About a year ago, Seth Klarman, founder and president of
Baupost Group, wrote in his year-end letter to clients that
2011 was like "playing a great hand of cards in the basement of
a condemned building filled with explosives during an
|| Baupost's Seth Klarman
Last year was nothing so perilous. Entering 2012, Klarman
sounded a more upbeat tone, saying his firm was poised to scoop
up bargains. His Boston hedge fund firm's cash balance stood at
21 percent of capital at the end of 2011, slightly less than 30
percent earlier that year. (Cash balances at the firm average
around 33 percent and have been known to range up to 50
Alas, the investor found it difficult to part with cash. "We
were all dressed up with no place to go," Klarman told clients
in his year-end letter dated January 24, 2013, describing the
year as "frustrating."
The trouble was, he explains, there wasn't enough supply of
securities and assets just as buy-side competitors became
increasingly aggressive. The bargains that came in the wake of
the 2008 and 2009 selloffs are long gone.
Instead, he says, Baupost, known for its eclectic taste in
undervalued assets ranging from equities, to distressed
securities to real estate, had to contend with potential
opportunities that were priced too high for the
Nonetheless, Klarman - who has returned a compounded annual
rate of at about 18 percent since he helped to launch Baupost
in 1982 - tells clients that, all things considered, he was
"quite pleased" with how the annual performance turned out.
Despite the dearth of new investment opportunities, Baupost,
now with about $26 billion in assets under management, finished
2012 up around 7.6 percent on a consolidated basis. By way of
comparison, the firm posted gains of just 4.5 percent to 5
percent in 2011.
"While our return for the year was not scintillating, we
regard it as acceptable considering the limited risk incurred
to achieve it, including the consistent maintenance of cash
balances that hovered around 30 percent of capital all year
before ending somewhat higher," writes Klarman.
In a separate report, Baupost managing director James
Mooney, head of the firm's public investment group, says his
team generated solid results in 2012, with significant gains
coming from several core positions.
The biggest gains came from its investment in the debt of
Lehman Brothers, which, all told, accounts for slightly more
than 20 percent of Baupost's net asset value. This include
Lehman entities in the United States and in administrative
proceedings in foreign jurisdictions, including Lehman Brothers
International Europe, or LBIE, Lehman's U.K. broker-dealer.
"The Lehman story continues to evolve towards resolution
both in the U.K. and in the U.S., and, during 2012, we received
significant distributions from both estates," Mooney informs
Altogether, Baupost received nearly $1.5 billion and expects
to receive "significant additional distributions" in 2013.
In the fourth quarter of 2012 alone, Baupost invested nearly
$1 billion in two major claims against LBIE. "Although the
market for claims remains competitive, we continued to reap the
benefits of the extraordinary analytical efforts of our Lehman
team, which allowed us to understand and value claims with
highly complex underlying transaction structures," Mooney
writes. During the year it also swooped in and bought Lehman
paper when prices fell.
Looking at 2013, opportunities for new investment in Lehman
won't be nearly as attractive, adds Mooney.
Baupost's structured products portfolio also fared very well
in 2012, even though its allocation in the firm's overall
portfolio fell from more than 20 percent of assets at the end
of 2009 to less than 8 percent as a result of sales. "All
positions in this segment of the portfolio were profitable,"
These included interest-only securities and collateralized
debt obligations, although such securities are losing their
appeal for 2013. "This is due both to a prevailing view among
market participants that the housing market is beginning to
recover as well as to the fact that investors, in general, are
willing to bid up risky assets to yields that we no longer see
as attractive relative to the inherent underlying risks,"
Looking ahead, he says, the firm expects to see increasingly
less chances of investing in structured products space, and it
will likely be a net over the course of this year. The one
exception may be Europe.
As for equities, 2012 had mixed results, resulting in a flat
performance, with a few notable exceptions. News Corp., Oracle
and Vivendi generated "substantial dollar profits," the letter
says. The firm also enjoyed solid contributions from a few
other, smaller positions.
Baupost's Hewlett Packard investment took a big hit, and by
year end the firm had unloaded most of its position.
On the other hand, the gold portfolio lost money, especially
one unnamed investment that Mooney says "fell sharply" because
an expected permit was indefinitely delayed. However, the firm
added to its exposure in cases where it thinks the returns
remain attractive, he adds.
Mooney also discloses that in 2012 Baupost had invested in
Greek sovereign debt, but it no longer holds this position as a
result of sales made before the government tendered for its
bonds in December and contractual maturities it received from
government loans repaid prior to year end.
"This was Baupost's first foray into sovereign credit and we
were very pleased to have generated a healthy profit," Mooney
Separately, Tom Blumenthal and George Rizk, co-heads of
private investments, report that the firm's private equity
portfolio had a good year last year, and the real estate
portfolio's contribution to profitability was in line with its
How is Baupost's deck of cards positioned for 2013? Klarman
believes U.S. stock market valuations are increasingly
expensive but not extreme. He says he is encouraged by the
country's moves toward becoming energy-independent and by signs
that low-cost natural gas is setting the stage for a
Klarman even waxes philosophically on the country's debt
crisis: "Our national debt is entirely denominated in our own
currency, so we cannot actually default. And the solution to
our irresponsible deficit spending lies in our own hands.
Unlike peripheral Eurozone countries, we are still the masters
of our fate."
Mooney, for his part, expresses concerns over the
"insatiable investor appetite" for corporate credit. While some
would argue that the market isn't that overheated because
credit spreads remain near historical averages, Baupost
maintains that, "at best, the level of absolute yields is yet
another manifestation of the overall interest rate bubble and,
at worst, is evidence that investors are accepting insufficient
returns for the risk they are taking."
Still, Europe is particularly interesting for the potential
distressed investment opportunities that it presents, Mooney
observes. He argues that the fundamental issues facing European
economies remain "ominously beneath the surface: exceedingly
high debt/GDP ratios, persistent budget deficits, and hundreds
of billions of euros of stranded assets on bank balance
Thus, he says, his firm is sifting through leveraged
companies and sovereign credits looking for the shakiest
His conclusion: Baupost's portfolio holdings are "quite
compelling as we enter 2013," and the firm is confident it will
achieve "solid long-term returns with limited downside risk
under any of the aforementioned scenarios."