| Seth Klarman at the Allen & Co. Media and Technology Conference in Sun Valley, Idaho on July 9, 2015 (Photo credit: David Paul Morris/Bloomberg). |
Much has been written about Baupost Group head Seth Klarman’s criticism of President Donald Trump’s policies and temperament after the New York Times reported on the hedge fund manager’s thoughtful year-end letter.
But almost overlooked is that Baupost enjoyed its best year since 2013.
The Boston hedge fund firm gained 9 percent in 2016, according to a Baupost investor (the letter simply states that the fund earned a return in the high single digits; the firm declined to comment on the results). And given the rash of high-profile hedge fund managers who posted losses last year and the now years-long period of generally lousy performance among hedge funds in general, Klarman seems especially proud of this accomplishment.
“Taking all this into account, it may have been a greater accomplishment for Baupost to earn a high single digit net return with quite limited risk in 2016 than it was for us to have earned higher returns in prior years,” Klarman writes in the 20-page letter, a copy of which was obtained by Alpha.
As a result of the strong performance, Baupost had $30 billion under management at the end of 2016, up from $28.5 billion the previous year.
Meanwhile, Baupost also announced in the letter that James Mooney was named president of the firm. Mooney, who has been with the firm since 2000, will continue to head the Public Investment Group and remain a member of Baupost’s management committee.
This is not a sign that Klarman is dialing back. In the letter he stresses that he remains portfolio manager and chief executive officer of the 35-year-old firm and Mooney will report to him.
“As I’ve frequently stated, I intend to continue to lead Baupost and oversee its investments for a long time to come,” Klarman assures investors. But he does indicate a concern about having in place a long-term succession plan. “In carving out the role of president, we have also established a position of authority separate from mine that will advance Baupost on its path toward the long-term organizational progression and permanence,” he explains.
In any case, Baupost’s gains last year were driven by equities and distressed debt, particularly paper issued by energy companies, according to a person with knowledge of the firm’s holdings. Most of the distressed-debt gains were generated in the fourth quarter of 2015 and the first quarter of 2016.
As we have previously reported, in the past year or two, Baupost has aggressively boosted its equity exposure. At the end of the third quarter, it had $7 billion of assets invested in U.S. equities (down slightly from $7.4 billion the previous quarter).
In January, Baupost reported that it sold more than 6.1 million shares of Cheniere Energy, or nearly one quarter of its position. As a result, as of December 31 it owned 9.25 percent of the total. At the end of the third quarter, the exporter of liquefied natural gas was by far the Boston hedge fund firm’s largest U.S. equity long position.
Baupost describes itself as a value-oriented firm that seeks out undervalued investments with catalysts in order to realize full value. It is an eclectic investor that seeks out what it deems to be ignored assets — or very complex ones — mostly in distressed debt, commercial real estate, mortgages, and equities.
Baupost fashions itself as taking a much longer view than most hedge funds. It also limits exposure to shorting and is known for holding sizable amounts of cash, sometimes exceeding 40 percent of assets. Currently, this cash position stands in the mid-30 percent range, according to a person with knowledge of the firm.
This helps Baupost to pursue fluid opportunities that sometimes disappear as more investors exploit previously underexploited markets. “To outperform over time, managers must find edges that enable them to earn excess returns,” Klarman writes in the latest letter. “We believe we have real edges as a firm, such as our truly long-term focus and flexible investment mandate,” including holding significant amounts of cash.
However, Klarman stresses in the letter that investment edges “are not constant.” He points out, for example, that so-called special situations are no longer a reliable edge for Baupost.
“Widely ignored several decades ago, many of these formerly below-the-radar situations are now widely researched and mostly picked over,” Klarman writes. He cites, as an example, thrift and insurance company demutualizations as previous investment plays that are no longer interesting.
At the same time, Klarman stresses the firm has built new edges. For example, he says the firm has established a global network of sourcing and operating partners who bring the firm “a fairly steady stream of interesting opportunities.”
Another edge, he says, is the firm’s ability to “flexibly and quickly structure transactions” for sellers of assets.
Addressing the current investment environment, Klarman concedes it has become difficult to find investment bargains, blaming this on growing market efficiency. This has made it hard for Baupost and competitors to earn historically strong returns. But Klarman assures investors he is not disheartened.
“While industry returns have clearly suffered from great competition, as well as the low return nature of the overall market environment, the emotional swings of human nature virtually ensure that markets will always be inefficient,” he states.
