The Baupost Group’s Seth Klarman is a well-known and dedicated value investor, and he wrote in a recent note to clients that he believes value investing is primed for a comeback.
Baupost is a hedge fund that dabbles in just about every kind of investment, including stocks, distressed debt, real estate, credit default swaps — literally wherever Klarman and his team see value.
But his favorite asset actually is cash and Baupost averages around 31% of its assets held as cash — which is not great for retail investors but OK for value investors like Klarman and Warren Buffet.
Value investors generally hold large sums of cash for large purchases and acquisitions, and Klarman says there is a growing list of options for value investors. In his 2019 letter to investors, Klarman says “capital outflows of late seem to be resulting in less efficient pricing, and emergent bargains are becoming even more compelling for those who can hang on and grow their exposures.”
That said, Baupost is holding firm on its long-term investment goals.
“For Baupost, investing is not a sprint but a marathon… Over the long run, major mispricings are eventually corrected — the share price and value of a business tend to converge — because short-term illusions are pierced, and enduring characteristics become more apparent.”
As long as there are companies trading at good prices, value investors like Klarman will be there to scoop them up. And the higher the price a company is, the higher the chance it won’t lead to good returns.
Looking at his comments, it appears that Klarman is suggesting the current market environment is throwing up lots of attractively priced high-quality companies that long-term value investors can commit capital to without taking on too much risk.
These companies are unlikely to outperform the market in the short term, especially if money continues to flow into passive index tracker funds (which benefits large-cap tech stocks disproportionately), but over the next five or ten years, there is a good chance that this anomaly will correct itself.
While critics will argue that just because a stock is cheap, that doesn’t make it a good buy because it could remain cheap for the next decade.
But when it comes to quality, buying high-quality “cheap” assets are better than betting on low-quality cheap assets turning things around.
When it comes to value investing, it’s not about buying cheap stocks, but quality cheap stocks.