Investors were excited this morning on news that activist hedge fund manager Ralph Whitworth, the co-founder of Relational Investors LLC, now owns 1 percent of Hewlett Packard’s outstanding shares and has secured a seat on the company’s board of directors.
His move bid up the stock by more than 3 percent. Whitworth was appointed to the Finance and Investment Committee and the HR and Compensation Committee of the Board. Under the agreement, the board will support Whitworth’s election as a director at the next two annual meetings provided Relational continues to hold at least 0.5 percent of HP’s stock.
The hope, of course, is that the opportunist investor will nudge the board to find ways to extract more value from the stock.
But perhaps a more reassuring seal of approval came earlier in the week when, with little fanfare, Baupost Group’s Seth Klarman disclosed he took a gargantuan stake in the embattled computer and ink company.
At the end of the third quarter, Baupost reported a new stake of 20.75 million shares, worth more than $566 million at the time, making it the largest new investor in the stock. Even larger than Relational, the second largest new investor in HP at the end of the third quarter.
Why is it a good omen to see Baupost make such a big commitment to the stock? Because Klarman is one of the savviest, shrewdest value sleuths around.
This guy has racked up a roughly 19 percent annualized return since he started the Boston-based hedge fund in 1983 despite typically being 30 percent in cash. Sometimes more.
He has accomplished this by exploiting virtually any undervalued market, including domestic and foreign stocks and bonds, emerging market securities, distressed securities and trade claims, performing and non-performing bank loans, real estate-related debt and equity, privately negotiated investments, and other illiquid investments.
In fact, American equities are generally a small part of his total assets, which topped $24 billion at the end of June. At the end of last year, Baupost was the 11th largest hedge fund firm in the world.
Interestingly, Baupost took another seemingly big contrarian bet in the third quarter: He lifted total U.S. equity assets to $3 billion, up 25 percent from $2.4 billion the prior quarter and two-thirds more than the total at the end of the first quarter.
Has Klarman turned bullish on the U.S. stock market? He won’t say and a spokesperson declined to comment on his holdings. Last month I did report that Klarman was mulling whether to accept additional money from just existing investors that he had he returned earlier in the year. It is not clear whether he in fact did take additional money.
But here is the critical, nuanced part about interpreting the moves of Klarman. The $3 billion is spread over just 23 securities issued by 21 companies that apparently offered attractive value at the time. That’s all.
They include the ADRs of oil giant BP, his largest U.S. equity holding at the end of the recent quarter. He also took a new, $306 million position in Microsoft in the third quarter. This means Klarman feels strongly about these individual investments and nothing more.
He is the quintessential bottom-up investor. He does not make market bets. No exchange traded funds reflecting a broad market index, or even one specializing in a particular industry basket.
It is a discipline honed since Klarman was first exposed to value investing principles working during the summer of his junior year at New York’s Mutual Shares, the legendary value-driven mutual fund firm founded in 1949 by Max Heine, and also headed by Michael Price, who in his 20s had become a Heine protégé. Upon graduation, Klarman returned to Mutual Shares and after 18 months Klarman left the firm for Harvard Business School, where he earned his MBA and was named a Baker Scholar.
Klarman likes to describe the connection he made to value investing as an inoculation. Either it takes or it doesn’t. “Ultimately, it needs to fit your character,” he said to me in an earlier profile. “If you are predisposed to be patient, disciplined and psychologically like the idea of buying bargains, then you’re likely to be good at it. If you have a need for action, if you want to be involved in the new and exciting technological breakthroughs of our time, that’s great, but you’re not a value investor and you shouldn’t be one.”
Managing risk and determining the margin of safety are the backbone of Klarman’s investment process. He and his team look at what could go wrong in a company, the economy, how some event or issue could affect the company or the security. “You can like a company but not find opportunity in its securities, or not like a company but find opportunity in the securities,” he said.
He says money managers ultimately must pick their poison. They are going to be wrong sometimes. The question is: What are they going to be wrong about? They could take a risk and then possibly lose their clients money or the client could see their money remain intact but wind up not liking you because you missed a great opportunity. “Our bias is to buy when we have a high degree of conviction and wait patiently when we don’t,” he said. “That’s the core of our approach, which has kept us out of trouble and has been a key distinguisher.”
Klarman said most of the time he prefers to buy bonds over stocks. Bonds are a senior security, offer a greater margin of safety and have a catalyst built in to them since debt, unlike equity, pays current principal and interest. If the issuer doesn’t make that timely payment, an investor can take action. “Catalysts can reduce your dependence on the level of the market or action of the market,” he said, because, for example, an acquisition or defaults are specific incidents affecting the company regardless of what is going on in the overall market.
Which only further reassures investors in Hewlett Packard, but maybe not so much investors in the broader U.S. stock market.
