Most Popular ArticlesHave It Backwards
June 16, 2009
If the technology existed to permit real-time performance measurement of his portfolios, Klarman said, he wouldn’t want it, since it would run completely contrary to his long-term focus.
After all, the result is behavior that makes little sense. Investment managers can usually be found “scurrying around” to achieve superior daily or weekly performance, even though their proper goal is to realize substantial gains farther down the road.
By contrast, managers with a long-term focus gained extraordinary advantages in the current crisis. Klarman described a situation that illustrated the disparity between managers who are able to focus on long-term objectives and those who must engage in short-term performance races: His firm had the opportunity to bid on a publicly traded debt instrument. Another bidder was willing to pay significantly more than his initial bid, but Klarman still determined that he would earn a 25% return, even at the higher price.
Klarman said every client should want their manager to make such an investment. But most with a nearsighted focus would be extremely reluctant to pull the trigger, particularly because the bonds in question lack liquidity and are unlikely to be marked up to the level where this trade would take place.
Having a long-term focus requires keeping the emotions of fear and greed in check. For most of the last 12 months, fear dominated greed, causing investors to flee to cash, despite its negative yields. Those investors, along with many who suffered losses on Treasury bonds bought at depressed yields, also paid dearly in opportunity cost – their inability to buy securities at depressed valuation. “Managers who were too fully exposed were unable to appreciate the opportunities,” Klarman said.
Frightened clients made things worse for managers, who are unfortunately guided by what clients think – or what they are afraid clients are thinking.
All managers made some mistakes and likely posted losses. Shrewd investors, who picked up bargains, looked like “risk takers.” Klarman even admitted to some mistakes of his own – he stretched his criteria to buy some marginally cheap stocks, for instance, and one of his private investments went bad.
But Klarman does see a sliver lining: He believes the current crisis may embolden more managers to stand apart from the crowd – and perhaps even charge fairer fees.
Among those who will have the opportunity to stand out are managers with broader mandates, who are particularly well positioned to serve clients’ needs, Klarman said. Narrowly focused managers, such as junk bond managers, he said, are often forced to be 100% invested, regardless of the risk/return profile of their investable universe. Such constraints eliminate the potential for contrarian thinking, which is critical to the success of value investors like Klarman.
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