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Klarman: Find Your Edge and Stick to It

- By Rupert Hargreaves

While reading an article on Seth Klarman (Trades, Portfolio) recently, I came across the following quote:


"If you are investing and you don't have an edge, you probably shouldn't be [investing]. And so we think about that a lot, that there are a lot of really formidable competitors, a lot of money that's 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 executives, former executives, and so it's 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."




I think this is a fascinating perspective and one that certainly deserves further attention. Klarman is best known for his skill as a value investor. Over the course of his career, reports suggest he has achieved an average annualized return for his investors at the Baupost hedge fund of around 20%.

What's more impressive is he has been able to do this with the firm's cash allocation exceeding 40% on some occasions.

A seasoned value investor

Klarman is a value investor through and through. Unlike Warren Buffett (Trades, Portfolio) who has transitioned away from the style Benjamin Graham originally developed toward quality at a reasonable price, the hedge fund manager has remained a Graham disciple. As a result, he is only interested in buying stocks that are trading at a deep discount to his estimate of intrinsic value.

By doing so, Klarman is staying within his area of expertise. He has an edge when it comes to discovering and assessing value, which is why he is still following this path to this day.

Klarman's idea of having an edge is also very similar to Buffett's "circle of competence," which was described in Berkshire Hathaway's (BRK-A) (BRK-B) 1996 letter to shareholders:


"What an investor need is the ability to correctly evaluate selected businesses. Note that word 'selected.' You don't have to be an expert on every company or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital."



Both of these quotes, from two of the most successful value investors of all time, really say the same thing. Investors should only invest in what they know and understand. If they understand a certain sector or industry, then it makes sense to keep their investments in this part of the market. If they understand bonds better than stocks, then perhaps this may be the best area for them to invest in.

Furthermore, it is important to note what these quotes don't. That is, if an individual doesn't know how to invest, or doesn't understand how to analyze businesses, then it is best to stay away.

Investing is an art, not a science. It is not something that can be learned overnight and requires a great deal of expertise to get right. If an investor doesn't know what they are doing, it is very easy to make silly mistakes that can be immensely costly.

That being said, there is no shame in an individual admitting they do not understand a sector, industry or investing in general. The only person people have to impress is themselves, and they won't do that by kidding themselves. That is just a shortcut to losses and mistakes.

Being a successful investor has more to do with portfolio management and investment analysis than anything else. Knowing what you own, and where your experience lies, is all part of that. That is why this Klarman quote is so exciting.

Disclosure: The author owns shares of Berkshire Hathaway.

Read more here:

  • Charlie Munger on Envy and Jealousy
  • Buffett on Diversification: There Are Not That Many Wonderful Companies Out There
  • Does Warren Buffett Have a Private Equity Problem?



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This article first appeared on GuruFocus.