of $1.3 billion in 2009, compared with a $1.5 billion loss in 2008. Some of its bonds have more than doubled in price since reaching lows in March 2009, Bloomberg data show.
More recently, the fund has been looking to buy privately held commercial real estate. While the fundamentals for much of that property are “terrible,” Klarman said, such investments may pay off for those willing to wait long enough.
Prices of publicly traded real estate securities have run up too far, he said in the interview. If the firm can’t come up with enough opportunities, it may return cash to investors, Klarman said.
“At this point, the clients don’t seem to want their money back,” he added. Baupost, whose investors are wealthy individuals and institutions such as Harvard University’s endowment, currently has about 30 percent of its assets in cash.
Graham and Dodd
Klarman is a disciple of Benjamin Graham and David Dodd, whose 1934 book, “Security Analysis,” is considered the bible for value investors. Graham taught finance at New York’s Columbia University where Berkshire Hathaway Inc. Chairman Warren Buffett was his student.
Klarman wrote the preface to the sixth edition of “Security Analysis,” which was published in 2008. His own book, subtitled ‘Risk-Averse Value Investing Strategies for the Thoughtful Investor,” has become a collector’s item.
Chris Ely, portfolio manager at Nichols Asset Management LLC in Boston, tried to get the book through his suburban library system. He was the 18th person on the waiting list and after six months still hadn’t gotten a copy, he said in a telephone interview.
“Seth writes about investing better than anyone ever has, bar none,” Michael Price, the longtime value investor, said in a telephone interview. Price, who sold his former firm, Heine Securities Corp., to Franklin Resources Inc. of San Mateo, California, in 1996 for more than $600 million, is now managing partner of New York-based MFP Investors LLC.
Red Sox Partner
Klarman, who was born in New York and grew up in Baltimore, worked for Price before and after graduating in 1979 from Cornell University in Ithaca, New York. He later earned a master of business administration at Harvard Business School in Boston.
Klarman is a limited partner of Major League Baseball’s Boston Red Sox, whose principal owner is commodities fund trader John Henry. He is chairman of the board of Facing History and Ourselves, a nonprofit that encourages the study of racism and anti-Semitism in schools.
As early as January 2006, Klarman warned in a letter to shareholders about “tremendous leverage,” “untested” products such as credit derivatives, low interest rates and “a housing bubble that is starting to burst.”
‘Perennially Bearish’
Today, Klarman says he worries that the dollar could lose value and interest rates and inflation may rise. Stocks will probably provide poor returns for the next 10 years, he said.
“We are perennially on the bearish side of things,” he said in the interview.
Baupost held $1.7 billion of U.S. listed stocks at the end of March, according to its latest filing with the Securities and Exchange Commission.
“We are not against owning stocks,” Klarman said in the interview. The problem, he said, is that except for a brief time in March 2009, “stocks haven’t been at bargain prices for most of the last two decades.” U.S. stocks reached a 12-year low in March 2009.
Klarman’s views on the U.S. stock market echo those of Jeremy Grantham, chief investment strategist at Boston-based Grantham Mayo Van Otterloo & Co., who recommended investors buy stocks in March 2009 after more than a decade of saying they were overvalued. Grantham’s latest forecast, posted on the firm’s website, predicted U.S. large cap stocks would return 0.3 percent a year, adjusted for inflation, over the next seven years.
Klarman called Grantham “a very smart person” whose forecasts he watches carefully. In an e-mail, Grantham called Klarman “just about the smartest guy around.”
Credit-Default Swaps
Klarman buys put options and credit-default swaps, which he calls “cheap insurance,” to protect Baupost against risks such as a steep fall in the stock market or a surge in inflation. He currently has a put, or an option to sell a set amount of a security by a specific date, that will pay off only if interest rates go dramatically higher, he said in his Boston speech. In an October 2008 letter to shareholders the firm said it benefited from credit-default swaps, without saying what the swaps were meant to protect against.
When Klarman can’t find investments he likes, he holds cash. “We prefer the risk of lost opportunity to that of lost capital,” he wrote in his 2004 yearend letter to shareholders. In 2007, Baupost gained more than 50 percent, even as it held more than 40 percent of its assets in cash.
Bruce Berkowitz, named Morningstar Inc.’s domestic stock manager of the decade and a contributor to the latest edition of the Graham and Dodd book, said Klarman stands out among fund managers because he’s able to make money while holding cash and avoiding leverage.
“If he isn’t Elvis, he’s pretty close,” Berkowitz said.

Jeffrey Gundlach’s Milkshake, Sex And Drug Paraphernalia Bring All The Investors To The Yard

Suck it, TCW. No, really. Do it.

Congratulations are in order for Jeff Gundlach and the DoubleLine Team! In addition to being ranked number one globally in asses (on tape), the new firm has gathered the most assets among 2010 fund launches. Naturally this calls for a celebration and a screening of Ass Traffic Volume 2 at the office would probably be most fitting, if anyone has a copy lying around.
Jeff Gundlach’s new fund is the most successful mutual fund launch of the year, but it is not the only success. Numbers just out from Morningstar show that Pimco, AQR and Fairholme are also pulling in assets with new mutual funds. The data was released by Morningstar in its May U.S. Mutual Fund and ETF Asset Flows report. Of the 80 non-target date funds launched so far in 2010, DoubleLine Total Return has pulled in $610 million since its early April launch. That puts DoubleLine’s fund more than $100 million ahead of the No. 2 new fund — Pimco EqS Pathfinder, an equity fund which pulled in roughly $500 million over a similar time span. The Pimco fund is PM’d by a pair of former investment professionals who jumped from Franklin Resources’ Mutual Series family.

The news must be especially sweet to Gundlach, who founded DoubleLine after leaving TCW last December. At TCW, he was the PM for TCW Total Return, a rival fund to Pimco’s flagship Total Return fund PM’d by Bill Gross.

Monday, June 07, 2010

Biggest Equity Outflow In Recent History Leads To Fifth Consecutive Outflow From High Yield Funds

Last week was the fifth consecutive week of HY mutual fund outflows, which while smaller than the prior week's $1.4 billion, was still a material $759 million. With that the five consecutive weeks of HY outflows now stand at $4.3 billion, which is the second largest 5 week sequential outflow from HY funds in history, only better compared to the $4.9 billion in August of 2003. With the disappointing end of week performance in stocks last week, we anticipate that next week Lipper/AMG will announce another huge outflow. With this week's HY outflow, YTD flows are now just barely positive at $898 million. Yet the HY action was nothing compared to the unprecedented, if not record, outflow in domestic equities: ICI reports that the week ended May 26 had $13.4 billion in domestic equity outflows: a number the likes of which we don't recall even in the post-Lehman days.

Curiously, even as flows out of all risky assets picked up, money market saw yet another outflow of $11.5 billion, bringing total YTD money market outflows to $414 billion, or -12.9% of total money market assets. Ironically, the only asset class (aside from gold) outperforming this year is the dollar. Instead of keeping capital invested in cash, Americans have shifted nearly half a trillion out of the best performing asset in 2010.
Yet what is once again odd, is that the differential between YTD Money Market outflows and all other risky asset inflows, is now a 2010 high $120 billion. For all those who wonder where the money to buy 2 million iPads immediately after launch comes from, here is your answer. Americans are moving capital away from what they deem (incorrectly) is an unsafe asset class, and instead of putting it into riskier assets, they are spending it. One can only wonder what happens to already weakening retail sales, once the temptation to reallocate capital back to money markets rears its ugly head.

Wednesday, June 02, 2010

Looking at the May Swoon

The stock market just finished its worst May since 1940. As it turns out, watching France fall to the Nazis isn't good for stocks here. Also, watching the euro fall to reality is pretty nasty as well.
Let's take a closer look at where the market stands today. Here's the S&P 500 (black line, left scale) along with its earnings (gold line, right scale).


I've scaled the two lines at a ratio of 16 to 1 so whenever the lines cross, the market's P/E Ratio is exactly 16.
Let me add that looking at the market's P/E Ratio is far from perfect (the future earnings line is, of course, merely forecast), but nevertheless we can gain some insights as to what investors are thinking at the moment.
Two items stand out. The first is that the S&P 500 has fallen below a P/E Ratio of 16 which has generally been its lower bound over the past few years. The second is that the earnings forecast is still very favorable. If stocks keep pace with valuations, then the S&P 500 could easily be over 1400 within 18 months.

This is where the problems come in. It appears that investors are beginning to question the robustness of the recovery. Given the amount of aid needed, that's certainly understandable. So if the earnings forecast turns out to be overly optimistic, then the whole bullish scenario falls apart.


Whitney Tilson’s T2 Partners continues to outperform the market despite the recent volatility.  T2 was down just 2.8% in May while the S&P 500 declined 8%.  Tilson has been particularly prescient over this market cycle and was a notable real estate bear heading into the credit crisis.  Despite the recent market disruption Tilson is not concerned that we are repeating 2008.  In his May letter to clients Tilson detailed his market outlook:
“So if last month was analogous to late 2007, is the situation today like early 2008 (in which case, we should still be battening down the hatches)?  We don’t know for sure, but probably not.  We think the most likely scenario is more years of the choppy, range-bound market that we’ve been in for more than a decade – and that’s fine with us, as it rewards good bottoms-up stock picking, which is our forte.”
Tilson has been buying the weakness and using the opportunity to purchase more of some of his favorite positions:
“During the month, we did what we normally do when the market has violent swings: the precise opposite of the herd.  On weakness, we initiated a few new long positions, added to some existing holdings like General Growth Properties, and trimmed certain shorts like Simon Properties Group, which we owned primarily as an industry hedge against GGP and felt was no longer necessary with GGP falling into the $12 range. “
Tilson’s fund isn’t positioned for sunny skies, however.  He continues to maintain a substantial short book and feels extremely confident in the continued outlook for hedging strategies over the coming years:
“As you might expect, our long book dropped significantly (though not as much as the market), while our shorts offset much of these losses.  Losers of note on the long side were Liberty Acquisition Corp. warrants (-52.2%), Resource America (-33.7%), Borders Group (which we have mostly exited) (-22.4%), American Express (-13.6%), General Growth Properties (-10.7%) and Berkshire Hathaway (-8.2%).  In the plus column were Iridium, with the stock up 12.4% and the warrants up 21.9%, and EchoStar, up 9.5%.
On the short side, our largest position, InterOil, tumbled 26.5% (in addition, the puts we own jumped 70.2%), MBIA fell 22.2%, DineEquity dropped 17.9%, and the homebuilder ETF (ITB) declined 11.5%. “

Lunch is for wimps

Lunch is for wimps
It's not a question of enough, pal. It's a zero sum game, somebody wins, somebody loses. Money itself isn't lost or made, it's simply transferred from one perception to another.