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10 investing don'ts from Seth Klarman Recent in Library

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Seth Klarman is one of the world's most astute investors. At the helm of one of saving-funds-2.aspx)
the largest hedge funds in the world - Baupost, his book Margin of Safety Average monthly SIP inflow is at Rs 7,500 crore in FY18- Nov 19
(https://www.amazon.in/Margin-Safety-Risk-Averse-Strategies- 19 (/posts/49673/average-monthly-sip-inflow-rs-7500-
crore-fy18-19.aspx)
Thoughtful/dp/0887305105) has a cult following. Union AMC launches Value Discovery Fund Nov 19
(/posts/49670/union-amc-launches-value-discovery-
Here is some of his investing advice that has been taken from his book, fund.aspx)

newsletters and interviews over the years.

1) Don’t focus predominantly on return, focus on risk first.

Recent from this Author
The real pain occurs on the downside. When your portfolio is down by 50% you Union AMC launches Value Discovery Fund Nov 19
stare into an abyss and wonder if you are going to lose it all. (/posts/49670/union-amc-launches-value-discovery-
fund.aspx)

Focus on multiple scenarios. What can go wrong? How much can you lose? New Fund Offers (/posts/49667/new-fund-offers-2.aspx) Nov 19
4 myths about Millennials and investing (/posts/49652/4- Nov 16
Always be prepared for the unexpected, including sudden, sharp downward myths-millennials-investing.aspx)
swings in markets and the economy. Whatever adverse scenario you can Equity funds received robust inflows in October Nov 14
(/posts/49627/equity-funds-received-robust-inflows-
contemplate, reality can be far worse. october.aspx)
Sachin Kharate creates highest SIP record in Nashik Nov 13
Don’t think of risk in the academic sense of beta. Risk is the probability of losing (/posts/49610/sachin-kharate-creates-highest-sip-record-
nashik.aspx)
and how much you can lose if you lose.

Volatility is not risk. Volatility creates opportunities.

(/to
Uncertainty is not risk. Sometimes great uncertainty - such as in the fall of 2008
- drives securities prices to especially low levels, which make them less risky
investments.

2) Don’t get fooled by price.

(/h
The latest trade of a security creates a dangerous illusion that its market price
approximates its true value. This mirage is especially dangerous during periods
of market exuberance.

The concept of "private market value" as an anchor to the proper valuation of a

business can also be greatly skewed during ebullient times and should always be
considered with a healthy degree of skepticism.

[Private-Market value is an investor's assessment of the price that a

sophisticated businessperson would be willing to pay for a business. Investors
using this shortcut, in effect, value businesses using the multiples paid when
comparable businesses were previously bought and sold in their entirety (from
the Seth Klarman’s book Margin of Safety).]

If you don't overpay for it, your downside is protected. If you purchase it at a
discount, you have a real margin of safety.

Price is perhaps the single most important criterion in sound investment decision
making. Risk is not inherent in an investment; it is always relative to the price
paid. Every security or asset is a “buy” at one price, a “hold” at a higher price,
and a “sell” at some still higher price.

3) Don’t ignore valuations.

The real success of an investment must not be confused with its success in the
stock market. A rise in the stock price does not ensure that the underlying
business is doing well or that the price increase is justified by a corresponding
increase in underlying value. Likewise, a price fall does not necessarily reflect
adverse business developments or value deterioration. Value in relation to price,
not price alone, must determine your investment decisions.

The cheapest security in an overvalued market may still be overvalued. You

wouldn't want to settle for an investment offering a safe 10% return if you
thought it very likely that another offering an equally safe 15% return would
soon materialise.

An investment must be purchased at a discount from underlying worth. This

makes it a good absolute value. Being a good absolute value alone, however, is
not sufficient for investors must choose only the best absolute values among
those that are currently available.

A stock trading at one-half of its underlying value may be attractive, but another
trading at one-fourth of its worth is a better bargain. This dual discipline
compounds the difficulty of the investment task for value investors compared
with most others.
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4) Don’t let a down market upset you.
You must buy on the way down. There is far more volume on the way down than
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on the Welcome!
way back up, and far less competition among buyers. It is almost always
better to be too early than too late, but you must be prepared for price
markdowns on what you buy.

Don’t forget that stocks aren't pieces of paper that gyrate all the time --they are
fractional interests in businesses. And if you can buy “this thing” for a huge
fraction of what it's worth, why must you be worried if it goes down a little bit
more?

5) Don’t ignore psychology.

Investing is the intersection of economics and psychology.

The economics, the valuation of the business, is not hard. That is the easy part.
The tough part is the psychology -- How much do you buy? Do you buy it at this
price? Do you wait for a lower price? What do you do when it looks like the world
might end?

While time and experience helps you move up the learning curve, it does help to
have right psychological make up in the first place.

Unsuccessful investors are dominated by emotion. Rather than responding coolly

and rationally to market fluctuations, they respond emotionally with greed and
fear.

6) Don’t get carried away by the big picture; think bottom up investing.

Macro investing must take a backseat to individual investment ideas.

Most of the investment world has a top-down orientation. How is the economy
going to do? How are foreign currencies going to do? How are interest rates
going to do? It is not totally extraneous, but investments must be analyzed
bottom up one at a time.

It is incredibly difficult to have an accurate record of macro investing which has

been efficiently translated to make it relevant to industries and companies, and (/to
be early so that the stock prices have not already moved to reflect your
viewpoint.

7) Don’t let short-term underperformance divert your attention.

(/h
Long-term investment success is pursued at the price of short-term
underperformance. When markets are rising, speculative investments may
perform well. The payoff from a risk-averse, long-term orientation is–just that–
long term. It is measurable only over the span of many years, over one or more
market cycles.

Investing amidst failing markets is the best way to build positions at great
prices, but this strategy can cause short-term underperformance. Buying as
prices are falling can look stupid until sellers are exhausted and buyers who held
back cannot effectively deploy capital except at much higher prices.

Short-term underperformance should not trouble you; indeed, because it is the

price that must sometimes be paid for longer-term outperformance.

Patience and discipline can make you look foolishly out of touch until they make
you look prudent and even prescient. Investors need discipline to avoid the
many unattractive pitches that are thrown, patience to wait for the right pitch,
and judgement to know when it is time to swing.

8) Don’t go overboard with diversification.

Maintain sufficient but not excessive diversification. To quote Klarman: "Owning

a diverse portfolio in one market may greatly reduce the risk associated with a
single company hitting a bump in the road but will not at all reduce the risk of
being in that market. If that market runs into a pothole, its components could all
break down at once. This is particularly true if that market is trading at record
levels of valuation, supported more by money flows than by fundamentals, as
happens sometimes.”

9) Don’t try timing the market.

While it is always tempting to try to time the market and wait for the bottom to
be reached, such a strategy has proven over the years to be deeply flawed.

The price recovery from a bottom can be very swift. Therefore, an investor
should put money to work amidst the throes of a bear market, appreciating that
things will likely get worse before they get better.

Most investors take comfort from a calm, steadily rising market; a roiling market
causes panic. But these conventional reactions are inverted. When all feels calm
and prices surge, the market may feel safe; but, in fact, they are dangerous
because few investors are focusing on risk. When one feels in the pit of one’s
stomach the fear that accompanies plunging market prices, risk-taking becomes
considerably less risky, because risk is often priced into an asset’s lower market
valuation.

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 People should be highly skeptical of anyone’s, including their own, ability to
predict the future, and instead pursue strategiesWelcome!
(http://www.morningstar.in/) that can survive whatever may
occur.

10) Don’t let greed dominate your thought process.

Never hold on for the last nickel. You make a big mistake when you do that. We
never assume something will go past its fair value. We let someone else make
the last dollar or two. We always sell too soon.

This selling discipline allows him to rebuy a stock after it drops. It also helps him
avoid the psychological damage of watching an unrealized profit disappear due
to greed.

Nowhere does it say that investors should strive to make every last dollar of
potential profit; consideration of risk must never take a backseat to return.

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