Rare Seth Klarman Article: Why Value Investors Are Different

On February 15, 1999, Barron’s magazine published an opinion piece entitled, Why Value Investors Are Different. The article looked at one of the most important periods of Warren Buffett’s career and was written by none other than Seth A. Klarman.

As usual, Seth Klarman’s insights are invaluable. So, here are some key takeaways from the article.

Seth Klarman: Why value investors are different

Seth Klarman begins his piece on Warren Buffett with the following statement:

“The most dramatic and valuable lesson from the fabulous (and still counting) 50-plus-year investment career of Warren Buffett is the legendary account of his steadfast conviction amidst the 1973-75 bear market. He had correctly identified by 1973 that the shares of companies such as the Washington Post were selling for but a fraction of underlying business value represented by those shares.”

[A side note: The discounted value of the Washington Post’s shares was discussed in Warren Buffett’s famous essay, ‘The Superinvestors of Graham-and-Doddsville’.During 1973, The Washington Post Company had a market capitalization of $80 million. However, the figures showed that the company’s assets were worth $400 million, probably appreciably more according to Buffett.]

The stock price of the Washington Post continued to decline over the next two years, through 1975. But Warren Buffett kept buying. Roger Lowenstein later wrote in his biography of Warren Buffett:

“[the] impression of Buffett sweeping down the aisles of a giant store [buying stock]…As the market fell, he raced down the aisles all the faster.”

Seth Klarman

Studying behavior

Seth Klarman notes that studying Warren Buffett’s behavior during this period is extremely important for investors. He writes:

“…it powerfully evokes the memory of what happens in bear markets: Good bargains become even better bargains. It is also important testimony to the wisdom of staying power: Had Buffett worried about the interim losses in 1974 or 1975 from his earlier and more expensive purchase of Washington Post shares, he might have…panicked or been forced out…”

Here, Seth Klarman goes on to write about something that’s not usually mentioned when talking about Buffett nowadays; his human nature.

It’s easy to forget that Buffett is indeed human, not an invincible super investor that can do no wrong — even though this is the image that he gives off. What must Buffett have been thinking during the bear market of the early 70s when most of his stocks were falling? Seth Klarman writes:

“…the well-founded conviction a value investor is able to have, confidence in the margin of safety that a bargain purchase is able to confer…he [Buffett] simply decided that the market was wrong. His view was that the sellers were not thinking clearly…Their disagreement, if there was one, concerned the level of appropriate discount between share price and business value, a gap that Buffett saw as widening.”

What’s more:

“He didn’t worry about whether the stock was about to split or pay or omit a dividend. He most certainly did not evaluate the stock’s beta or use the capital-asset pricing…he simply valued the business and bought a piece of it at a sizeable discount.”

Seth Klarman then goes on to talk about the perception of risk. Was Buffett worried about risk? Of course, but as Klarman notes, Warren Buffett’s perception of risk is not the same as the short-term fund manager, who is worried about short-term underperformance. Instead, Buffett’s description of risk is the permanent loss of capital. And with that being the case, the best way to reduce risk is to try and buy a dollar for only $0.50.

This article was originally published on ValueWalk.com. Part two can be found here.

Warren Buffett partnership The Early Years — Part Two: Expanding

This is the second part of a multi-part series on Warren Buffett’s early years.

Before he acquired Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B), Warren Buffett managed a number of partnership for select investors, family and friends. And it was the management of these partnerships and his actions in the first few years of managing Berkshire that laid the foundations for him to become arguably the greatest investor of all time. Part one of this series can be found here.

 Warren Buffett the early years — Part two: Expanding

Warren Buffett’s first three partnerships, set up during, 1956 outperformed the market significantly during their early years and attracted plenty of attention. As a result, more potential investors began to approach Warren and ask him to manage their money.

So, to meet demand during June of 1957, Buffett started another partnership calledUnderwood, with one of the original partners of Buffett Associates, Ltd., Elizabeth Peters, with $85,000. Then, on August 5, 1957, Warren Buffett started his fifth partnership, which was called Dacee. Eddie Davis and his wife Dorothy Davis had Buffett manage $100,000 for themselves and their three children. The year after, on May 5, 1958, Dan Monen and his wife, Mary Ellen, formed the basis of Warren’s next partnership, called Mo-Buff.  They put in $70,000.

The five partnerships that were in operation during 1958 posted returns of 36.7% to 46.2%. As Buffett wrote in his annual letter to partners at the end of 1958:

“The latter sentence describes the type of year we had in 1958 and my forecast worked out. The Dow-Jones Industrial average advanced from 435 to 583 which, after adding back dividends of about 20 points, gave an overall gain of 38.5% from the Dow-Jones unit. The five partnerships that operated throughout the entire year obtained results averaging slightly better than this 38.5%. Based on market values at the end of both years, their gains ranged from 36.7% to 46.2%. Considering the fact that a substantial portion of assets has been and still is invested in securities, which benefit very little from a fast-rising market, I believe these results are reasonably good. I will continue to forecast that our results will be above average in a declining or level market, but it will be all we can do to keep pace with a rising market.” — Warren Buffett 1958 annual letter to partners.

You can find the rest of the article at ValueWalk.com

Warren Buffett The Early Years — Part One: The First Partnership

Following the my last ten part series on the life and career of Charlie Munger, Vice-Chairman of Berkshire Hathaway Corporation and Warren Buffett’s right hand man, in this series I’m taking a look at Warren Buffett’s early career.

Before Warren Buffett became well-known, and before he acquired Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B), he ran a number of partnerships, investing the money of family, friends and outside investors. It’s these partnerships that helped build his reputation and provided the funds for him to ultimately acquire Berkshire Hathaway.

This is the story of Warren Buffett’s early career, the years that laid the foundations for him to become the world’s greatest investor.

Warren Buffett — Part one: The First Partnership

In 1952, Warren Buffett went to work with the godfather of value investing, Benjamin Graham at the Graham-Newman partnership. Here, Warren Buffett put his education from the Columbia University to work and learnt his trade as a value investor.

Unfortunately, Graham-Newman partnership closed its doors during 1956 so Buffett, took his savings (around $174,000) and started the first Buffett Partnership Ltd in Omaha.

When he first set out to invest money for others, Warren Buffett knew that he wouldn’t be able to stand criticism from his partners if stocks he selected started to fall. As Buffett was going to be the sole manager of the partnerships run by Buffett Partnership Ltd., there was nowhere to hide if he failed. With this being the case, Buffett only invited family and friends to invest in his first partnership — Buffett Associates, Ltd.

In total, six other partners, plus Warren Buffett invested in Buffett Associates, Ltd. raising $105,100 in capital.

Two more partnerships were set up in the months after Buffett Associates, Ltd. started trading bringing the total number of partnerships controlled by Buffett to three by the end of 1956.

  • On September 1st, 1956, he raised $120,000 from Homer Dodge, a physics professor who had attended Harvard University. With it, Buffett setup Buffett Fund, Ltd.
  • Then, on October 1, 1956, Warren founded another partnership for a friend of his, John Cleary, who was his father’s secretary in Congress. (Buffett’s father served in the House of Representatives.) It had $55,000 in capital.

Read the rest of the article at ValueWalk.com

Charlie Munger — Part Eight: Berkshire At 50

This is part eight of a ten-part series on the life and career of Charlie Munger, value investor, lawyer, philanthropist, Vice-Chairman of Berkshire Hathaway Corporation and Warren Buffett’s right hand man. He is also chairman of theDaily Journal Corporation and a director of Costco Wholesale Corporation. Parts one through seven of this series can be found at the links below.

  1. Charlie Munger — Part One: The Beginning
  2. Charlie Munger — Part Two: Quality Over Value
  3. Charlie Munger — Part Three: Sit On Your A$$
  4. Charlie Munger — Part Four: Investment Advice
  5. Charlie Munger — Part Five: Checklist Investing
  6. Charlie Munger — Part Six: The Daily Journal
  7. Charlie Munger — Part Seven: Poor Charlie’s Almanack

To ensure you do not miss the rest of the series sign up for our free newsletter.

Charlie Munger — Part eight: Berkshire at 50

In part seven of this series, I looked at the book Poor Charlie’s Almanack, a compilation of Charlie Munger’s speeches, presentations and letters. One essay that wasn’t included in Poor Charlie’s Almanack (mainly because it was written almost a decade after the book was published — it’s still essential reading) is Charlie Munger’s contribution to the Berkshire Hathaway 50th anniversary letter.

Across five pages of the Berkshire Letter, Charlie Munger takes a look at the factors have been key to Berkshire’s success over the years.

And the commentary from Charlie Munger really does offer an invaluable insight into how Berkshire operates. However, these reflections are not just relevant to Berkshire. Charlie’s observations can also help the average investor improve their investing process.

Read the full article here: http://www.valuewalk.com/2015/04/charlie-munger-berkshire-at-50/

Credit Suisse; The Rise And Fall Of Industries

Credit Suisse’s Global Investment Returns Yearbook 2015 is a must read for investors. This year, the yearbook contains some extremely interesting long-term (115 years) data on industries.

Changing industries

Today, in the US and UK markets only the banks and mining industries have weightings close to their 1900 levels. Industries have risen and fallen as technology has advanced, but industries remain one of the original and most important factors in portfolio organization. When fund managers build, alter, or report on portfolios, they refer to industry weightings. So, getting these weightings right — or wrong — has consequences. Industry membership is the most common method for grouping stocks for portfolio risk management, relative valuation and peer-group valuation.

Credit Suisse Group AG (ADR) (NYSE:CS)’s research team covers more than 100 years of data in its research report. Starting at 1900 markets were dominated by railroads. In the UK, railway companies accounted for almost half the value of the stock market while in the USA they had a 63% weighting.

Long-term industries 1

It’s clear that the market today is much more diversified than it was 100 years ago, and rail stocks have all but disappeared.

Long-term performance

Using Ken French’s industry data (Fama and French, 1997), Credit Suisse then goes on to look at the performance ofUS industries. Using two data sets, that of Fama and French, 1997 (1926 to 2014) and 57 Cowles industries (1900 to 1925) Credit Suisse’s data shows that a dollar invested in the US market at start-1900 would have grown, with dividends reinvested, to USD 38,255 by end- 2014, representing an annualized return of 9.6%.

The worst performing industry was shipbuilding. A dollar invested in shipbuilding and shipping in 1900 would have grown to just USD 1,225 today, representing an annualized return of 6.4%. Tobacco came out top with an annualized return of 14.6%.

Long-term industries 2

It should be noted that this data does suffer from hindsight bias. The sample only contains those industries that existed in 1900 and which survived.

New industries

100 years ago the market was dominated with industrial companies. Today, in the US at least, there’s a heavier weighting towards technology.

Credit Suisse’s data shows that over the 20 year period from 1995, the beginning of the dot-com bubble, to 2015 tech stocks actually beat the market, with an annualized return of 10.5% versus 9.9% for US stocks as a whole. Despite the bubble, the technology sector has, for most investors, generated good returns — unless you were unlucky enough to buy at the top of the market in 2000.

Long-term industries 3

However, Credit Suisse’s data also shows that old; declining industries can also provide good returns. A prime example is the railroad industry.

According to long-term data from 1900, to date, railroads outperformed the market. The industry struggled during the 1950s and 1960s, as trucking took much of their freight traffic as Americans began to drive or fly rather than taking the train. But since the 80s railroads have outperformed airlines, road transport and the wider US market in general.

Long-term industries 4


Industries are a key investment factor. To exploit diversification opportunities to the full, investors need to diversify across a wide spread of industries. It is interesting to see which have done best and worst, although this tells us little about the future.

The industrial landscape will change during the 21st century perhaps even more radically than in the past. Should investors focus on new industries and shun the old? Or should they be contrarian? It’s not possible to say but as the chart above shows, even the market’s oldest industries (rail) have the ability to outperform over the long-term.

Charlie Munger — Part Four: Investment Advice

This is part four of a ten-part series on the life and career of Charlie Munger, value investor, lawyer, philanthropist, Vice-Chairman of Berkshire Hathaway Corporationand Warren Buffett’s right hand man. He is also chairman of the Daily Journal Corporation and a director of Costco Wholesale Corporation. Parts one, two and three of this series can be found at the links below.

  1. Charlie Munger — Part One: The Beginning
  2. Charlie Munger — Part Two: Quality Over Value
  3. Charlie Munger – Part Three: Sit On Your A$$

To ensure you do not miss the rest of the series sign up for our free newsletter.

Charlie Munger — Part four: Investment advice

Following on from part three of this series, which explored Charlie Munger’s ‘sit on your ass’ method of investing, in this part I’m going to take a look at some of the investment advice that Charlie Munger has dished out over the years.

Charlie Munger’s age and experience means that he has become one of the most quotable investors of all time. He says what’s on his mind, without fear of offending anyone, often making statements others would have trouble making in public.

Unfortunately, it’s not possible to cram all of Munger’s investment wisdom into one article. So with the limited space available here, I’m going to try and condense a few of Charlie’s best nuggets of advice on to this page.

The full article can be found at http://www.valuewalk.com/2015/04/charlie-munger-investment-advice/

Illiquid Stocks Consistently Outperform The Market

The search for value often draws investors into illiquid markets, and to some, this can be a daunting prospect. However, research suggests that illiquid stocks outperform their liquid counterparts over the long-term.


In what has been called an illiquidity-anomaly, several studies published over the past few decades have shown that the market rewards illiquid stocks, although it’s unclear exactly why. One of the earliest studies on the topic was conducted by researchers Amihud and Mendelson who used bid–ask spreads to explain stock returns between 1961 and 1980. Published in 1986, ‘Asset Pricing And The Bid-Ask Spread’ raised some interesting points.

The data showed that average portfolio risk-adjusted returns increased with wider bid-ask spreads. Moreover, the data lead to a conclusion that the spread was by no means an anomaly or an indication of market inefficiency; rather, it represented a rational response by an efficient market to the existence of the spread.

It was found that due to the existence of a wide spread, investors held the illiquid stocks for a longer period and the wider spreads actually attracted investors who were willing to invest with a longer time horizon.

In other words, wide spreads encourage responsible long-term investing, not short-term speculation. Unfortunately, while a wider spread may lead to outperformance, a company’s cost of equity capital will be higher due to the wider spread. Clearly this is not desirable from a company’s point of view.

In the latter part of the 1990’s, two more studies were published that looked at the above average returns of low turnover stocks. These studies, conducted by Haugen and Baker (1996) and Datar, Naik, and Radcliffe (1998)demonstrated that low-turnover stocks, on average, earn higher future returns than do high-turnover stocks.

Illiquidity as a strategy

During 2013, Roger G. Ibbotson, Zhiwu Chen, Daniel Y.-J. Kim, and Wendy Y. Hu released a study that went so far as to say that illiquidity should be a style of investing, like growth and value. The study, entitled Liquidity as an Investment Style argued that:

“Liquidity should be given equal standing with size, value/growth, and momentum as an investment style. As measured by stock turnover, liquidity is an economically significant indicator of long-run returns. The returns of liquidity are sufficiently different from those of the other styles that it is not merely a substitute. Finally, a stock’s liquidity is relatively stable over time, with changes in liquidity associated with changes in valuation.”

Data from the study is shown below.


For his work on the topic of liquidity, Roger Ibbotson and his co-authors received the 2013 Graham & Dodd Prize for the best article in the Financial Analysts Journal.

Ibbotson’s study focused on daily stock turnover as a measure of stock liquidity. He looked at 3,500 U.S. stocks, ranked them by their turnover and then divided them into four quartiles. The least liquid quartile showed an average return of 16.38% per annum over the study period, 1972 to 2011. The most liquid quartile showed an average annual return of 11.04%.

Unsurprisingly, many of the stocks in the most illiquid quartile were cheap, value style stocks, which goes some way to explaining their outperformance — value tends to outperform over the long-term. But Ibbotson and his team also performed the same exercise for all other recognized styles. They found that while the performance of illiquid stocks could be explained by stocks’ cheapness, there was a significant statistical outperformance by illiquid stocks across all strategies that could not be explained. Over the full 1972-2011 period, illiquid stocks fared better than small stocks and high-momentum stocks.

Further evidence

Only a year before the above study was published, Roger Ibbotson published a smaller  liquidity study in the Financial Analysts Journal, which dissected mutual funds.

This study looked at the holdings of U.S. equity mutual funds, offered for sale to U.S. residents, from February, 1995, to December, 2009. Each fund was classified according to its orientation on the value-growth spectrum and the liquidity of holdings. Liquidity was calculated by taking a stock’s average volume over the last year divided by its shares outstanding. In this study, value stocks outperformed growth by 0.80% per annum. Small-caps beat large caps by 1.89% per annum and small-cap value funds outperformed by 3.23% per annum.

The difference in performance between illiquid and liquid stocks was even wider. Value funds that held the least liquid 20% of stocks, outperformed value funds with the most liquid stocks by an average of 2.28% per annum. Illiquid growth funds also outperformed liquid growth funds by 2.25% per annum.

Funds holding the least-liquid small value stocks beat those with the most-liquid large growth stocks by 4.99% on average each year.


So, there is a certain amount of evidence that points to the fact that illiquid stocks outperform the market over the long-term.  There’s also evidence to suggest that illiquid stocks are less likely to suffer dramatic drawdowns during periods of heavy selling, as the FT explores:

“As illiquid stocks should be harder and more expensive to trade, it becomes harder for share prices to readjust smoothly, creating volatility. But in practice, the experience of the 2008 crisis was exactly the opposite. Daniel Kim, one of the co-authors and research director for Zebra Capital Management in Connecticut, reports that illiquid stocks suffered far lower drawdowns during the most dramatic days of heavy selling. That was because, in an emergency, people sold whatever they could, so liquid stocks were sold first.”