Klarman Holding 50 Percent Cash

[Palantir]

The other reason is that simply he is a political conservative, where he is strongly against the government interfering in the economy and debasing the dollar.

 

If you hold what Thomas Sowell's A Conflict of Visions defined as a constrained view of the world (believing human reason limited and so preferring spontaneous order to central planning), you are probably constitutionally unable to have faith (like those with an unconstrained view) in the Fed.

 

That is fine, but I believe that the Fed's actions in the past few years have been far from central planning. I feel that Mr Klarman just doesn't have the mental models, to use Munger's term, to deal with this scenario leading to inevitable cognitive dissonance.

[Guest]

ni co, the cash question, I think also is based on someone's personality and size. I think at the height Burry was managing like $700 million give or take $100 million. Klarman manages more than $20 billion.

 

Something else to think about. Munger, at DJCO, held cash I heard for like 7 years and then deployed almost all of it in early 2009.

[APG12]

I feel that Mr Klarman just doesn't have the mental models, to use Munger's term, to deal with this scenario leading to inevitable cognitive dissonance.

 

Klarman is obviously very educated on the subject. It seems way too simplistic to assume his views are due to a lack of mental models. His views are too precise and well thought out to be the result of ignorance. Judging from his support of Jim Grant I think that his opinions probably stem from the fact that he subscribes to an Austrian-esque economic philosophy.

 

I believe that the Fed's actions in the past few years have been far from central planning.

 

The government has nationalized the monetary system and influences the price of money across the entire economy. If the concept of central planning is to have any meaning it must apply here.

[Palantir]

 

Klarman is obviously very educated on the subject. It seems way too simplistic to assume his views are due to a lack of mental models. His views are too precise and well thought out to be the result of ignorance. Judging from his support of Jim Grant I think that his opinions probably stem from the fact that he subscribes to an Austrian-esque economic philosophy.

 

I disagree, I do not believe he is "obviously very educated" on this subject nor do I believe there is any evidence to suggest that he has the mental models to deal with this. I would venture that very few people would have the mental models to understand this, one of them being Ray Dalio.

 

 

The government has nationalized the monetary system and influences the price of money across the entire economy. If the concept of central planning is to have any meaning it must apply here.

 

What does "nationalized the monetary system" mean? The concept of central planning is very, very different from what the Fed is doing. I'll point out that the Fed is an independent entity from the government.

 

All in all, Klarman is making a fairly standard bearish argument primarily based on his political views.

[ERICOPOLY]

Something else to think about. Munger, at DJCO, held cash I heard for like 7 years and then deployed almost all of it in early 2009.

 

How much cash is he holding at DJCO today?

 

[racemize]

Something else to think about. Munger, at DJCO, held cash I heard for like 7 years and then deployed almost all of it in early 2009.

 

How much cash is he holding at DJCO today?

 

Well, it wasn't cash at the time, it was much higher yielding bonds, which turned out to be genius in retrospect.  Now, he doesn't have decent yielding bonds, and his bank holdings are paying higher dividends than the bonds would anyway.

[ERICOPOLY]

So the point is that he isn't selling what he bought in 2009.

[racemize]

So the point is that he isn't selling what he bought in 2009.

 

Yes, I agree, I was mostly talking about the cash comment from stahleyp.

[ERICOPOLY]

How much gold does Munger have exposure to in order to hedge against the central planning that worries Klarman?

 

(rhetorical question)

 

[APG12]

I disagree, I do not believe he is "obviously very educated" on this subject nor do I believe there is any evidence to suggest that he is very well educated on it nor that he has the mental models to deal with this.

 

Hmm, well with no way to talk to Mr. Klarman we may have to agree to disagree. One thing to keep in mind is the extraordinary intelligence and thoughtfulness Mr. Klarman must have/exhibit to be in the position he's in today. Does this jive with the idea that he's economically ignorant?

 

What does "nationalized the monetary system" mean?

 

I mean they control the U.S. currency through a federal entity. Banks no longer issue their own notes because the government now controls the monetary system. It seems like a fairly uncontroversial statement to me. People don't generally put it in those explicit terms I guess.

 

I'll take the time to point out that the Fed is an independent entity from the government.

 

Independent in what sense? It's clearly not a private entity so what is it? When the Fed 'makes money', it goes to the treasury. I guess I'm just confused about what your point is. Are you saying the fed isn't a government entity and therefore what they're doing shouldn't be considered central planning? Or are you saying that politically their decision making is independent of other branches of government? If the you're saying the latter, I agree but don't understand the relevancy to the discussion. If you're saying the former I think it's clear that the fed IS a government entity (hence the name lol).

 

Our disagreement probably stems from different ideas of what central planning is. Stealing from Wikipedia: "Economic planning refers to a coordinating mechanism outside the mechanisms of the market." Again, I don't see how the federal government setting price controls over money (adjusting interest rates) is not central planning. Maybe you could describe what you consider to be central planning.

 

has the mental models to deal with this

 

Could you also explain what you mean by mental models? I've never seen a definition of mental models but when I use the term I mean: a set of principles with cross disciplinary applicability that are formed for the purpose of understanding a complex situation. That's just a definition I made up so I welcome any commentary regarding it. Is this generally what you mean by mental models? What models is Klarman missing?

 

All in all, Klarman is making a bearish argument primarily based on his political views, and in that vein, he is no different from any other commentator, many of whom regularly write the same things in the WSJ.

 

Yes, I agree with you to a certain extent. In the closing statements of this event, Grant made the point that people's economic views are always interrelated with their political views. I don't see this as an obstacle to objectivity, though. In fact, I think it's necessary that your political views and your economic views are in agreement because if they weren't that would imply a logical inconsistency somewhere.

[Liberty]

The last nail in the coffin of gold and commodities as insurance against catastrophe XYZ for me was when I saw a study that showed that common stocks did better during periods of very high inflation. I don't remember exactly the article, but I remember that I posted it on the board..

 

Anyway, so what's the point then? Better to own a wonderful business with pricing power if things are going to go real bad.

 

What's left then is trying to time where you are in the gold/commodity cycle to catch it at the bottom and sell it at the top, but that's not a game I want to play. I'll leave that to Rick Rule...

[ni-co]

The last nail in the coffin of gold and commodities as insurance against catastrophe XYZ for me was when I saw a study that showed that common stocks did better during periods of very high inflation. I don't remember exactly the article, but I remember that I posted it on the board..

 

That's not the way Dalio and Klarman think about gold. I don't think Buffett's remarks on gold are that helpful because he only argues against gold as an "investment". Neither Klarman nor Dalio nor Einhorn see gold as an investment but as a form of – inflation hedged – cash.

 

Dalio says this explicitly:

 

So the real question is which form of cash to hold – a question Buffett avoids by simply treating gold as an "investment". He makes it look too easy.

[APG12]

The last nail in the coffin of gold and commodities as insurance against catastrophe XYZ for me was when I saw a study that showed that common stocks did better during periods of very high inflation.

 

The 1983 appendix did it for me. It's so well reasoned: http://www.berkshirehathaway.com/letters/1983.html

 

[Liberty]

That's not the way Dalio and Klarman think about gold. I don't think Buffett's remarks on gold are that helpful because he only argues against gold as an "investment". Neither Klarman nor Dalio nor Einhorn see gold as an investment but as a form of – inflation hedged – cash.

 

Dalio says this explicitly:

 

So the real question is which form of cash to hold – a question Buffett avoids by simply treating gold as an "investment". He makes it look too easy.

 

I don't know the position sizing of Klarman and Dalio in this. I know that Paulson definitely saw it as an investment.

 

But even as cash.. Ok, maybe my cash (of which I never have much, as I tend to be closer to fully invested) will lose a bit of value over time, but gold is so volatile that I absolutely can't predict that it won't lose more value than cash over any period of a few years, and on top of that, I don't really see a good way to value gold to know if it's overvalued or not, so it's very hard to know when it has a good chance of doing well. Maybe if I was going to hold gold for decades I could be fairly certain that it would go up in price vs the dollar with inflation, but why would I hold a non-productive asset for decades when I could own a business?

 

The same people who were right about the bull market in gold over the past decade were wrong about the recent slump, so I doubt anyone has a reliable formula.

[enoch01]

The last nail in the coffin of gold and commodities as insurance against catastrophe XYZ for me was when I saw a study that showed that common stocks did better during periods of very high inflation.

 

The 1983 appendix did it for me. It's so well reasoned: http://www.berkshirehathaway.com/letters/1983.html

 

 

"gold is a great thing to sew onto your garments if you're a Jewish family in Vienna in 1939 but civilized people don't buy gold - they invest in productive businesses." - Munger

 

I think he's right.  Probably the time where it is rational to have gold is when the [local] civilization is breaking down.  So gold is a bad hedge in periods of very high inflation, but only if you assume that there is no threat to [local] civilization.

 

The very high inflation is probably a necessary condition to owning gold, but not sufficient.  Who cares if you own a lot of Coke if there is no rule of law.

[ni-co]

"gold is a great thing to sew onto your garments if you're a Jewish family in Vienna in 1939 but civilized people don't buy gold - they invest in productive businesses." - Munger

 

I think he's right.  Probably the time where it is rational to have gold is when the [local] civilization is breaking down.  So gold is a bad hedge in periods of very high inflation, but only if you assume that there is no threat to [local] civilization.

 

The very high inflation is probably a necessary condition to owning gold, but not sufficient.  Who cares if you own a lot of Coke if there is no rule of law.

 

Yes. However, it has some value if you like to hold "cash" in a hyper-inflationary environment and maybe that's why Klarman, whose investment style depends on these huge cash positions, owns it.

 

I don't know the position sizing of Klarman and Dalio in this. I know that Paulson definitely saw it as an investment.

 

But even as cash.. Ok, maybe my cash (of which I never have much, as I tend to be closer to fully invested) will lose a bit of value over time, but gold is so volatile that I absolutely can't predict that it won't lose more value than cash over any period of a few years, and on top of that, I don't really see a good way to value gold to know if it's overvalued or not, so it's very hard to know when it has a good chance of doing well. Maybe if I was going to hold gold for decades I could be fairly certain that it would go up in price vs the dollar with inflation, but why would I hold a non-productive asset for decades when I could own a business?

 

The same people who were right about the bull market in gold over the past decade were wrong about the recent slump, so I doubt anyone has a reliable formula.

 

I don't know about Paulson but I think Dalio and Klarman don't have large positions in it (at least if Dalio follows his own recommendation in this interview which you can never be sure of). I am no gold bug at all, but I try to understand their thinking and it seems to be that in one special scenario (hyper-inflationary environments) gold is the "better cash" – that's all. Therefore, I don't think that they care about its volatility in "normal" environments; that's why they call it "insurance". Speculating on price appreciation in normal environments, like so many gold bugs do, is silly and that's also where Buffett and Munger are definitively right.

[Liberty]

But cash is not an end in itself, right? If gold is a kind of cash, it's a kind of cash that you plan to use.

 

So their thinking must be something like: "If we come to a situation where gold does really really well, we sell it and buy productive assets with the proceeds". Otherwise, the high volatility and unpredictability of gold as cash doesn't make it work as a regular source of liquidity for normal investing needs, so it almost has to be held for these special situations.

 

That makes some sense on its own, but in practice, situations where gold would do really really well seem pretty rare. As I said, stocks have done better over time in very high inflation periods, so you would need something pretty dramatic for gold to have been better adjusted for the whole opportunity cost of holding it. That doesn't seem to happen ever quarter of a century, maybe every half-century, I don't know.

 

What if instead of holding gold mostly tracking inflation for 50 years you held a good business growing IV at 10-15%?

[ni-co]

But cash is not an end in itself, right? If gold is a kind of cash, it's a kind of cash that you plan to use.

 

So their thinking must be something like: "If we come to a situation where gold does really really well, we sell it and buy productive assets with the proceeds". Otherwise, the high volatility and unpredictability of gold as cash doesn't make it work as a regular source of liquidity for normal investing needs, so it almost have to be held for these special situations.

 

That makes some sense on its own, but in practice, situations where gold would do really really well seem pretty rare. As I said, stocks have done better over time in very high inflation periods, so you would need something pretty dramatic for gold to have been better adjusted for the whole opportunity cost of holding it. That doesn't seem to happen ever quarter of a century, maybe every half-century, I don't know.

 

What if instead of holding gold mostly tracking inflation for 50 years you held a good business growing IV at 10-15%?

 

That's exactly how I see it, too. This goes back to my question about the benefit of Klarman's large cash positions. If you think – like Klarman seems to – that keeping a balanced cash/equity portfolio offers a better risk/reward ratio than an "equities only" portfolio, I can see the logic in it.

 

However, I keep following the Buffett/Munger advice and "much rather earn a lumpy 15% over time than a smooth 12%".

[Liberty]

That's exactly how I see it, too. This goes back to my question about the benefit of Klarman's large cash positions. If you think – like Klarman seems to – that keeping a balanced cash/equity portfolio offers a better risk/reward ratio than an "equities only" portfolio, I can see the logic in it.

 

However, I keep following the Buffett/Munger advice and "much rather earn a lumpy 15% over time than a smooth 12%".

 

Yeah, and people like Klarman and Howard Marks invest differently than most here. They buy lots of distressed debt when things blow up.

 

I think it's probably easier to find undervalued good businesses on any random day of any random year than it is to find truly irrationally priced debt (but that's just my sense -- I'm no debt expert).

 

As for Dalio, well, he seems in a class of his own for that macro stuff.

[ni-co]

One final thought on this cash position thing and rebalancing. I had to think of this interview with John Hempton:

http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/interview-with-john-hemptonbronte-capital/

(around the 18 min mark)

 

In it, Hempton discusses a long equity fund that improved its performance by adding a short portfolio that, if you look at the bottom line of the short portfolio itself, lost money. So, in this case, the sum of the parts seems to be greater because of the rebalancing effect. This might be behind Klarman's cash position and if this were true for all portfolios it would also apply to smaller investors. Incidentally, this also seems to be Pabrai's strategy since 2009.

[racemize]

One final thought on this cash position thing and rebalancing. I had to think of this interview with John Hempton:

http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/interview-with-john-hemptonbronte-capital/

 

In it, Hempton discusses a long equity fund that improved its performance by adding a short portfolio that, if you look at the bottom line of the short portfolio itself, lost money. So, in this case, the sum of the parts seems to be greater because of the rebalancing effect. This might be behind Klarman's cash position and if this were true for all portfolios it would also apply to smaller investors. Incidentally, this also seems to be Pabrai's strategy since 2009.

 

I have generally not found that to be true with most investors (at least looking at cash holdings, not shorting).  It is true for 2/3 of Pabrai's portfolios over their life span though.

[indythinker85]

Klarman on tech/social media bubble (note: I cannot upload it but part of the latest Klarman letter is in the latest excerpt from VII) http://www.valuewalk.com/2014/03/klarman-on-tesla-motors-inc-netflix/

[Liberty]

Klarman on tech/social media bubble (note: I cannot upload it but part of the latest Klarman letter is in the latest excerpt from VII) http://www.valuewalk.com/2014/03/klarman-on-tesla-motors-inc-netflix/

 

Maybe the actual letter has more insights than the summary, I can't comment on it since I haven't seen it, but pointing out a bunch of business trading at very high valuations doesn't really draw a convincing parallel with, for example, the dot-com bubble, IMO. To be clear: I'm not saying these companies aren't overvalued and that you should invest in them. Just that the parallel he seems to be making isn't that obvious to me.

 

Back in dot-com days, you had a whole index trading sky-high, and even old-economy companies were trading super high (Coca-Cola at 50x). But another important difference is that a lot of the dot-com companies were not real businesses. They had no customers and nobody had made money on the things they were doing before. They were truly tulip bulbs.

 

A lot of the current high flyers have actual businesses and real customers. Maybe they are very overvalued, but if the price of Netflix or Tesla drops by 50% or 75%, the business will keep going, or others will take their place because what they're doing is meeting real needs and providing real value. Maybe they'd have to cut R&D and fire employees if they couldn't raise as much equity, but they can be profitable.

 

Most of the dot-com companies had no other reason to exist than to IPO and extract money from delirious investors. Nobody had shown you could make money with what they were doing before, and after the crash, they almost all disappeared.

 

Twitter might be very overvalued, I don't know, but it has real users and could make real money selling ads and sponsored content and such. If there's a big correction, it won't just disappear as if it had been just a mirage all this time. And if you aren't investing in these high-flyers, I'm not sure they have such a big impact on the rest of the economy that you should worry..

 

I guess if we invert, we could ask: Is there any period over the past 100 years when there wasn't a bunch of high-flying stocks? Probably a few, but I doubt the rest of the time it always meant we were on the edge of the precipice. A correction? Sure. A bubble bursting, leaving rubble in its wake? I don't really see it, IMO. There can always be big external shocks (a big war, whatever), but I don't think valuation alone is bubbly overall.

 

Not that all this is worth much, but it's my 2 cents.

[oddballstocks]

Klarman on tech/social media bubble (note: I cannot upload it but part of the latest Klarman letter is in the latest excerpt from VII) http://www.valuewalk.com/2014/03/klarman-on-tesla-motors-inc-netflix/

 

Maybe the actual letter has more insights than the summary, I can't comment on it since I haven't seen it, but pointing out a bunch of business trading at very high valuations doesn't really draw a convincing parallel with, for example, the dot-com bubble, IMO. To be clear: I'm not saying these companies aren't overvalued and that you should invest in them. Just that the parallel he seems to be making isn't that obvious to me.

 

Back in dot-com days, you had a whole index trading sky-high, and even old-economy companies were trading super high (Coca-Cola at 50x). But another important difference is that a lot of the dot-com companies were not real businesses. They had no customers and nobody had made money on the things they were doing before. They were truly tulip bulbs.

 

A lot of the current high flyers have actual businesses and real customers. Maybe they are very overvalued, but if the price of Netflix or Tesla drops by 50% or 75%, the business will keep going, or others will take their place because what they're doing is meeting real needs and providing real value. Maybe they'd have to cut R&D and fire employees if they couldn't raise as much equity, but they can be profitable.

 

Most of the dot-com companies had no other reason to exist than to IPO and extract money from delirious investors. Nobody had shown you could make money with what they were doing before, and after the crash, they almost all disappeared.

 

Twitter might be very overvalued, I don't know, but it has real users and could make real money selling ads and sponsored content and such. If there's a big correction, it won't just disappear as if it had been just a mirage all this time. And if you aren't investing in these high-flyers, I'm not sure they have such a big impact on the rest of the economy that you should worry..

 

I guess if we invert, we could ask: Is there any period over the past 100 years when there wasn't a bunch of high-flying stocks? Probably a few, but I doubt the rest of the time it always meant we were on the edge of the precipice. A correction? Sure. A bubble bursting, leaving rubble in its wake? I don't really see it, IMO. There can always be big external shocks (a big war, whatever), but I don't think valuation alone is bubbly overall.

 

Not that all this is worth much, but it's my 2 cents.

 

+100 very insightful.  I completely agree.  Yes maybe Twitter and Facebook and LinkedIn are overvalued, but they have real users and have a viable business model.  They are providing value to users and making money themselves.

 

Everyone is so quick to make a comparison to the dot-com bubble, why is that?  Why is it bad if we're in a plain old bull market?  Why is everyone always so quick to call everything a bubble?

[Palantir]

Everyone is so quick to make a comparison to the dot-com bubble, why is that?  Why is it bad if we're in a plain old bull market?  Why is everyone always so quick to call everything a bubble?

 

Because like Mr Klarman, we are (mostly) value investors. When stocks are going up...what else will we do?  ;D