Seth Klarman: The Forgotten Lessons of 2008

[farnamstreet]

In this excerpt from his annual letter, investing great Seth Klarman describes 20 lessons from the financial crisis which, he says, “were either never learned or else were immediately forgotten by most market participants.”

 

http://bit.ly/ck0xki

[value-is-what-you-get]

Thank-you very much farnamstreet. 

 

I will keep that one in a safe place and re-read regularly.

[Hoodlum]

My personal favorite is False Lession #6.

 

Markets need not be in sync with one another. Simultaneously, the bond market can be priced for sustained tough times, the equity market for a strong recovery, and gold for high inflation. Such an apparent disconnect is indefinitely sustainable.

[Rabbitisrich]

It's a classic letter. I'm sure many managers will save a copy of these lessons.

 

I liked 12. Be sure that you are well compensated for illiquidity – especially illiquidity without control – because it can create particularly high opportunity costs.

[Santayana]

I think that point about liquidity is great also.    One of the real problems many people faced was thinking they had liquidity and then it turned out they didn't (oops!).  Is anything really liquid besides Treasuries and FDIC covered amounts? 

 

[Viking]

I think the FFH could have written many of the lessons. However, there are a couple that appear at odds with FFH (and even Buffett):

Lesson

16.Financial stocks are particularly risky. Banking, in particular, is a highly leveraged, extremely competitive, and challenging business. A major European bank recently announced the goal of achieving a 20% return on equity (ROE) within several years. Unfortunately, ROE is highly dependent on absolute yields, yield spreads, maintaining adequate loan loss reserves, and the amount of leverage used. What is the bank's management to do if it cannot readily get to 20%? Leverage up? Hold riskier assets? Ignore the risk of loss? In some ways, for a major financial institution even to have a ROE goal is to court disaster.

 

False Lesson

7.In a crisis, stocks of financial companies are great investments, because the tide is bound to turn. Massive losses on bad loans and soured investments are irrelevant to value; improving trends and future prospects are what matter, regardless of whether profits will have to be used to cover loan losses and equity shortfalls for years to come.

 

I think this is exactly the logic Buffett has used to explain his support for Wells Fargo... future earnings will cover current losses...???

 

[Viking]

The lesson that jumped out at me (personally) the most was:

 

9.You must buy on the way down. There is far more volume on the way down than on the 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.

 

My experience the past 15 years (since current management took over to coin a phrase I love) I have been quite good at this 'lesson'. However, I need to continue to get better at the hold part of the equation (not that I am complaining too loudly).

[twacowfca]

The lesson that jumped out at me (personally) the most was:

 

9.You must buy on the way down. There is far more volume on the way down than on the 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.

 

My experience the past 15 years (since current management took over to coin a phrase I love) I have been quite good at this 'lesson'. However, I need to continue to get better at the hold part of the equation (not that I am complaining too loudly).

 

 

How true. How true # 9 is.  The first time we bought FFH, we waited and waited until it dropped from over $300 cn to less than $50 us.  Then, when we jumped in, we couldn't get complete fills.  We chased it all the way to $85, and then said "the heck with it".  Later we paid much higher prices in future years.

[value-is-what-you-get]

I think the FFH could have written many of the lessons. However, there are a couple that appear at odds with FFH (and even Buffett):

Lesson

16.Financial stocks are particularly risky. Banking, in particular, is a highly leveraged, extremely competitive, and challenging business. A major European bank recently announced the goal of achieving a 20% return on equity (ROE) within several years. Unfortunately, ROE is highly dependent on absolute yields, yield spreads, maintaining adequate loan loss reserves, and the amount of leverage used. What is the bank's management to do if it cannot readily get to 20%? Leverage up? Hold riskier assets? Ignore the risk of loss? In some ways, for a major financial institution even to have a ROE goal is to court disaster.

 

False Lesson

7.In a crisis, stocks of financial companies are great investments, because the tide is bound to turn. Massive losses on bad loans and soured investments are irrelevant to value; improving trends and future prospects are what matter, regardless of whether profits will have to be used to cover loan losses and equity shortfalls for years to come.

 

I think this is exactly the logic Buffett has used to explain his support for Wells Fargo... future earnings will cover current losses...???

 

 

I would say that on the surface it appears at odds, however Klarman's false lesson says "stocks of financial companies" as a generality and of course this is correct.  I think Buffett has said as much too, but he has obviously done his own math on the reserves for losses and bad loans at Wells specifically and deemed it a bank that will earn it's way out of this.  He has also said CITIbank is in the too tough pile so he's talking about specific companies as opposed to going with a general sector rule.  I recall him saying that the idea here is to figure out which will still be standing when others fall.