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 percent).
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
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," Mooney states.
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
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 states.
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 expectations.
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 manufacturing recovery.
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."