Baupost is the highly successful hedge fund run by Seth Klarman, one of my long time investing role models. Its quarterly and annual letters to investors aren’t publicly available. But Business Insider recently published an article liberally quoting Baupost’s third quarter letter to investors.
Usually, Klarman writes each missive. This time, he asked Brian Spector, a 17-year Baupost veteran who is soon retiring, to provide unedited insights into any topic of his choosing.
Spector focused on the firm’s investment process.
The Business insider article is worth reading in its entirety. But I wanted to highlight a few things that particularly interested me. I really like Spector’s metaphor for the two types of investing Baupost undertakes – ‘needle in a haystack’ and ‘tide comes in and tide goes out’ investing.
‘Most of the time’, Spector explains, ‘we are in periods of haystack investing’. Most of the time markets are orderly, with most stocks trading somewhere near fair value. For every keen seller there is a keen buyer, keeping things in order.
In these times, your job is to look for the proverbial needle in the haystack. You’ll spend much more of your time sifting than buying. But comb resourcefully through thousands of companies and, every now and then, you’ll run into a stock that you can understand better than the rest of the world. Betfair is a recent example of this sort of investment for our own International Shares Fund.
While you’re looking for needles in haystacks, you’ll come across a lot of businesses that are attractive but don’t offer compelling value. That watch list will come in handy for Spector’s other investment metaphor – ‘tide comes in and tide goes out’.
Every now and then markets become disorderly. As Spector says, the tide turns and ‘we see distressed sellers, illiquid securities, huge redemptions, and an excess of paranoia and fear’. It happens in differing magnitude at least every few years. The widespread mini-panic in August being one modest example.
This is the time to pull out the names from your watch list. For months prior, nothing happened. That didn’t mean doing nothing, but rather diligently working on your watch list while largely sitting pat when it came to trading. Suddenly, the market shifts violently and a handful of stocks immediately offer a compelling margin of safety. You haven’t bought a stock for months, and now you buy five in a single day or over a week.
Good investors are constantly on the lookout for needles in haystacks while diligently updating and expanding a watch list of stocks for use on some unknown future day of opportunity.
Spector also discussed Baupost’s ideal way of utilising analytical resources, a topic that may hold more interest for our investment organisation than for individual retail investors. Spector had already highlighted the power law nature of good investing – most days you take no action, occasionally you take a lot.
It’s also how they arrange their investment process. Most days, analysts are looking far and wide for value. Most days they do so alone or in small teams. Most days they go home empty handed.
But when someone finds something highly prospective, a battalion is mobilised to work on it – good ideas are time sensitive. The organisation thinks sensibly about who is best to manage the investigation – not necessarily the person who first identified the idea – and any team member that can add value to any part of the analytical process pitches in.
If understanding a complex investment opportunity takes, say, a month, why get one analyst to spend a month on it rather than throw a month of man-hours at it, or more, in a day or two? It’s something we try to do here at Forager Funds but Spector reminds us that there’s room for improvement.