Margin of Safety – by Seth Klarman
Read first half of Margin of Safety book by Seth Klarman, a seasoned value investor and fund manager for Baupost Group. The book was written in 1990 but is valuable for all seasons and decades.
‘Yield Pigs’ as they have been derisively called, mutual funds, pension funds, have been served slop of insured mortgages since the 1980s. Bankers are quick to turn out exotic instruments at seductive prospect of fees/commission.
Rationality applied to buying electronics, household whiteware is absent when it comes to investing, money earned in years is invested in minutes.
Investors must try to understand the institutional investment
mentality for two reasons. First, institutions dominate financial market
trading; investors who are ignorant of institutional
behavior are likely to be periodically trampled. Second, ample
investment opportunities may exist in the securities that are
excluded from consideration by most institutional investors.
Picking through the crumbs left by the investment elephants
can be rewarding.
Investing without understanding the behavior of institutional
investors is like driving in a foreign land without a map. You
may eventually get where you are going, but the trip will certainly
take longer, and you risk getting lost along the way.
Emphasis on the junior claims against a company is a greater-fool argument, wherein
one takes comfort from the potentially foolish actions of others rather than from the wisdom of one’s own.
They accepted claims of a low default rate, and they used cash flow,
as measured by EBITDA, as the principal determinant of underlying
value. They even argued that a well-diversified portfolio
of junk bonds was safe.
As this market collapsed in 1990, junk bonds were transformed
into the financial equivalent of roach motels; investors
could get in, but they couldn’t get out.
A pile of junk is junk no matter how you stack it !
We may confidently expect that there will be new investment
fads in the future. They too will expand beyond the rational
limitations of the innovation. As surely as this will happen, it is
equally certain that no bells will toll to announce the excess.
Investors who study the junk-bond debacle may be able to identify
these new fads for what they are and avoid them.
Yield Pigs have been served dirt of CBOs (Collateralised Bond Obligations, bundling of junk bonds) in 1980s which failed in 1990 very much like CDOs in early 2000s (Collateralised Debt Obligations, bundling of sub prime mortgages) which failed in 2008. Funny eh !
The way capitalism has been unleashed, each man is for himself on financial Titanics sinking ever so frequently. “What we learn from history is that we don’t learn from history”.
Two investment fads in India spring to mind, after Power industry in 2009, that is Microfinance and Education sector.