Professional Documents
Culture Documents
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As the father of value investing, Benjamin Graham, advised in 1934, smart investors
look to the market not as a guide for what to do, but as a creator of opportunity.
Value investing is, in effect, predicated on the proposition that
the efficient-market hypothesis is frequently wrong.
As value investors, our business is to buy bargains that financial market theory says do not exist.
Buying such bargains confers on the investor a margin of safety, room for imprecision,
error, bad luck, or the vicissitudes of economic and business forces.
To value investors, the concept of indexing is at best silly and at worst quite hazardous.
Price is the ultimate thing that matters, [although we] worry
about risks before focusing on returns.
Every security or asset is a buy at one price, a hold at a higher price
and a sell at some still higher price.
Successful investors tend to be unemotional, allowing the greed
and fear of others to play into their hands.
You have to be able to stand things going bad before they go good.
ON LONG-TERM ORIENTATION
Beyond [an] investors speculative impulses, technological innovation over the years has
compressed investor time horizons. Technology enables a money managers performance to be
measured not only annually, quarterly, or monthlybut of course daily, hourly and constantly.
The performance pressures most investors feel drives them
into an absurdly short-term orientation.
We dont try to be anyones best performing manager in a given year because
such an attempt would almost certainly fail. It would distract us from our focus
on risk-aversion and the pursuit of excellent long-term results, while shifting our
attention toward quick gains, short-term trades and market momentum.
With the exception of an arbitrage or a necessarily short-term investment, we
enter every trade with the idea that we are going to hold to maturity in the case of
a bond and for a really long time, potentially forever, in the case of a stock.
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We pursue opportunity largely off the beaten path, sifting through the debris of
financial wreckage, out-of-favor securities and asset classes in which there is limited
competition. We specialize in the highly complex while mostly avoiding plain vanilla,
which is typically more fully priced. We happily incur illiquidity but only when we get
paid well for it, which is usually when others rapidly seek liquidity and rush to sell.
When you have been doing this for a while, you start to become more proficient about where to
look, which rocks to look under. The rocks we look under tend to have a few things in common.
You must buy on the way down. There is far more volume on the way down than on the
way back up, and far less competition among buyers. It is almost always better to be too
early than too late, but you must be prepared for price markdowns on what you buy.
Market inefficiencies, like tax selling and window dressing, also create
mindless selling, as can the deletion of a stock from an index.
These causes of mispricing are deep-rooted in human behavior and
market structure, unlikely to be extinguished anytime soon.
Investing is, in many ways, a zero-sum activity in which your returns
above market indices are derived from the mistakes, overreactions, or
inattention of others as much as from your own clever insights.
Typically, we make money when we buy things. We count the profits later,
but we know we have captured them when we buy the bargain.
ON HAVING AN EDGE
You cannot have an edge doing what everyone else is doing; to add value you must stand apart
from the crowd. And when you do, you benefit from watching the competition at work.
If you are investing and you dont have an edge you probably shouldnt be [investing]. And so
we think about that a lot, that there are a lot of really formidable competitors, a lot of money
thats flowed into the hands of very capable value investors, long-term oriented, smart people.
There are obviously also people that know a huge amount about industries, industry specialists,
corporate executive, former executives, and so its very competitive out there most of the time.
So much of the time we have drifted into less liquid or more obscure parts of the universe.
Wed rather not try to outsmart somebody, were not sure we could.
Wed rather try to hunt where theyre not looking.
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We believe that while investors need to focus great attention on the fundamentals,
they must simultaneously answer the question: Whats your edge?
To succeed in todays overcrowded environment, investors need an edge, an advantage over
the competition, to help them allocate their scarce time. Since most everyone has access to
complete and accurate databases, powerful computers, and well-trained analytical talent, these
resource provide less and less of a competitive edge; they are necessary but not sufficient.
You cannot have an edge doing what everyone else is doing; to add value you must stand apart
from the crowd. And when you do, you benefit from watching the competition at work.
In highly competitive financial markets with thousands of very smart, hard-working participants,
what will enable you to reliably outperform the field? Your toolkit is critically important:
truly long-term capital; a flexible approach that enables you to move opportunistically
across a broad array of markets, securities, and asset classes; deep industry knowledge;
strong sourcing relationships; and solid grounding in value investing principles.
ON RISK
Bauposts investment approach is highly risk-averse.
We continuously worry about what can go wrong with each investment and the
portfolio as a whole; avoiding and managing risk is a 24/7/365 obsession for us.
Our general predisposition is that we ought to run our money as if it is our own.
The best investors do not target return; they focus first on risk, and only then
decide whether the projected return justifies taking each particular risk.
Right at the core, the mainstream has it backwards. Warren Buffett often quips that the
first rule of investing is to not lose money, and the second rule is to not forget the first rule.
Yet few investors approach the world with such a strict standard of risk avoidance.
We try to focus on the downside. We diversify. We try to look
into places that other people dont consider.
We clear a high bar before making an investment, and we resist the many
pressures that other investors surely feel to lower that bar. The prospective return
must always be generous relative to the risk incurred. For riskier investments,
the upside potential must be many multiples of any potential loss.
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ON BEHAVIORAL FACTORS
In investingas in most thingspeople like what is popular, trendy, exciting
and dislike what is boring, out of favor and stigmatized. They like assets
that have been rising and shun those that have been falling.
Investing, when it looks easiest, is at its hardest.
The overwhelming majority of people are comfortable with consensus,
but successful investors tend to have a contrarian bent.
Most investors tend to project near-term trendsboth favorable
and adverse indefinitely into the future.
Most people lack the courage and stamina to stand apart from the herd and
tolerate short-term underperformance in order to reap long-term rewards.
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I have had friends at other hedge funds say to me, You have a better model,
but we cant do this with our clients. Our clients just would not understand.
The truth is, some of our clients dont understand, but weve worked really hard
over time to explain it and to educate them to our way of thinking.
People ask me for advice and I say, The first and most important thing is make sure
that you choose your clients carefully. Most people would either look at me like
I had three heads, like Youve got to be kidding me, like, Thats quaint.
We work in a team environment and [have] a very open seating
environmentI have a private office. Im never in it.
Having great clients is the real key to investment success. It is probably more
important than any other factor in enabling a manager to take a long-term time
frame when the world is putting so much pressure on short-term results.
In our minds, ideal clients have two characteristics. One is that when we think
weve had a good year, they will agree. It would be a terrible mismatch for us to
think we had done well and for them to think we had done poorly. The other is that
when we call to say there is an unprecedented opportunity set, we would like to
know that they will at least consider adding capital rather than redeeming.
MISCELLANEOUS
I traded my first stock when I was 10.
It is very hard for the government to be countercyclical
because all political pressure is against that.
There comes a responsibility with success, and that is leaving the world better than you found it.
Weve managed to do really well for ourselves by putting clients first, by charging
a fair fee, and by focusing on their best interests. Im proud of the fact that
virtually everybody who has been connected with the firm employees, clients,
advisers, business partners has benefited from that experience.
An economy built with no margin of safety will eventually implode.
Everyone can ask questions, but not everyone can identify the right questions to ask.
I have never calculated the alpha or beta of my firms investment performance, which
is how some people would determine whether or not we have done a good job.
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