Seth Klarman: despite all the stimulus, risk has not gone away

Action by governments and central bankers has convinced investors that risk “has simply vanished”, says value investor Seth Klarman, founder of the Baupost hedge fund, in his latest letter to investors, quoted in the Financial Times.

Klarman has long been a critic of the Federal Reserve’s loose monetary policies, which he believes have badly undermined “the market’s usual role in price discovery... With so much stimulus being deployed, trying to figure out if the economy is in recession is like trying to assess if you had a fever after you just took a large dose of aspirin”.

Klarman points to electric-car maker Tesla as one of the most egregious examples. The group’s share price has risen “seemingly beyond all reason”. He blames low interest rates, which drive up the value of the estimated future cash flows used by analysts to calculate the present value (see box) of a company. “The more distant the eventual pay-off, the more the present value rises. When it comes to the value of cash flows, the vast and limitless future, yet to unfold, has gained considerable ground on the more firmly anchored present.”

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That said, while Klarman may feel that the investment environment is hostile, his fund has still been putting money to work. In the third quarter of 2020, Baupost invested $400m in a “special purpose acquisition vehicle” (a cash shell, effectively) launched by fellow hedge-fund manager Bill Ackman, with the goal of investing in “mature unicorns” – private companies valued at between $10bn and $15bn.