Iconic hedge fund manager Seth Klarman says investors are missing huge risks

An iconic hedge fund manager says investors are misperceiving risks in the markets — at a time when markets are hitting historic highs.

Baupost Group’s Seth Klarman laid out his concerns in an April client letter, a copy of which was reviewed by Business Insider.

Risk, Klarman wrote, is the most important consideration when investing, and investors are being too trusting.

To make his point, Klarman contrasted today to the start of financial crisis.

“When share prices are low, as they were in the fall of 2008 into early 2009, actual risk is usually quite muted while perception of risk is very high,” Klarman wrote. “By contrast, when securities prices are high, as they are today, the perception of risk is muted, but the risks to investors are quite elevated.”

Klarman oversees one of the US’ largest hedge fund firms with some $US30 billion under management. He has a huge following on Wall Street, with investors naming his book “Margin of Safety” their favourite investment book in a recent SumZero survey. A used copy on Amazon retails for more than $US900.

He is no stranger to raising concerns on the markets under President Donald Trump. Earlier this year, he laid out his worries in a separate investor letter, raising red flags about Trump’s tax cuts, for instance, which could considerably raise the government’s deficit.

Markets have rallied since Trump was elected in November, as Wall Street took confidence in the president’s plan to cut taxes, roll back on regulations, and boost infrastructure spending. Even as the Trump administration faces notable headwinds — federal investigations over Russia’s influence in the campaign, flubs in passing healthcare — the markets don’t seem to care.

There could be several reasons for that. In Klarman’s more recent letter, he flagged three forces that investors are regularly combatting:

  • greed and fear, which “pressure investors to do the wrong thing at every turn”
  • “aggressive brokers, investment bankers and traders who routinely promise more than they can deliver”
  • and investors focusing on the short-term and trend-following, and restrictions that are supposed to limit risk but actually prevent outperformance.

As for potentially missing the Trump rally, by continuing to hedge and focusing on the long term? “We truly don’t care,” Klarman wrote. “We’re not going to fall into the trap of trying to outsmart others with clever short-term trading.”

Baupost managed $US30.3 billion at the start of the year, according to the Hedge Fund Intelligence Billion Dollar Club ranking. A spokeswoman for the firm declined to comment.

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