Clients withdrew $7 billion over 3 years, with an annualized return of only 4%. Can "Little Buffett" Klarman's fund turn the tide?

The once high-profile hedge fund Baupost Group has fallen into performance difficulties in recent years.

On January 22nd, Eastern Time, Bloomberg cited investor sources stating that since 2014, this fund founded by renowned value investor Seth Klarman has achieved an average annual return of only about 4%. This performance is not only far below one-fifth of its historical level but also lags behind other multi-strategy hedge funds and mixed equity-bond index funds.

Over the past decade, Baupost has recorded losses in three years, although the maximum decline was less than 5%. The long-term low interest rate environment and the continuously rising stock market have led to a reduction in the distressed asset investment opportunities that Klarman excels at. This market pattern has made it difficult for Baupost to fully leverage its traditional advantages, thereby affecting overall performance. In the past three years, investors have withdrawn about $7 billion from Baupost, and the persistently poor performance has undermined investor confidence.

To reverse the downturn, Baupost announced last June the largest layoffs in 42 years, cutting nearly 20% of its investment team. The layoffs aim to refocus on the company's historically most successful strategies: distressed debt and special situation investments, event-driven stock investments, private equity investments, and providing financing for companies.

In his year-end letter to clients, Klarman stated:

"By streamlining the investment team, we have improved energy levels, focus, accountability, and collaboration efficiency."

This letter is also seen as a progress report on the company's transformation efforts.

So far, Baupost's performance has begun to improve. According to investors, the fund achieved about a 10% return last year, marking the first time it reached double-digit growth since 2021. However, this achievement still lags behind many of its multi-strategy hedge fund peers and is far below its historical average.

The Glorious History of Klarman's Investment Legend

Seth Klarman is a recognized master of value investing on Wall Street. The Baupost fund he founded in 1982 once achieved remarkable performance. Klarman's book "Margin of Safety," published in 1991, is regarded as the bible of value investing, with the market price of a signed first edition now reaching $9,500. This book emphasizes the importance of buying securities at a discount price, providing investors with a margin of safety.

In the early years, Klarman's approach was very successful. According to a 2008 report by Harvard Business School Alumni Magazine, in the first 26 years of Baupost's operation, its annualized return rate reached as high as 20%. The fund's size primarily grew through compounding rather than attracting new capital, eventually peaking at about $30 billion.

However, in recent years, the performance of the Baupost fund has been unsatisfactory. Some institutional clients have expressed disappointment with the persistently low return rates and have begun to withdraw funds. The assets under management have decreased from $28.8 billion at the end of 2021 to about $23 billion currently, despite achieving some gains last year.

Klarman has always adhered to a cautious investment style, prioritizing loss avoidance over the pursuit of high returns. He is accustomed to holding a large amount of cash when he does not see good opportunities, with cash sometimes accounting for as much as 30% of assets. Klarman frequently reminds investors that Baupost's performance will inevitably lag behind the market during bull markets Over the past decade, historic low interest rates have inflated the valuations of many companies, regardless of their fundamentals, creating a serious mismatch with Klarman's investment philosophy.

Compared to other value investors, Baupost has failed to effectively mitigate the negative impacts of the adverse market environment. The fund has also made some internal mistakes, first by expanding beyond its traditional areas of expertise, and second by allowing certain portfolio managers to operate with excessive independence.

Baupost has acknowledged these issues to its investors.

Baupost Repositions Investment Focus

By the end of 2023, Seth Klarman and his partners began discussing how to reposition the firm. Baupost Group has maintained four core investment areas: public equities, public credit, private equity and debt, and real estate, but has narrowed the scope of specific investment types.

As interest rates rise, some real estate transactions have been impacted. However, Baupost began to discover more investment opportunities in 2024, with investment amounts exceeding those of 2022 and 2023.

The firm has reduced its bets on public equities, as this area has struggled to generate profits in recent years. Notably, Baupost once held nearly a quarter of satellite communications company Viasat Inc., but the company's stock price has fallen about 90% since its peak in May 2019.

The rise in interest rates has helped the firm identify more distressed companies. Baupost has increased its allocation to credit investments from 5% two years ago to nearly 25% now. Currently, cash accounts for about 10% of its assets.

Sources familiar with Klarman revealed that while he plans to continue leading the firm for many years, he has begun preparing for succession. Klarman is encouraging certain partners to oversee small portions of the portfolio.

Klarman is urging partners to consider the portfolio more comprehensively. This includes not only proposing purchase recommendations but also considering what to sell to fund those purchases. He has also encouraged team members to debate each other's investments.

In a letter to clients, Klarman expressed greater optimism about the firm's future profitability. He wrote:

"These changes have made us increasingly excited about our current portfolio and our ability to discover attractive investment opportunities in the future."