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ANDREW CARNEGIE USED to say that competitors were welcome to tour his factory, to see his production line up close. Why? Because of Carnegie Steel’s massive scale and complex operations, he was confident no one would ever be able to replicate what he’d built.
Hedge fund manager Seth Klarman is a modern-day Carnegie. Klarman founded the Boston-based Baupost Group in 1982, and while performance numbers aren’t publicly available, the firm’s track record is believed to be among the best in the industry. By some accounts, returns have averaged 20% per year, roughly double the overall market’s returns.
Like Carnegie, Klarman’s approach is so specialized and so unique that he’s happy to tell people how he does it. He regularly gives interviews and even wrote a book detailing the different ways Baupost makes money.
While this approach isn’t appropriate for everyday investors, these strategies—known as deep-value—are so different from what’s popular on Wall Street that they’re worth understanding.
Klarman’s philosophy rests on several key pillars, the first of which is that he avoids making forecasts. He jokes that he’d “predict ten of the next two recessions,” and as a result, doesn’t find that a useful basis for making investments. This is a particularly important point because active management often involves forecasting. Klarman’s view, though, is that it’s too unreliable and thus the wrong approach.
Other successful investors share this view. Peter Lynch, the retired manager of Fidelity’s Magellan Fund, called forecasting “futile” and argued that “crystal ball stuff doesn’t work.” Lynch was especially wary of economic forecasts. “If you spend 13 minutes a year on economics, you’ve wasted 10 minutes,” he once commented. Instead, Lynch would go company by company, looking for stocks that, in his estimation, were selling for less than they were worth.
Warren Buffett has expressed largely the same view. “What you really want to do in investments is figure out what is important and knowable,” he’s said. And while the future direction of the economy is important, it isn’t knowable. For that reason, Buffett says, investors should avoid making forecasts and should avoid listening to others’ predictions.
If forecasting isn’t part of the value investors’ toolkit, then how do they choose investments? In short, they search for things selling at such steep discounts that a crystal ball isn’t necessary. But because these sorts of opportunities are rare, they’re often looking far off the beaten path. Obvious investments—even if they look like good investments—don’t appeal to value investors. Baupost doesn’t own Apple, Amazon or Microsoft. This approach, in other words, is the opposite of what Wall Street tends to promote.
To illustrate how Baupost operates, Klarman describes an early investment. When he was a teenager, he worked out an arrangement with a local bus driver to secure rare coins. At the end of each day, the driver would go through the bus’s coin box, and when he found an out-of-circulation coin like a Mercury dime, the driver would give it to Klarman in exchange for a regular coin. In other words, Klarman would pay 10 cents for something worth far more than 10 cents somewhere else. In finance, this is known as arbitrage, and it’s among the strategies that hedge funds like Baupost use.
In his book, Margin of Safety, Klarman describes some of the other unusual investments favored by value managers. These include corporate spinoffs, bankruptcies, thrift bank conversions, rights offerings and other complex securities.
If these sound complicated, that’s the idea. These investments tend to be profitable because they’re so arcane. Consider spinoffs. Why do they present opportunity? Margin of Safety explains that individual shareholders receiving spun-off shares will often sell reflexively because “they may know little or nothing about the business,” and institutional investors “may deem the newly created entity too small to bother with.” For these reasons, newly spun off shares tend to trade at depressed prices, providing opportunity for value investors willing to go against the grain.
In one sense, the types of investments Klarman pursues are straightforward. Value investors like to say that they’re simply looking to buy a dollar for 50 cents. It’s really no more complicated than that.
Hedge fund manager Joel Greenblatt ran a firm called Gotham Capital that pursued many of the same strategies as Baupost, and with similar results. Over one 10-year period, Gotham averaged 50% annual returns, a remarkable feat. And just like Klarman, Greenblatt wrote a book detailing exactly how he did it. It’s called You Can Be a Stock Market Genius. What’s telling, however, is how few people choose to follow their lead. That’s because deep-value investing like this requires more than just a playbook; it requires a commitment of time and patience, it involves significant legwork, and perhaps most important, it requires the mental fortitude to intentionally go against the crowd.
What can individual investors learn from these strategies? Just as with Carnegie’s steel mill, funds like Baupost and Gotham are a marvel. Their complexity, though, tells us something important: It illustrates just how difficult it is to beat the market. This type of investing entails significant effort and enormous cost. To run his fund, Klarman employs 250 analysts. To reliably beat the market, that’s what’s required. And even then, it doesn’t always work. According to the data, the majority of actively-managed funds underperform each year. Recent reports indicate that even Baupost has been struggling of late.
That’s why, at the risk of sounding like a broken record, I always recommend index funds. To be sure, they aren’t designed to beat the market. But by avoiding counterproductive strategies like forecasting and tactical trading, index funds are designed to do something else critically important: They’re designed to help investors avoid underperforming.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
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As with so many things in the investment world, timing is everything. Or, as we used to say when I worked in this business: better lucky than good.
Firms spend a lot of money developing investment strategies that they hope will produce marginal returns, and sometimes it even works, but seldomly for very long. As you correctly note in your article, few investors have either the expertise or resources to compete with the likes of Klarman or Lynch, and frankly shouldn’t even try.
As a retiree, I am quite happy to use a few low cost funds and keep my trading activity to a minimum. After 10+ years of retirement, our retirement savings have grown comfortably without making any significant changes in our spending.
The challenge is, of course, doing this consistently. Indexes are one way to deal with fear of underperforming. However, my largest concern has always been the ravages of inflation. That’s what I intend to beat, and with a significant margin.
The dollars I saved represented many hours of labor. I “parked” that work via investments so I could draw upon them in retirement. I viewed this as “shadow working” while I was retired. In essence I’m currently working and every dollar I pull from my retirement accounts is the wages for my success.
Klarman’s “deep value” approach would be difficult to replicate but a spin on Lynch’s and Buffett’s value approach has been doable for me.
I do think I’ve passed on more opportunities than I’ve selected and my long term returns reflect that; overall, these have been significantly better than the S&P index but no where close to the 50% annual returns that Gotham achieved. Since 1995 we are closer to the 20% annual growth of Baupost and I’m satisfied. This could simply be due to my long term approach, a few good long term stocks picks and a well-diversified portfolio. I’ve always owned foreign stocks (currently 14% of my equities) and have a significant value component, even when these have been out of favor.
My portfolio changes are infrequent. For example, I added or increased positions in three stocks in 2024 and none in 2025 (other than dividend re-investment). It is also about how much time one is willing to spend doing this.
I do not chase the market; I changed in 2000 and never looked back. I have had a long-term plan for about 25 years and have adhered to it. I don’t buy or sell as segments or companies come into favor. Buying the current hot thing is a form of market timing which I do avoid. However, I have purchased “on the dip”, but infrequently. I didn’t do it with Covid and I didn’t do it in 2022 or April. I do sometimes purchased stock in individual companies when I conclude it is advantageous to do so.
I’ve always considered myself to be a contrarian investor. For example, I’ve never owned Microsoft or Apple, although in 1996 I did hold a few shares of Amazon until the Dot-Com bust nearly wiped me out. I purchase stock in individual companies on the merit of the company and value..
At present I do own several stock ETFs but no indexes. I’ve posted my personal reasons for doing this. I also own stocks in 16 different companies. My spouse owns stocks in two companies and indexes.
Interesting that three of my stocks are spin-offs, a technique mentioned by Klarman. The spin-offs I own have done well. Overall, my equity portion is about 42.8% individual companies and the largest stake in any one is 6.9% of that equity portfolio. The equity portion is about 38% growth of which about 9% would be classified as “aggressive” growth. In 2020-2021 I reduced my growth exposure as I approached true retirement. However, at present I have a 52/48 portfolio because I’m retired and practicing what some call “wealth defense”. That’s the lowest percent equities I’ve ever owned. I expected this would significantly alter (reduce) my returns and recent data confirms this. Good bye to double digit annual returns!
Interesting to me, my spouse who is a more conservative investor than I currently has a 57/43 portfolio. Her equity portion is 50.25% growth stocks style. 23.5% of her equities is “aggressive growth”. My portfolio only has 8.72% “aggressive growth”. Why this difference? For one reason she has a larger index component and owns Vanguard Target Date Funds and a “balanced” fund.
Overall, I’ve found it extremely helpful to mentally distance myself from the predictions and forecasts of others. I agree with Lynch about the problem with predictions. I perceive these to be for entertainment purposes, not for making money. Many so called predictions have been made after the horse has left the barn; these are merely observations disguised as prescient knowledge.
Adam thanks for another very interesting article, we continue to enjoy your work. I have NO intentions of ever following a so called 20% per year average winner. Things always seem to change, check this out:
Baupost 2015–2025: Performance dropped significantly, averaging only ~4% annually. The fund faced headwinds from:
Nothing of these abundant annual earnings last forever. My take, stick with the tried and true S&P 500, that is where 75% of my investments are, I am a believer in very long term excellent performance, 10% and more is just fine, as that means my investments double every 7 years.
S&P 500 10-Year Cumulative Return:Approximately +180%, or about 10.9% annualized over the decade.
Despite volatility in 2018 and 2022, the index delivered strong gains overall—especially in 2019, 2021, and 2023. If you’re benchmarking Baupost or other value funds against this, the S&P has clearly outpaced many traditional hedge strategies in recent years.
I with Buffett, who said if he dies, his wife should put most of her investments 85% in the S&P 500. Amen.
I thoroughly disliked Gregory Zuckerman’s “The Man Who Solved the Market: How Jim Simons Launched the Quant Revolution,” but maybe a discussion of big data and quants claiming they can beat the market would make for an interesting article for HD. Although this book doesn’t describe the methods in a meaningful way.
250 analysts seems to me to be a liability. They can’t effectively share information.
Index funds work because there are still enough active traders who don’t index. But index funds have become a huge part of the market. What would happen if the market were far less active?
I have beaten the SP500 per risk-adjusted performance = the Sharpe ratio, since retirement in 2018.
In the first 5 years (2018-23) I beat the SP500 in performance + lower volatility. See it at https://ibb.co/kgZ26D7b
From 2018 to current, my portfolio lags by 2.7% at 11.24% while SPY=13.9%. See it at
Our Schwab accounts are 99+% of all our money and include all brokers, banks, credit unions.
My portfolio never lost more than 1% from any last top. You can see it in the charts above
I have used about 95% bond funds + timing. I have used special bond funds.
I only invest in 2-3 funds, and they must be top funds at all times. Any fund that starts going down or loses more than 0.7-0.8% from its last top has been sold.
It took me “only” 15 years to tweak my system. It was never get rich quickly. It was never based on predictions, only on current markets because markets in real time are always correct no matter what anyone says.
Most times I hold, but in critical, very high-risk situations, I sell everything to MM and wait until the risk goes down.
Making the wrong calls is part of the system. When I’m wrong, I’m out for 2-5 days. When I’m right, I’m out for weeks-months.
Example: I was out 3-4 weeks in Q4/2018 and Q1/2020(covid). I was out 10 months in 2022, from January to November.
The system is based on the big picture. It has only 2 choices: invested or not. No gray area.
I look for unique conditions. Examples: 2008=MBS, 2018=The Fed raise rates several times, 2020=covid, 2022=after a high inflation, the Fed promised to raise rates rapidly. When the big picture is unique, it’s a yellow signal.
After that I look for specific indicators: VIX goes up quickly, MOVE(bond volatility) goes up quickly. If most stocks+bond categories go down, it’s unique. The rest is proprietary.
If these indicators signal a sell, I go to 99+% MM.
Then comes experience and paying attention to the right stuff.
Hints: I don’t pay attention to any “expert”. It’s based only on current markets.
The system doesn’t involve fast trading; it’s a market-based system. I may hold for months, or I can sell within days if the fund I just bought start losing money.
So, what kind of bond funds can do it. I held CLOZ for about 1.5 years.
See https://schrts.co/zUePQMAE
Sure enough, I was out in the first week of 08/2024.
Adam, I was able to hear the broken record. Thank you for that.
Adam I much appreciate your insights and candor.
That said I think you missed the mark talking up Seth Klarman and Baupost Group. Three keys points you failed to mention that the click-thru ‘reports’ reference in the second to the last paragraph reveals;
You somewhat redeem yourself in the last paragraph espousing index funds but the article should have reflected the full rest of the story.
If he had 20% returns they would be published, just like if Trump was a great student he would proudly display his grades. Anyone can say they do great, but when they refuse to document it, beware.
How much of this is just luck? When a classroom of kids are flipping coins, one of them might get heads six times in a row.
Since 2020 I’ve kept a side account where I have been making bets of $1k each on between 15 and 20 individual stocks. My other rule is I have to hold a stock at least one year. I’ve sold a few big losers and a few slight winners. Overall, I’ve beat the market by a little. Sometimes I congratulate myself on my incredible insight. Other times I ask if the slight winning is really significant; have I deviated from the mean? I think about the statistics books I’ve read. My winning is pure luck or noise.
But it’s fun nonetheless.
Nice review—David Swensen-when alive and running Yale’s endowment—Klarman and even Buffett in their books, all describe much of their success in investing as coming from special opportunities—supporting takeovers and mergers, venture capital startups and financing bailouts. These deals all take a lot of capital and a huge investment in screening. Swensen and Buffett more or less said common investors don’t have access to these favorable deals and recommended low cost diversified investing for most investors. We still have the advantage of patience that most of the venture capital investors with their 4-5 year time-lines lack.
Bloomberg reported in January that Baupost posted 4% annualized returns for past 10 years. Clients pulled 7B since 2021.
No one knows Klarman’s performance and his book Margin of Safety is mostly a grab bag of generalities as are his interviews. Re Greenblatt, lots of people outperform over short periods of time just like if you take a large enough sample someone will flip 100 heads in a row or something similar. Peter Lynch outperformed for a short period of time based on the strategy buy what you know. Works when consumer products are in favor. Not when biotech is hot.
Thanks Adam. 250 analysts? Consistently, achieved a 20%/year return since 1982, over 43 years?
I guess I would be more convinced if you could point us to someone he hired in 1982 or 1983, who watched the sausage being made, later went off on her/his own and achieved comparable results.
Typically, that’s the only way to test theories, investment or science, can you independently duplicate the results.
Else it may be a one off, something unique, a Musk, Bezos, Gates.
Interesting story. Best to you, Jack
Adam, I’d be interested in knowing the returns AFTER taxes and fees. Is it the typical hedgefund fee structure? Is he passing a lot of capital gains on to his shareholders? This info would be helpful. Thanks
Adam, interesting and insightful article. The one advantage that Peter Lynch and Warren Buffet had was that their investing acumen was accessible to many investors through Magellan and Berkshire Hathaway. As such, their performance was tracked, scrutinized, audited and celebrated for their outstanding returns. Others may follow, although Klarman hasn’t joined the mainstream of investment guru/ household name over his almost 50 years of investment success. I wonder why not?
Yep at $2500 that’s a hard pass on the book maybe I’ll find it cheap at a used bookstore haha.
Adam,
Three issues with your issue:
Excellent article, thanks Adam. The last two paragraphs are the real message, and certainly what resonates for me. Unfortunately I think for many (not the HD community) the part they hear is “returns have averaged 20% per year, roughly double the overall market’s returns”. The allure of “beating the market” will remain strong.