Investment Theory #19: Klarman’s 1997 Letter

Lately, it appears a fresh wave of animal spirits has gripped the markets — just look at the post-election rally in equities. Investors seem to have bought into the narrative that tax cuts and deregulation will jump-start the economy, while at the same time ignoring the risks inherent in an “America-First” protectionist agenda.

In times of market loftiness, it serves us well to reexamine how similar cycles have played out in the past, and there is probably no better case study than Seth Klarman’s handling of the late 1990s. Klarman is a well-respected value investor who founded the Baupost Group in 1982. Since then he has generated an average annual return of 19%. Klarman’s investing philosophy can be summed up by the title of his book Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor.

This series of posts will reflect on Klarman’s activity during the period 1995 to 2001. Links to past posts: 1995, 1996

Continue reading “Investment Theory #19: Klarman’s 1997 Letter”

Economics #7: Rent vs Buy

Lately and frequently, the topic of homeownership has been popping up in my life. I don’t know if this is a result of my age or current economic trends, but I figured I might as well organize my thoughts on the subject.

Generally, the renting vs buying debate goes something like this: renting is essentially throwing money down the drain, while buying builds equity and sets you on the path to financial freedom. Throw in some narratives about the American dream and some wishful thinking about home price appreciation, and owning is just always better.

This post will explore this argument through the economics of renting vs buying. Of course, there are non-economic factors that come into play. For example, buying a house might just make you happier or vice versa. Buying can provide the stability of knowing you can’t be kicked out by a landlord or have your rents raised dramatically. Buying allows you to customize your house the way you want it. Renting can provide the freedom and flexibility to change your life up at a moments notice. Renting can be less stressful, no headaches from repairing a roof or a water heater. These factors might even be more important than the by-the-numbers analysis. To each their own.

Continue reading “Economics #7: Rent vs Buy”

Investment Theory #18: Klarman’s 1996 Letter

Lately it appears that a fresh wave of animal spirits has gripped the markets — just look at the post-election rally in equities. Investors seem to have bought into the hype that tax cuts and deregulation will jump-start the economy, while at the same time ignoring the risks inherent in an “American-First” protectionist agenda.

In times of market loftiness it serves us well to reexamine how similar cycles have played out in the past — and there is probably no better case study than Seth Klarman’s handling of the late 1990s. Klarman is a well-respected value investor who founded the Baupost Group in 1982. Since then he has generated an average annual return of 19%. Klarman’s investing philosophy can be summed up by the title of his hard to find book: Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor (plenty of pdfs floating around the internet though).

This series of posts will reflect on Klarman’s activity throughout 1995-2001. Links to past posts: 1995

Continue reading “Investment Theory #18: Klarman’s 1996 Letter”

Investment Theory #17: Klarman’s 1995 Letter

Lately it appears that a fresh wave of animal spirits has gripped the markets — just look at the post-election rally in equities. Investors seem to have bought into the hype that tax cuts and deregulation will jump-start economic growth, while at the same time ignoring the risks inherent in an “American-First” protectionist agenda.

In times of market loftiness it serves us well to reexamine how similar cycles have played out in the past — and there is probably no better case study than Seth Klarman’s handling of the late 1990s. Klarman is a well-respected value investor who founded the Baupost Group in 1982. Since then he has generated an average annual return of 19%. Klarman’s investing philosophy can be summed up by the title of his hard to find book: Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor.

This series of posts will reflect on Klarman’s thinking throughout the period 1995-2001.

Continue reading “Investment Theory #17: Klarman’s 1995 Letter”

History #17: Artificial Intelligence

Thomas Kuhn, in his book The Structure of Scientific Revolutions, provides us with a framework for modeling the historic progression of scientific progress. Opposing the prevailing view of scientific progress as an accumulation of accepted facts and theories, Kuhn argued that scientific progress took a more episodic path, in which periods of normal science were interrupted by periods of revolutionary science.

According to Kuhn, when enough anomalies have accrued against a current scientific consensus (some level of error is always inevitable), the field is thrown into a state of crisis, in which new ideas are tried, eventually leading to a paradigm shift. Investment of time and money pure in as the new paradigm proves successful in solving old and new problems. Eventually, this new paradigm may run into intractable problems of its own and the cycle repeats.

It is with this framework in mind that we will dive into the history of Artificial Intelligence. It’s a history littered with so-called “AI Summers” and “AI Winters”, where new ways of thinking spark rampant enthusiasm, followed by rampant pessimism when the lofty promises aren’t kept. It’s the boom and bust cycle that shows up again and again throughout human history.

Continue reading “History #17: Artificial Intelligence”

Investment Theory #16: Performance Appraisal

This is the last post in a three-part series on investment performance evaluation. The series explores: 1) Performance Measurement, 2) Performance Attribution, and 3) Performance Appraisal. In other words, how much we made, how much we made compared to a benchmark, and how much we made adjusted for the amount of risk we took on.

Performance evaluation allows us to examine the effectiveness of our investment process. It provides us with a systematic way of judging our decision-making process and improving on it, which is what investment theory is all about.

Today’s post deals with performance appraisal, which is a technique used to compare returns with an account’s corresponding risk. Risk is a hard thing to pin down, but for our purposes we will stick with two typical measures: systemic risk, measured by beta, and total risk, measured by the standard deviation of returns.

Continue reading “Investment Theory #16: Performance Appraisal”

Investment Theory #15: Performance Attribution

This is the second in a three-part series on investment performance evaluation. The series explores: 1) Performance Measurement, 2) Performance Attribution, and 3) Performance Appraisal. In other words, how much we made, how much we made compared to a benchmark, and how much we made adjusted for the amount of risk we took on.

Performance evaluation allows us to examine the effectiveness of our investment process. It provides us with a systematic way of judging our decision-making process and improving on it, which is what investment theory is all about.

Today’s post deals with performance attribution, which is a technique used to explain why a portfolio’s performance differed from a benchmark. That difference is known as active return. For example, if our portfolio returned 10% while the S&P500 returned 20%. Our active return would be -10%.

Continue reading “Investment Theory #15: Performance Attribution”