Source: Smart Investors

“For those stocks that are widely followed, you can't make money if you're not smarter than others and your views are the same as others.”

“The discount is big enough to probably offset your lack of the deepest understanding of it.”

“Expanding your investment horizons is not only attractive, it can also be very valuable.”

“If you look to the market for answers, you're only following popular opinions. But if you think of the market as a manic counterparty, you can profit from the capricious market.”

“Investors need to think not only about cyclical changes like Graham and Dodd feared during the recession, but also structural changes. The combination of the two makes value investing more difficult.”

“You have to leave room because you can make mistakes. The market may be contrary to what you think, but if you are patient, you can find and have a margin of safety.”

This is a wonderful view shared by “Boston Prophet” Seth Callaman, a rare appearance with Ted Cedes on the “Capital Allocator” podcast on July 17, 2023.

This one-and-a-half-hour interview not only discussed Karaman's early business and career path, value investment principles that evolved with the times in his eyes, but also discussed Baupost's thoughts on applying value investment concepts when searching for investment targets, due diligence, investment portfolio construction, and risk management.

Karaman rarely appears in public, and although he is not a well-known investor even in the US, he is the subject of many value investing gurus.

He is one of the founders of hedge fund Baupost. Baupost was founded in 1982 by Harvard University professor William Poorvu and his partners. It advocates the principle of value investment. Karaman is still its investment manager and manages assets of nearly 30 billion US dollars.

In his 40 years with a track record of performance (beginning in 1982), his return was negative for only 5 years, with an average annual performance of more than 15%.

Callaman is also a practitioner and evangelist of Graham and value investing. He prefaced the 7th edition of Graham and Dodd's classic book “Securities Analysis.”

In 1991, at the age of 34, he wrote the book “Margin of Safey” (Margin of Safey), which was highly recognized by the industry, and Buffett was also praised. This book is currently not being reprinted, and is currently the only way to systematically understand Karaman's investment philosophy. It is currently the only way to systematically understand Karaman's investment philosophy.

During this exchange, Karaman also expressed his views on insufficient liquidity, global investment, and how to adjust the investment portfolio to suit the environment. Finally, he also mentioned the “significant benefits” investment in the Boston Red Sox, as well as his thoughts on reprinting the book “Margin of Safety.”

Smart investors read many translations. ShawnQ published this edition of “Investment Ideas”. It is currently the most fluent edition, and is well worth collecting and studying.

01 “Microentrepreneurs”

Q How did you first become interested in business and investing?

When Karaman was a child, I always did some “small business”. I was a “micro entrepreneur” and worked cleaning fallen leaves and mowing lawns.

I set up a cone stand when I was 9, but when I started selling hot dogs, I got hooked with the Baltimore Health Department because we didn't have a license. I hosted a small carnival for the kids in the yard, and built a mini golf course in the yard, but my mom didn't like it.

(Editor's note: Most of the investment masters we know from overseas have “micro entrepreneurship” experience. (Guijiang also emphasized the importance of “infiltrating business” from an early age in value investment courses. Our quality education is still lacking in cultivating logical thinking at the bottom of business. This may also affect investors' perception of an enterprise and a business model)

I have a slight interest in collecting coins. I used to buy and sell some coins by mail, which is also a mini business. As can be seen, I have done many things to explore and learn, but my main interest is the stock market.

I'm a very sensitive person to numbers, and I love to read baseball statistics. I often read the sports edition of the “Baltimore Sun”, which publishes data for every hitter and pitcher in the American League, and I'm also learning how to calculate this data.

Until one point, I noticed that the back few pages of the baseball page were covered with lots of numbers. I asked my father what it was, and it turned out to be a stock list from the stock exchange.

So I set out on another journey to try to connect my interests to find out what's really going on in the market and what's going on with the stock market. I read a lot about the market.

I remember reading a book about how to make $1 million in the stock market, and I also read “How to Buy Stocks” by Lewis Ingle (Lewis Ingle). It can be said that I've read all the books on the market.

02 Complexity can be an investor's friend

Q From picking a bunch of stocks yourself to later working and seeing the idea behind them, what was your first epiphany?

What is clear about Karaman is that you have to choose the stocks yourself, and you need to know what those companies are doing. But I really don't know how to link anything tangible to the share price, like why should I pay a specific price? Or what factors made that stock go up or down?

So after entering this industry, I've been observing and noticing minor things every day. For example, you can't just think you can buy any stock there just because stocks are trading at this price or bonds are trading at this price.

Because it's a market, maybe you can buy it, maybe it's not that liquid, or the price has changed a lot when you decide what to buy. So there are a lot of details that affect the whole equation.

Just sitting at Mutual Shares was fine (Karaman interned at Mutual Share in his junior year and worked full time after graduation), because Max Hain's office had an old railway bond trader, Hans Jacobsen (Hans Jacobsen), and you'd hear all kinds of company names that traded at different prices, and you really didn't know what was hidden behind it at the time.

But at the end of the day, things are becoming more obvious, and you understand why prices fluctuate and why they can be very attractive as investment targets.

I also remember analyzing the first stock. At the time, Michael Price threw a prospectus on my desk and said, “Come on, figure this out.”

This company, called Telecore, is an electronics distributor. At the time, it was losing a contract with a Japanese company, and Telecore distributed the products of this Japanese company. Telecore is intended to be acquired for the value of net working capital or similar.

Telecore also has a subsidiary called “Electro Rent,” which specializes in renting out similar electronic devices. In the process of Telecore being acquired, its shareholders will receive around $8 in cash within a certain period of time, as well as a percentage of Electro Rent shares.

However, the implied valuation of Electro Rent shares obtained in this way is less than 1 times the price-earnings ratio. This is a mathematical operation I can do in my head; it makes the inefficiency of the market so dazzling and obvious.

For me, this is a great example of how complexity can be an investor's friend.

If a person wanted to buy Electro Rent before, they couldn't. The only way is to buy it this way.

In most cases, you wouldn't want to spend $8 to buy the entire company for a subsidiary worth a few cents per share; you're doing this because you can get most of the principal back from the liquidation payments after the Telecore contract ends.

This is a great lesson, that is, there are arbitrage opportunities in the market, and complexity sometimes brings investment opportunities. You need to really calm down and pay attention to every detail before hidden opportunities are revealed.

03 “Cook Your Own Food and Eat Your Own Food”

... I joined Baupost after graduating in May '82. Shortly after the company was founded, I met many fund managers in New York, and while I saw them, I thought, “How about hiring this person? Would it be good to hire that person? What kind of competitive environment are they in?”

This revealed a number of issues, and ultimately led to our decision that it was better to manage the funds ourselves.

What did the question reveal?

Not to mention Karamanbe, it reveals a great deal of group thinking. Everyone's favorite stock was the same. Back then it was Warner Bros. because they owned Atari Games.

Just as every few years a different hot spot pops up in the market, people were excited about video games. What struck me then was that few money managers actually invest their money into the same products they want their customers to participate in, and how important this alignment of interests is.

This is also the main reason why Baupost did not invest in any of those fund managers. We realise that these people are being outspoken, but they don't need their own real money to follow, which is why “cook your own food, eat at home” is such a fundamental principle of Baupost.

To this day, the company's employees and their families together remain Baupost's biggest customers.

04 Broadening investment horizons and making it valuable

Q. How do you define value investing?

The basic definition of value investing in Karaman comes from Graham and Dodd. The idea is that since the market is inefficient, prices will deviate from value.

Sometimes, the price is lower than the intrinsic value, and the investment at this time will be worth the money, making it a value investment; other times, the stock price may be hyped up, or even greatly exceed the intrinsic value. At this point, you should sell. If you tend to go short, you may be able to go short.

These principles make sense. At the beginning of my career, my understanding of Graham and Dodd was probably too limited in the literal sense. I read “The Smart Investor” first because it was the easier one of his two books to understand; “Securities Analysis” was read later.

But I don't think I'm practicing Graham and Dodd's value investment method, but Mutual Share's value investment method.

At the time, I was already looking for special circumstances (referring to investment opportunities brought about by special events such as mergers, acquisitions, spin-offs, etc.). I focused on the broader capital market, not only stocks, but also the field of arbitrage and credit. As far as those railway bonds were concerned, I mainly looked at distress credit (distress credit).

This has given me excellent analytical skills, rather than being confined to a single asset class, and understood that investors can look at the whole picture.

For example, if you can figure out a stock, why can't you figure out the overall value of a private business?

If you can understand bonds, why can't you understand bank loans, convertible bonds, or municipal bonds? Or a bond backed by real estate? There are plenty of ways to learn here.

For investors, broadening your investment horizons is not only attractive, but it can also be valuable, because this way you can allocate capital to the most attractive places.

(For example) Sometimes the price of stocks is high and the price of bonds is low; sometimes the price of shares is high, while the price of real estate is low. This is also an idea.

Q When I first read Graham and Dodd's article, was there any aspect that you were too attached to it?

Karaman I'm so obsessed with book values. When you consider book value, you need to go back to 1934, when Graham and Dodd wrote the first edition of “Securities Analysis” and proposed the basic principles of value investing.

Warren Buffett published an article called “Super Investor” in the Columbia Business School magazine in the early 60s. This article explains a few investors Buffett is familiar with and how they have achieved extraordinary results.

I'm not sure if this is a perfect scientific test because not everyone can identify it beforehand.

However, they all follow general value principles in their investments, although they follow different methods. Some people focus on large market capitalization companies, others invest in small market capitalization companies, and others invest globally, not just the US.

So you've at least seen how this approach might work in a variety of places.

Buffett also pointed out in that article that value investing is not something everyone can accept; it's like getting vaccinated. When you're introduced to this method of investing, either it makes sense or you're rejected.

I think I've been vaccinated with this vaccine. It's understandable that people find it difficult to be patient, wait for the best investment opportunities to appear, and always dive in without being fully prepared.

Bill Ackman (Bill Ackman) once told me that investing in value in the traditional sense is like watching paint dry, and I brought a hair dryer.

I think this is a good definition of shareholder activism (Activism, which can also be translated as shareholder activism, meaning that investors actively participate in the decisions of listed companies through voting, proposals, or lawsuits to influence their value creation process, thereby increasing the company's market value and obtaining investment returns).

Of course, I'm not the kind of person who holds a certain stock permanently and waits for the stock to rise. Sometimes, it can be challenging to do so. In fact, the difficulty with investing is that the market always tells you, “You're wrong!”

The factors that allow you to spot incorrect pricing and market inefficiency, as well as the factors that cause the stock to discount, are likely to apply even after you buy it, and may even make it fall worse.

Graham and Dodd didn't overlook this; “Securities Analysis” also covered it. What I'm saying is that maybe there are ways to speed up the (return of value) process, and maybe you can apply Bill Ackman's “hair dryer” concept to this process.

One of the things Baupost has done over the years has been to follow basic principles: we look for bargains, we're patient, we're disciplined, we're willing to say “no” often, and as Warren Buffett said, we're not afraid to put the bat on our shoulders without waving it.

But sometimes, you swing, and at this point you have to feel safe about some important elements of value investing, and you have to accept that cheaper stocks may become cheaper.

This is probably the point that resonates most with me: if you seek feedback from the market, the market may often tell you: “You idiot, you bought the wrong one, it went down, you have no idea what you're doing.”

But the reality is, you have to look at it all in a different light; you have to think of it as the market now offering you a better price. Either you maintain confidence in yourself (your judgment), or you believe the market has given you valuable information.

As Graham and Buffett said, if you look to the market for answers, you'll only follow popular opinions.

However, if you think of the market as a manic counterparty, sometimes selling you something at a much lower price than its value, and sometimes making you pay more than it's worth, then you have an idea, then you can profit from the capricious market.

05 Find opportunities for imbalances between supply and demand in the market

Q. How did you adjust the way you evaluate businesses and assets from Graham and Dodd's early experiences?

Karaman In the 1930s, when the economy was hit hard and stocks were mispriced, it was almost certainly because we were in a recession and experienced a cyclical recession. Graham and Dodd realized this, and they wrote in their book that it is unreasonable to assume that the depression will continue.

However, they don't know when the recession will end or if things will get worse before they get better. The companies (they are talking about) have long since disappeared, either merged or been liquidated, and many of the principles they talked about were based on the laws of the time, such as the “Prudent Man Rule” or other regulations that no longer apply.

Despite many changes in the investment environment, general principles still apply. These rules and restrictions depend on people's sometimes fanatical, sometimes decadent mentality, and human-imposed restrictions (for example) you must buy high-rated bonds; you can only buy stocks that want dividends; you cannot buy stocks below a specific market value or a specific share price... These rules and restrictions will cause inefficiency in the market.

Therefore, although the specific symptoms of inefficiency have changed a lot in '89, I think the probability that it will continue to exist is still very high. Even if computers replace humans as money managers, inefficient markets will still exist. Because the essence that causes (market) inefficiency is humans, computers are trained to imitate what humans do.

So how does Baupost practice value investing?

I don't think we're based on “let's see the world like everyone else.” We don't have industry-specific analysts.

We're not going to set up a white list of stocks (and then say) “Just let us know about these 200 stocks.” Nor are we going to focus on certain industries just because we like their growth prospects.

Our setup is more opportunistic. Where might the current market be inefficient? How can we get them into our eyes so we can do our research? We are looking for opportunities where there is an imbalance between supply and demand in the market.

Now, if you tell me that a Turkish stock will be delisted from the exchange, I'll tell you that although we don't watch Turkey, we might start watching this stock.

Because when it is delisted from exchanges and removed from the index, many people may have to sell it, and many people who follow the index may no longer hold this stock. So all of a sudden, the stock price might drop below rock bottom, and you have a chance.

However, the general principles that cause stocks to be overstated can also cause corporate prices to be overstated: for example, financing is becoming more and more difficult to obtain, so buyers need to use more capital as share capital, which causes prices to fall;

Another example is that banks and insurance companies need to remove a non-performing loan from their accounts at the end of the quarter; or, a real estate fund established 12 years ago still has one or two assets left. Once the last few assets are monetized, they can close the fund to raise the next or next fund.

Tracking opportunities this way and looking for opportunities this way is quite different (from traditional practices).

That's what Baupost has been doing for 40 years. We're searching far and wide for our prey; I like to say we look for opportunities within miles, and when we think we can find them, we drill deeper.

Perhaps in stark contrast to this, others went deep. They knew every industry well, and knew pharmaceuticals, automobiles, finance, and others, but they didn't pay attention to why one of these industries was mispriced.

In recent years, the world has changed rapidly due to technological disruptions. In Graham's day, he could look at his balance sheet and profit and loss statement and say, “I want to buy this stock with 6 times PE, 2/3 working capital, or 0.7 times PB,” and knew he was probably right, and the situation would reverse.

What's different today is that a company may be doing a good job right now, but if someone is tinkering with something disruptive in their own garage. The company may not exist in 5 years, or profits will definitely be drastically reduced.

As a result, investors need to think not only about cyclical changes, as Graham and Dodd feared during the recession, but also structural changes.

I think the combination of the two makes investing harder, and also makes value investing harder.

Investors can't just calculate a few numbers and say that this stock was mispriced; they need to dig deeper. There's always something wrong with hard work, and I think investors who watch carefully will continue to find opportunities for mispricing.

06 Identify common patterns that cause inefficiency

Q. How do you organize a team to conduct extensive research to determine the areas you want to study in depth?

Karaman, I think the most important part of this is probably pattern recognition. You'll find that past patterns are not exactly the same, but are repeated in a similar way.

For example, a fund is liquidating its last asset, and they are under pressure: “You'd better remove this asset from your books; we don't want to carry it over to the next year.”

As a result, an asset that would not normally be sold now suddenly needs to be sold urgently.

It could also be some other simple pattern. For example, realising that a bond or loan is about to default, it may be traded at a large discount or that there is an opportunity for restructuring; or the market misjudged a lawsuit, either that the lawsuit is irrelevant, or that the lawsuit is more important than it actually is.

Most investors are trained to analyze cash flow, but when it comes to extrapolating the probability of legal action, I don't think anyone is good at it. Although we're also trying, I wouldn't dare say we're good at it. But I think some commercial factors like these are more important than ever.

There are many, many similar factors in the market, which combined will create some “playgrounds” where fewer people may play, leading to incorrect pricing. At the same time, it may also make some fields more likely than others to be mispriced.

Therefore, I think as long as we follow our instincts, and by looking for models and seizing the similarities, we can eventually get a good portfolio. They may all be mispriced, and the whole thing is decentralized.

“When you came to Baupost as a young man, either we did something that resonated with you or didn't.

I think for most people who have been working here for a long time, coming here is like being allowed to know a little secret. They realized that it might not be interesting to see what everyone else was watching.

With stocks that are widely tracked, you can't make money if you're not smarter than others, and your opinions are the same as others.

But there are plenty (other opportunities) out there, right? The private equity market (private market, in Chinese) is often translated as a private equity market, but “private equity” refers more to the source of capital; many private equity funds may also invest in the secondary market, and “private market” better expresses the investment of capital in unlisted private enterprises, which is closer to Karaman's original intention) can be said to be as large as the secondary market, or even larger; the real estate market itself is considered comparable to the size of the global stock market.

So there are lots of assets, lots of deals, and lots of things to buy.

Currently, feedback from the market is that you should hold those obvious stocks, and you should transfer your funds to an index (fund) because the index performs better.

But I'd like to say that over a longer period of time, stocks that aren't included in the index are attractive stocks, because if they aren't included in the index, you can buy similar stocks at a lower price than similar companies in the index.

And one day it is included in the index, then you can reap significant benefits from this promotion.

The favoured ones are often well priced, and the unpopular ones may fall even further out of favor, but often provide better investment fundamentals.

Looking at long-term returns, no matter how they are measured, better returns come from paying lower profit multiples, lower book value multiples, higher dividend rates... (or other measures used to measure valuation).

07 Free conversation is important

Q What was Baupost's entire review process from seeing opportunities to in-depth research to preparing investments?

Karaman This (process) could be a few days or a few years. It depends on the nature of the opportunity. What I'm saying is that a big enough discount might offset your lack of the deepest understanding of it.

I think investors need to be careful because opportunities don't always exist, but they also need to act humbly because the market doesn't send money in vain.

There are plenty of smart people in the market. The seller probably knows as much as you do, or even more than you; after all, they've had it for a while and you haven't.

Therefore, you should do your best (make yourself comfortable with what you are investing in), and at least make sure you're not a scapegoat on the table Buffett described.

There is more information available today than ever before. Compared to people in the most important investment positions 20 or 30 years ago, we all have more free or low-cost information.

Having said that, the reason information is valuable is also how you use it, because you have different views on the same information.

We conduct active internal debates, and teams meet in groups, often composed of a partner, a senior analyst, and a junior analyst.

When they're ready to recommend (a stock), they might go through it with another group just to say, “Hey, does this sound outrageous?”

We have analysts meet once a week at lunch. Anyone close to them and wants to meet can participate, but partners don't.

So it's a free space where analysts can pass things through with each other without thinking that partners will hear them or comment on some of their naive and stupid ideas. I think this is very important for personal development.

If this is an open idea, our traders will also be there. They can provide some trading insights or what the market thinks about that stock at this moment. We usually make decisions within an hour.

Sometimes we don't make a decision and agree to meet again; or we agree that it's interesting, but the current price isn't right;

Other times, we meet, we agree, we buy, and then, after a few days, we meet again because the price has dropped further, and now it's cheaper, do we want to have more? I always play around with these things in my head.

Sometimes I wake up the morning after a meeting and think, I forgot to ask a question, or there's a risk I didn't consider, but now I think about it.

So we're having another meeting, which might freak my employees out a bit, but I've always believed that protecting my clients' funds is more important than whether I'm driving someone crazy.

So if it gets closer to our target price, we'll keep meeting again and again.

In investing, there are two things that are limited and limit every investor: one is money, and the other is time. Both of these things are very important.

So if a stock you hold falls, even if you like it as much as before, you'll swap it out just because there's a new opportunity you like better.

I think these conversations are very helpful in optimizing portfolios.

08 Looking for a “catalyst”

Q How do you view position size?

Karaman's handling of position size has always been an advantage in Baupost's development process.

I've come across some funds, and the opinion is quite the opposite of mine. They believe that the goal of investing is to prevent an asset from causing excessive losses. So the key is to have 200 ideas in your fund, none more than 0.5%.

If you can determine whether an idea is good or bad, why can't you tell if the idea is very good or just plain good? Why can't that really good idea (position) take up more?

I also believe that a portfolio can withstand a loss of more than 10% or 20% of total assets ('a portfolio can lose more than a loss or two tenths of one percent of loss'). I'm not sure if Karaman can accept a 10%-20% drop in positions accounting for 1% of total assets, or a 10%-20% decline in total assets), so we prefer to identify whether a good idea has become a very good idea through continuous research and price drops;

Or through an event, through a company announcement, announcing “something is about to happen...” Maybe you've been studying this company long enough to understand or understand what this news means right away, while others may think (this news) isn't the direction you are judging, or at least don't understand the impact behind it.

Obviously, we stay away from any insider information, but we wanted to take advantage of our level of insight and patience, which were given to us by long-term oriented clients.

Over the years, most of the ideas that made us make a lot of money initially (the trend) went against our expectations, and then we lowered the average price by buying at a lower price.

When they are “catalyzed,” that is, some event is about to happen (and thus return its value), this will allow us to make money.

We don't just rely on “someone waking up tomorrow and liking this company better than today”, but rather that the company will actually complete a restructuring plan, or will probably complete a merger and acquisition deal, or an asset in the company's portfolio will be sold, and then they will use the profit to buy back shares.

Whatever it is, these are just the “catalysts” we're looking for. The existence of “catalysts” allows us to hold larger positions with greater confidence.

Without a “catalyst,” the hardest part about value investing is that you might hold an unpopular stock for a long time. For 5, 10, or more years, “bought too soon” and “bought wrong” all looked the same. You may start to get confused, your employees may start to get confused, and your customers may have doubts.

Of course, every investor should ask themselves this question: if one of your stocks keeps falling and falling again, is there something wrong with you? Or at least you could have seen a few things clearly before entering the market instead of owning it for your highest purchase price.

09 No one can handle a 50% drop peacefully

Q What do you think of risk management?

Karaman Baupost was founded to protect the founding family's capital. Therefore, I would describe our approach as a risk-averse approach (risk-averse approach). We consider downside risk in every investment.

Instead of incorporating it into the portfolio, we intellectually (intellectually) consider how relevant the portfolio is? Is our portfolio's risk exposure as bad as a single investment?

Or rather, since we have (risky) complementary investment targets, the overall risk exposure is much smaller? If this investment is performing well, is the other likely to perform worse? Or if this investment doesn't perform well, could the other one be a “home run”? Is there a way to mitigate risk through complementary elements in the portfolio?

You can also mitigate risk through “catalysts.” “Catalysts” can shorten the investment period, so you don't have to rely so much on future overall market performance.

We know that Buffett wrote in “Fortune” magazine from 73-74: “If you can't handle a 50% drop, you shouldn't hold common stock.”

I can tell you that almost no one is comfortable with a 50% drop in the market, yet Americans own more stocks than ever before. So I think people have forgotten this admonition. I think this is very important.

So, that's why I don't want to simply prolong the stock market, but rather diversify my investments into other asset classes, such as credit.

Shorten your investment period, create a higher-priority position and capital structure, and (in this case), you can get a return even if the stock falls into a quagmire, or you can get 80% of your capital back even if you can't keep all of your capital.

Many things can completely spread market risk: through diversification of positions or through portfolio-level hedging.

We tend to combine appropriate macro hedging, commodity type hedging, and interest rate hedging based on the specific circumstances of each investment.

The reason is that the market's long-term average price-earnings ratio is about 17 times. Currently, it is 20 times, sometimes close to 30 times, and sometimes 10 times.

When market prices are above historical averages, you're frantically exposed to the risk of (valuation) falling multiple times to the long-term average. This return to the mean alone can cost you a lot of money.

So we're trying to prevent this.

In the absence of an opportunity, I hold on to cash. The combination of these hedging and risk aversion measures provides us with a significant degree of downside protection. In Baupost's 41-year development process, there have been losses in only 5 years. With the exception of two, the losses were within single digits.

10 Liquidity by itself does not provide returns

Q. How do you consider price and liquidity issues when investing in the primary market?

Karaman I think you have to be compensated for the lack of liquidity. There is a cost to waive the right to “come in and out”, but there are also compensation.

One compensation is that if you buy an entire building, although it lacks liquidity, if you own it, you can decide when to sell it.

In contrast, if you own 100 or 1 million shares in a company, management may lose money by doing something you wouldn't do very foolish.

So I want to make sure that if I give up my right to change my mind at any time, I am compensated.

In recent years, some money managers have a big misunderstanding that as long as they choose illiquid assets, they will automatically receive a certain amount of return.

I don't think there's anything more strange than this kind of thinking. The reason you can make money from illiquid assets is because the other party to the transaction has illiquid assets, and they suddenly need to cash them out.

They want to strip it off the books, which could allow the asset to be traded at a discounted price, which heralds higher returns. But liquidity itself doesn't (provide returns).

Generally speaking, when customers ask this question, I'll say that whether you want to earn 200 or 500 basis points more, giving up liquidity and the right to change your mind is valuable.

Q: If you look at historical research in combination with the current era, how do you adjust your portfolio positions, and how are they different from the past?

Karaman For the past 12 years, we, like everyone else, have been in a state of scarce earnings until interest rates began to rise a year ago.

We love credit. Credit is often misunderstood, leading to its inefficiency. When a bond's rating is downgraded, for example below the investment grade, some holders will naturally want to settle for it, which also leads to inefficient pricing.

Therefore, we like to look at credit assets, we like distress credit (distress credit), and we like bankrupt debt (bankrupt debt). We don't want this to happen, but when these markets exist, they'll be our “hunting grounds” for opportunities.

When there was almost no bad credit, Baupost had to take a different approach.

Therefore, during the period 2010-2021, we will focus more on private markets and related inefficient areas. Real estate is one of them, and private equity is also one of them, but this is not the same as private equity as others understand. Our private equity investments are more like frightening one-off transactions, which are mispriced for specific reasons.

We have now rebalanced credit (note: increase the share of credit investment). Everything we do is bottom-up, not top-down asset allocation.

But the good news is that we have found enough debt assets to account for 15% of our portfolio and have been growing steadily.

This isn't like a peak of opportunity; I think it will continue to increase, depending on inflation and how the economy develops. Even in an economic situation where interest rates fall and inflation is suppressed, the ensuing economic downturn may cause more companies to face financial difficulties.

Many companies borrow too much, far beyond prudence. As such, this is probably the biggest change the portfolio has faced.

We've hedged this risk a lot, and although we don't try to hedge every risk, we've never done that, and we're not a zero beta or similar fund, but we've put in place some protective measures to protect against extreme conditions.

We wouldn't be surprised if we were to run into these situations.

11 Consistency with customers is important

Q: In the early years, you had no clients other than your family. Later, you brought in some institutional clients, but you have always been very careful about who the investors are. How do you see the importance of being consistent between “what you're trying to do” and “who is your investor”?

In the first few years since Karaman was founded at Baupost, we solicit family customers through word of mouth, and we may add one or two families every year. Even so, our assets are still within hundreds of millions of dollars in the 10 years since establishment.

We added our first institutional client in 1998, and they've always been a great partner because we have shared our interests.

Every type of customer has its steadiness. We love individual clients because we can directly explain our work to them.

Individuals tend to think about how to protect against downside risks. If not more than institutions, at least like institutions, they may consider issues from a longer-term perspective without having to compete with each other like institutions. But both of these types of customers can be great customers.

We've always been very careful to avoid “hot money” and short-term thinking customers. Regardless of the type of investors you have, consistency is one of the most important success factors.

If you don't have long-term oriented customers, you can't invest in the long term. I don't know how to make effective short-term investments, and I don't know how to invest for those without long-term capital.

When someone wants to fund us, I'll say I won't accept your money unless you read this annual letter. You read the letters of the past 5 years, learned how we work, and really appreciated what we did...

We don't want inconsistencies, such as when we think we did a great job this year, but you don't. So let's first talk about what we want to achieve, what's achievable, and what's not.

I think the Endowment Fund is particularly suitable for us. Over the years, following the wisdom of my mentor David Swenson, the endowment community has worked hard to establish long-term partnerships with managers.

This long-term partnership is a type of trust, which is embodied through actions and performance. The team understands each other not one-on-one at senior level, but deep into the entire organization.

I think from an agency's point of view, being able to follow the manager's ups and downs (very important), you can read a brochure, you can talk to a manager for an hour, but you can't really understand how he will handle adversity, and you can't really understand his personality.

This will take a long time to see. From a manager's perspective, it's also helpful to understand how customers act; can they be a long-term partner? Are funds available when you need them most?

12 Consider republishing “Margin of Safety”

Q. Do you have any new thoughts on “Margin of Safety” that you wrote 30 years ago? Are you considering updating or revising that expensive, scarce, and only available on eBay?

Karaman is indeed out of print, and I may republish it at some point in the future. I have an idea in my head that maybe a companion version can be made to reprint it in some way.

I know I can only make one, but (but) I think this book is worth updating. The world has changed dramatically in 15 years.

I'll talk more about the investment process. I'll talk about company culture and investment institutions. I'll talk about flexibility in approach. You don't need to look exactly like last year or 5 years ago. The market is growing and the types of securities are changing. I'll talk more about private market investing and the application of Graham and Dodd's principles to private market investing.

Also, 30 years have passed since the last edition of “Margin of Safety” was released, and it is partly just a continuation of the wisdom of “The Smart Investor,” and I think I've almost achieved it. But there are some things I wouldn't write again if I wrote them today, and some things I think are wrong.

For example, I don't really understand the value of intangible assets. The bad debt part still applies, and it's still interesting, but I'll add some brand new content because the rules of the game have changed in this area, so it's arguably worse. So, there's still plenty worth talking about.

I still love the title I blatantly stole from “The Smart Investor,” which accurately captures what value investors strive to do: you need to leave room because you might make mistakes.

The market may be contrary to what you think. But if you're patient, you can spot and have a margin of safety. In other words, you probably won't shed tears with other investors.

13 Baseball and value investing

Q. Are you considering the Boston Red Sox as an investment? Consider that your job is so focused on value investment analysis.

As a lifelong baseball fan, as a fan of “The Penalty Shot” (Moneyball, an American film, which tells the story of a team manager using Cybermetrics to select players to form a team and achieve amazing results), he is a loyal fan of the Boston Red Sox.

The story behind this is that about 20 years ago, when the Boston Celtics franchise was about to change hands, someone found me and asked me to buy it.

I seriously thought about it but gave up because I think my true love is baseball. I said to the sports agent who was marketing to me at the time, “I'll give up on this deal, but if you see an opportunity to join the Red Sox, please call me.”

After four or five years, he actually made a phone call. In fact, he's a former Patriots (Patriot) player. We talked on the phone and then I bought another person's shares.

At the time, I didn't know if it was a good investment. The price is about 30 times the current cash flow. I just thought this would be really interesting.

The results proved that the investment was better than I had imagined, and no less than any other investment. I only bought a very small portion of the team's shares, which at the time were not expensive compared to the team's overall valuation.

Under the operational leadership of Sam Kennedy, the team achieved a brilliant record. He is the best CEO in the entire sports world, and I think most would agree. They have greatly increased the value of the company. John Henry and Tom Warner have also created tremendous value through their respective actions and leadership.

So it's great, and it turns out it's a value investment. I didn't know this at first, but for me, the real return on this investment is still a pleasure for me.

14 Don't be afraid to bet on yourself

Q What are some life experiences you wish you knew sooner?

A well-known investor in Karaman once said to me, never be afraid that no one will be able to place a safe bet on yourself for a 50% drop.

Obviously, my career path is about betting on myself, but I might have done better if I had more confidence in the uniqueness of the opportunities I discovered early in my career.

I don't want to look back. I never want to complain about “could”, “should”, “should” or “should” anything. Maybe I could have made a little more, but I think “don't be afraid to bet on yourself” is very important.

This is also the advice I often give to young people. I'm not going to tell them to set up a fund, but once you go out and break out, once you feel ready, don't rush to sell your business, make good use of yourself, and make your business as good as possible.

We all bring our traits and dreams to everything we do, and make the best use of the opportunities available to you.

Editor/Somer