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BrianSpectorleavingBaupostletterBusinessInsider

Alettergivesarareglimpseintoone
oftheworld'smostsecretiveand
mostsuccessfulhedgefunds
JULIALAROCHE
NOV.4,2015,3:31PM

Therearetwo
typesofinvesting,
accordingtothe
departingpartner
ofhugely
successfuland
secretivehedge
fundBaupost
Group:"needlein
ahaystack
investing"and
"tidecomesinand
tidegoesout
investing."
Onetypetakes
rigorousworkas
yousearchfora
smallnumberof
opportunities.The
other,"chutzpah."

GettyImages/ScottOlson

SethKlarman,thepresidentandCEOofTheBaupostGroup.

Thepartner,BrianSpector,madethosecommentsinalettertoinvestorsinthe$27billion
hedgefund.
Theletter,includedwithBaupost'squarterlyupdate,providesarareglimpseintotheBoston
basedfund,whichisledbyiconicvalueinvestorSethKlarman.
Spector,aseniormemberofthefund'spublicinvestmentgroup,willretireattheendoftheyear
after17yearsatthefundtofocusonhisfamilyandphilanthropy,accordingtothethirdquarter
update,datedOctober15andobtainedbyBusinessInsider.
Klarman,theauthorofthefamedbookonvalueinvesting"MarginofSafety,"describedSpector
as"anoutstandinginvestor,collaborator,andmentor."
KlarmanalsoaskedSpectortowritedirectlytoinvestors.
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"Becauseofhisuniqueperspectiveandinsights,IaskedBriantodraftalettertoyouthat
accompaniesthisletter.Healonedeterminedthecontent.Ihopeyoufindthatitfurthersyour
understandingofBaupost,"Klarmanwrote.
Asoftheendoflastyear,BaupostGrouphadachievednetgains(afterfees)of$23.4billion
sinceitsinceptionin1982,placingitamongstthetopperformingfundsintheworld,according
todatafromLCHInvestments.
Inmorethanthreedecades,ithashadonlytwodownyears.Rightnow,thefundisontrackfor
itsthirdannualloss,sufferinga"midsingledigityeartodatedecline"afterwhatKlarman
describedasa"painful"thirdquarter.

Dotcombubble
Spectorwas25whenhejoinedBaupostinMay1998duringthe"heart"ofthedotcombubble.It
wasatoughtimetobeavalueinvestorbroadlydefinedasfindingstocksthatareundervalued
bythemarketandpoisedtorise.
Backthen,somethoughtthattheglorydaysofvalueinvestinghadpassed.
"Traditionalmetricslikecashflowandassetvalueswerebeingblatantlydisregardedbythe
marketinfavorofnewfoundmetricssuchaseyeballsandclicks.Hightechcompanieswerethe
darlingsinarapidlyrisingmarketwhilelesssexyvaluestockssignificantlylagged,"Spector
wroteintheletter.
Baupostfinishedtheyeardownover12%.
Twoyearslater,though,thedotcombubbleburst,presentinganopportunityforBaupost.
Whileothersweresellingofftheirpositions,Baupostcontinuedtobuytechstocksat
"remarkableprices."
Itwasn'teasy.Spectorwrotethatthereweremanysleeplessnightswatchinginvestmentsthey
madeatbargainpricescontinuetofall:
Thebearmarketpickedupsteamandwefoundanumberofstockstradingnearoreven
belowtheirnetcashvalue.Weboughtbasketsofformerlyhottechnologystocksthatwere
gettingpummeled,despitehavinggoodbusinesseswithcontractedrevenues.Although
manyofthesecompanieswereexperiencingnegativecashflow,theirmanagementteams
wereshrinkingheadcounttoaligntotheneweconomicrealityandweresuccessfully
loweringoreliminatingcashburn.Itseemedlikeshootingfishinabarrel.Wewerebuying
cashatadiscountwithanoptionthattheunderlyingbusinesseshadrealvalue.Allwehad
todowaswaitforthatunderlyingvaluetoberecognized.Whatcouldbeeasierthanbuying
cashatadiscount?
Itturnsoutbuyingadollarfor50centsisalotharderthanitseems.Everydayweaddedto
thesepositions,thinkingweweregettinganevenbetterbargainthanthedaybefore,onlyto
wakeupandwatchpricesdropfurther.Otherrespectedinvestorswouldoftencomment
abouthow'valuetech'wasa'valuetrap,'besttobeavoided.Itwasasifthemarketwas
havinga'goingoutofbusiness'saleandwehappenedtobetheonlycustomerwhoshowed
up.Whilebothexhilaratingandpainfulatthesametime,whatIremembermostvividlyis
exhaustion.Aftercountlesslatenightsattheoffice,Iwouldheadhome,collapseonmy
couchandstareattheceiling.Iwasunabletoread,watchtelevision,orfallasleep.AllI
coulddowasworryaboutwhatwemighthavemissedinouranalysis.
Ultimately,Baupostwasrightinitsthesis.Themarketturned,andthestockstheyhadbought
shotup.
What'smore,momentslikethatdon'tcomeuptooofteninthemarket.Itwasa"tidecomesin
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andtidegoesout"opportunity.
"Mostofthetimeweareinperiodsofhaystackinvesting,"heexplained."Wesiftthroughlotsof
investmentideastofindafewdecentopportunities.Wesellmoresecuritiesthanwebuyandour
cashreservesbegintobuild."
Then,onceortwiceadecade,themarkets"becomesignificantlydislocated"andthetides
change.That'swhenit'stimetogetin,andittakesnerve.
Fromtheletter:
Weseedistressedsellers,illiquidsecurities,hugeredemptions,andanexcessofparanoia
andfear.Wequicklyfindanumberofinterestingopportunities,deployingoursignificant
cashbalancesaswetradeourpreciousliquidityformispricedsecurities.Wemaylose
moneyintheshortterm,asweaddtoourportfoliowhilepricesaredropping.Butwhen
marketsturn,weexpectmultipleyearsofstrongprofitability.
Investingintidemarketstakeschutzpah.Todosoeffectively,youneedtoflyinthefaceof
publicopinion,youhavetofightnormalhumanemotions,andyouhavetobepreparedto
doubledownonyourbetswhenyourconvictionismostinquestion.AsBenjaminGraham
oncesaid,'Theinvestor'schiefproblemandevenhisworstenemyislikelytobehimself.'
Butmostimportantly,youhavetobeataplacethatempowersyoutosucceedaplacethat
isuniquelysituatedtotakeadvantageofthesemarketconditions.AplacelikeBaupost.
AtypicaldayatBaupostinvolvestheteamsiftingthroughpossibleinvestmentideas:
Onmostdays,itoffersamenufullofbland,unhealthy,andfullypricedchoices.Wedo
enoughworkontheofferingstomakesurewearentmissinganythingandoftengohome
feelingunsatisfiedandunproductive.
Then,theyfindsomethingthat'scompellingandfocustheirenergyonit:
Weworkfuriouslytounderstandthedriversoftheinvestment.Wespendanenormous
amountoftimefocusedonthedownsideandtheriskofpermanentcapitalloss.Wealsotry
tounderstandpotentialoptionalityandupside.Weaskourselves,'Howandwhenwillthe
marketeventuallyseethesituationdifferently?'Oncewehaveahypothesisaboutwhyan
investmentmaybeinteresting,westartdownthepathoftryingtoconfirmorrejectour
originalthesis.Dependingoncomplexityandprice,thisprocessmaytakedays,weeks,or
evenmonths.Oftentimesweplaceinvestmentideasbackontheshelfandwaitforalower
price.Onlywhentheinvestingstarslineupwillweaddthepositiontoourportfolio.
Wecandothissuccessfullybecausewehaveacultureofpatience.Eventhoughwework
hardeverydaytryingtouncoverthenextgreatinvestment,weonlydeployourcapitalwhen
wehaverealconvictionthatwehavefoundone.Whenwedontfindinterestingideas,wedo
nothingandholdcash.Forthisreason,IveoftenjokedthatIm97%unproductive.While
thismeansIbetterbedamnproductivetheother3%ofthetime,italsomeansexercising
patienceoftenandwaitingforgreatopportunities.Ontheflipside,whenanideahasbeen
analyzedandisfullybaked,wedropwhateverelsewearedoing,discusstheinvestment,and
makeadecision.Ourportfoliodecisionprocessmustbeincrediblyefficient,aswerecognize
thatgoodideasarescarceandmayprovefleeting.
WarrenBuffettsaid,'Bigopportunitiescomeinfrequently.Whenit'sraininggold,reachfor
abucket,notathimble.'Whenagreatopportunitycomesaround,itisimperativetosizeit
correctly.
Onekeyreasonthefundisabletoinvestinthosebigideasisitkeepscashonhand:
OneofthemostcommonmisconceptionsregardingBaupostisthatmostoutsidersthinkwe
havegeneratedgoodriskadjustedreturnsdespiteholdingcash.Mostinsiders,ontheother
hand,believewehavegeneratedthosereturnsBECAUSEofthatcash.Withoutthatcash,it
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wouldbeimpossibletodeploycapitalwhenweenteratidemarketandgreatopportunities
becomewidespread.Sethhassaidonanumberofoccasionsinbothtypesofmarkets,'Ifyou
havegreatideas,youwillhavecapitaltodeploy.'Thisisincrediblymotivatingtoour
investmentteam.
Asidefromdiscussinghowthefirmusesthefundamentalsofvalueinvesting,Spectoralso
delvedintothecultureofBaupost.Unlikesomefundswheretheenvironmentissuper
competitive,SpectorsaidthatBauposthasaculturerevolvingaroundteamworkandconfidence
inoneanother.
Whenateammemberfindsagoodidea,wediscusswhoshouldworkonitandhowit
comparestootherideaswearecurrentlyfinding(aswellasotherpastideas).Thisisa
complicatedmanagementissue.Goodideasarescarceandmostinvestorsliketopursue
investmentstheyhavesourced.Atmostinvestmentfirms,analystsoperateasfreeagents.
Theirpayisbasedprimarilyontheperformanceoftheirindividualbook.Ratherthan
cooperatingandmaximizinginvestmentreturnsforthefirm,theyareoftenincentivizedto
dotheconverse.Thismaybreedacultureofmistrustandmisplacedmotivations.
AtBaupost,itisjusttheopposite.ThisisanareathatIbelievemakesBaupostexceptional
andcantbefullyunderstoodfromtheoutside.Peopleworktogethertomaximizethe
returnsforourclients,partlybecausetheyareincentivizedtodoso,butalsobecausethey
believeinoneanother.Noonewouldwanttohandoffagoodideaandwatchanother
analystdroptheball.But,sinceourinvestmentstaffisaccountabletoboththepartnersand
theteam,theycomfortablymakehandoffs,rootforoneanother,andtrytohelpinanyway
possible.Thismeansreviewinginvestments,exchangingimpactfulinformationand
opinions,aswellasmentoringoneanother.
Itisarunningjokeinourindustrythatportfoliomanagerslookenviouslyattheteamsof
theircompetitors,alwaysassumingtheothergroupsarebetter.Nothere.AtBaupost,Ive
neverthoughtthatIwouldwanttogointo'investmentbattle'withanyoneelse.Ourteamis
excellentandIbelieveithasimprovedaswehavegrown.(Quitefrankly,IwonderifIwould
evenhavetheopportunitytointerviewattodaysBaupost!)Wegetalong,shareideas,
supportoneanother,mentoryoungeranalysts,andhaveagoodtimetogether.Iknowthe
partIwillmissmostaboutBaupostisthedailyinteractionwithmysmart,ethical,hard
working,andfunny(someintentionally)colleagues.
Henotedthatyou'dneverknowwhatthemarketisdoingbasedontheatmosphereofthefund's
tradingfloor:
Wetrytomaintainacalmworkingenvironment.Inordertoreallyunderstandafirmandits
decisionmakingprocess,oneneedstocomprehendhowitactsinaperiodofuncertainty
andstress.Arepeoplecalmoryellingateachother?Doesitfeellikebusinessasusualoris
everyoneparalyzedbyalltheredontheirscreens?AtBaupost,ifyouwereinourtrading
room,youwouldnotknowifthemarketwasup5%ordown5%.Thisisbydesign.Itis
mucheasiertomakereasoneddecisionswithoutsomeonescreamingatyouorsecond
guessingyourjudgment.Itsnotalwayseasy,butwetrytomaintainthesameatmosphere
andinvestmentprocessinallmarkets.
SpectorconcludedthatBaupost'ssuccessfullongtermtrackrecordisn'tduetoa"silverbullet"
of"formula,"butratherthe215peoplewhomakeupthefirm.

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