Value investor Seth Klarman, the founder of Boston-based hedge fund Baupost Group, thinks this market looks like the 1998 Jim Carrey movie "The Truman Show."

In the film, Carrey's Truman Burbank lives a peaceful suburban life, but his world collapses upon realizing he's the star character in a massively popular reality show.

His entire life — from his father's death to convenient product placements — has been orchestrated by the show's creator, Christof (played by Ed Harris).

"As Truman starts to unravel the truth, his anger erupts and chaos ensues," Klarman writes to clients in his latest letter.

In Klarman's telling, Ben Bernanke and Mario Draghi play the "creators" who have "manufactured a similarly idyllic, if artificial, environment for today’s investors." Check out an excerpt from the rather bearish letter (via ZeroHedge):

But there is one fly in the ointment: in Bernanke’s production, all the Trumans – the economists, fund managers, traders, market pundits – know at some level that the environment in which they operate is not what it seems on the surface. The Fed and the Treasury openly discuss the aim of their policies: to manipulate financial markets higher and to generate reported economic “growth” and a “wealth effect.” Inside the giant Plexiglas dome of modern capital markets, just about everyone is happy, the few doubters are mocked and jeered, bad news is increasingly ignored, and markets go asymptotic. The longer QE continues, the more bloated the Fed balance sheet and the greater the risk from any unwinding. The artificiality of today’s markets is pure Truman Show. According to the Wall Street Journal (12/20/13), the Federal Reserve purchased about 90% of all the eligible mortgage bonds issued in November.

...Every Truman under Bernanke’s dome knows the environment is phony. But the zeitgeist so so damn pleasant, the days so resplendent, the mood so euphoric, the returns so irresistible, that no one wants it to end, and no one wants to exit the dome until they’re sure everyone else won’t stay on forever.

A marketplace of knowing Trumans seems even more unstable than the movie sound stage character slowly awakening to reality. Can the clued-in Trumans be counted on to maintain their complicity or will they go off-script? Will Fed actions reliably be met with the desired response? Will the program remain popular? Could “The Truman Show” be running out of material? After all, even Seinfeld ended.

"When the show ends, those self-deluded Trumans will be mad as hell and probably broke as well," Klarman concludes. "Hopefully there will be no sequels."

Read the full letter at ZeroHedge »

SEE ALSO: 12 Brilliant Insights From Investing Legend Seth Klarman

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Seth Klarman, one of the most successful investors in history, recently returned $4 billion of capital to his clients. He also reportedly has 40% of his portfolio in cash.

Why?

Because Klarman can't find anything he is comfortable investing this money in.

Klarman recently sent a letter to his clients explaining his view of the world. This view can be described as "confident that these good times will come to an end."

Klarman doesn't say stocks are "a bubble." He doesn't say prices are "ridiculous." He doesn't say the things that some of the louder doom-and-gloomers are howling about the coming devastation. 

But he certainly thinks that what's happening now is, in large part, the result of unsustainable easy-money policies from the Fed, and that it is too good to last.

One of the most important things you can do as an investor is to try to seek out smart arguments that lay out the opposite side of the views that you hold. In other words, if you're bullish, you should seek out smart bears, and vice versa.

So every investor who is bullish on stocks should read Seth Klarman's recent letter.

And if you just don't have time to do that — if you're so sure that stocks are just going to keep going up and that anyone who voices caution is a moron — then at least read Klarman's conclusion below.

And don't just read it. Actually think about it.

Someday, financial markets will again decline. Someday, rising stock and bond markets will no longer be government policy – maybe not today or tomorrow, but someday. Someday, QE will end and money won’t be free. Someday, corporate failure will be permitted. Someday, the economy will turn down again, and someday, somewhere, somehow, investors will lose money and once again come to favor capital preservation over speculation. Someday, interest rates will be higher, bond prices lower, and the prospective return from owning fixed-income instruments will again be roughly commensurate with the risk.

Someday, professional investors will come to work and fear will have come to the markets and that fear will spread like wildfire. The news flow will be bad, and the markets will be tumbling.

...

Six years ago, many investors were way out over their skis. Giant financial institutions were brought to their knees...

The survivors pledged to themselves that they would forever be more careful, less greedy, less short-term oriented.

But here we are again, mired in a euphoric environment in which some securities have risen in price beyond all reason, where leverage is returning to rainy markets and asset classes, and where caution seems radical and risk-taking the prudent course. Not surprisingly, lessons learned in 2008 were only learned temporarily. These are the inevitable cycles of greed and fear, of peaks and troughs.

Can we say when it will end? No. Can we say that it will end? Yes. And when it ends and the trend reverses, here is what we can say for sure. Few will be ready. Few will be prepared.

In that last paragraph, Klarman reveals the full extent of his wisdom: He admits that he doesn't know when the current euphoria will end. 

In an environment when market pundits are supposed to have a black-and-white, minute-to-minute view of what the market will do next, this admission is startling. And it's also true.

No one knows that the market will do next.

Some people, though — Jeremy Grantham, Seth Klarman, John Hussman, Robert Shiller, and many others — are looking at the current level of stock prices and comparing them to average prices over the past 150 years. And, based on these prices (and other factors, like the Fed), they are concluding that stocks have a lot of downside risk. So much so that, Klarman at least, is forgoing fees to avoid getting clobbered by this risk.

Klarman, et al, may be wrong. We may still be in the early stages of an amazing new bull market. Stocks may climb this little "wall of worry" and march much, much higher from here. They may never return to historical averages again.

But if you are confident that that's what stocks will do, at least do yourself the favor of thinking carefully about why you believe that—that you're not just optimistic because the last 5 years have been so good and that you have a strong fundamental thesis to support your views. And be comfortable with the 40%-50% downside that you might experience if you are wrong.

Because hope is not a strategy. And no one benefits from ignoring smart folks on the other side of the trade.

You can read a long excerpt from Seth Klarman's letter a Zero Hedge here >

SEE ALSO: Anyone Who Thinks Stocks Will Keep Going Up If The Economy Keeps Growing Should Brush Up On History

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The market is making Seth Klarman nervous.

On Wednesday night, Zero Hedge posted an excerpt from Klarman's latest letter to investors. Klarman said, among other things, that we are marching towards a re-creation of the 2007 market.

Klarman writes:

"It’s not hard to reach the conclusion that so many investors feel good not because things are good but because investors have been seduced into feeling good—otherwise known as 'the wealth effect.' We really are far along in re-creating the markets of 2007, which felt great but were deeply unstable when shocks started to pile up."

And Klarman doesn't think the Fed is doing enough to keep markets in check.

"Even Janet Yellen sees 'pockets of increasing risk-taking' in the markets, yet she has made clear that she won’t raise rates to fight incipient bubbles. For all of our sakes, we really wish she would."

Klarman also notes that in the current low-rate environment, investors have increased risk taking as the need for greater returns requires greater risk-taking with a shrinking potential payoff:

"The pressure to reach for return virtually ensures that many investors will take greater and greater risk for less and less potential reward at market peaks... A recent brokerage report excitedly touted the new HoldCo PIK Toggle notes of a Croatian consumer goods retailer. Nearly every word of that description is a flashing red light to seasoned investors." 

On Wednesday, Bill Fleckenstein of Fleckenstein Capital got into a shouting match on CNBC while defending his stand against the Fed's monetary policy.

And recently we've seen noted bears, like Gina Martin Adams and Bob Janjuah turn less-bearish, and Klarman says that, "Investors have clearly grown weary of worrying about risky scenarios that never seem to materialize or, when they do, don’t seem to matter to anyone else." 

On Wednesday the Fed released its latest monetary policy decision, which indicated little change in the Fed's language.

On Thursday, the S&P 500 and Dow Jones Industrial Average hit new all-time highs. 

You can read the full excerpt from Klarman's letter at Zero Hedge here. 

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Wall Street donors are a massive source of cash for political candidates.

Thanks to Crowdpac, a data firm dedicated to informing citizens about the political process, Business Insider has identified the top 16 megadonors in the finance industry heading into the 2016 presidential race.

SEE ALSO: 'The 2016 Money Race Has Begun' 

Crowdpac analyzed all of the Federal Election Commission's campaign finance reports from the two most recent election cycles — 2012 and 2014 — to identify the top donors who came from a list of financial firms provided by Business Insider. It includes some figures who have long been associated with campaign cash as well as others whose role in politics has been far more obscure.

In total, Crowdpac says these 16 Wall Streeters are all within the top 150 donors from the past two cycles. When combined, they are responsible for 21% of all the donations from the top 200 in 2012 and 2014. 

Based on Crowdpac's analysis, this list skews conservative, with six of the donors giving to mostly liberal figures and organizations compared to 10 whose contributions lean conservative. The liberal donors, however, are far less moderate, while a few of the conservatives landed nearly on the middle of Crowdpac's scale.

Here is the full list of donors along with the amount of money each is responsible for giving in the past two cycles.

1. Thomas Steyer —  $167,471,767
Steyer is the cofounder of the San Francisco-based hedge fund Farallon Capital Management LLC. He left the company in 2012 to focus on philanthropy and political and environmental activism. Since then, Steyer has clearly been busy. According to Crowdpac, he is by far the top donor on this list. Based on Crowdpac's analysis of the causes Steyer has supported, he is also the most liberal of the top Wall Street donors. He spoke on stage at the Democratic National Convention in 2012. 

2. James Harris Simons — $17,191,500
A mathematician who rarely gives interviews, Simons founded the hedge fund Renaissance Technologies. He used his mathematical expertise to become known as the "king" of quantitative analysis and to build up an estimated net worth of more than $14 billion. Simons retired at the end of 2009. He donates to largely Democratic causes, but, according to Crowdpac, he ranks at the bottom of the six liberals on this list.  

3. Robert Mercer — $15,189,788
Mercer is the co-CEO of Renaissance and was recruited from IBM by Simons. However, unlike his old boss, Mercer leans right. In fact, based on Crowdpac's analysis he is by far the most conservative donor on this list. He reportedly owns a super yacht named "Sea Owl." 

4. Paul Singer — $14,623,969
Noted activist investor Singer is the founder and CEO of Elliott Management Corporation. He is embroiled in a massive dispute with the government of Argentina and is suing it for more than $1 billion in debt. Singer is a conservative, but he supports same-sex marriage. In fact, Singer was one of the GOP donors who paved the way for the passage of gay marriage in New York in 2011 by throwing his support behind that legislation. 

5. George Soros — $9,523,200
Long a bogeyman for the right wing, hedge funder Soros was one of the top financial opponents of President George W. Bush. The amount of his donations has dropped off slightly over the past two cycles, but Soros is clearly still a player. According to Crowdpac, he is the second-most-liberal donor on this list, coming in just a hair behind Steyer. 

6. John W. Childs — $6,955,400
Perhaps it is no surprise that Childs, a private-equity executive based in Massachusetts, was a major supporter of Mitt Romney in 2012. Childs is known as a leveraged buyout specialist and has worked on many high-profile deals involving companies including Snapple and Equinox. 

7. Donald Sussman — $5,891,540
Sussman is the husband of Rep. Chellie Pingree (D-Maine), and, naturally as the spouse of a Democrat, he is the third-most-liberal donor on this list. Sussman started his career in finance as a 12-year-old in 1958 with a winning bet on the effect the Cuban Revolution would have on sugar exports. He went on to found his own hedge fund, Paloma Partners. JPMorgan acquired the middle and back office operations of the firm in 2006. Since then, Sussman has continued to run the company in addition to backing and investing in other funds.

8. Kenneth C. Griffin — $5,671,050
Griffin raised eyebrows last year with a $150 million gift to Harvard University that was the largest single gift in the school's history. According to Harvard, the gift is expected to affect "as many as 800 undergraduates every year." Griffin, who is in the midst of a contentious divorce that could affect his fortune, also made millions in conservative donations between the past two election cycles.

9. Dick DeVos — $5,290,281
DeVos, the son of the man who founded the multilevel marketing company Amway, hasn't just donated to conservatives. He ran for governor of Michigan as a Republican in 2006 and lost to Democrat Jennifer Granholm. DeVos is president of the Michigan-based investment management firm Windquest Group. 

10. Julian Robertson — $4,378,400
Investor Robertson founded Tiger Management in 1980. In a nearly two-decade-old profile, Businessweek described him as the "reigning titan of the world of hedge funds" in the early 1990s and lauded his unparalleled "stock-picking acumen." Last year in an interview with Bloomberg, Robertson discussed his desire to see a Republican majority in Congress. 

11. Sean M. Fieler — $3,063,031

Fieler is president of Equinox Partners LP and the Kuroto Fund LP. He also works with a variety of conservative organizations. Fieler is Catholic and has focused some of his efforts on organizing religious voters who are against gay marriage and abortion. According to Crowdpac, Fieler is the third-most conservative donor on this list. 

12. Daniel Loeb — $2,865,867

Hedge fund manager Loeb is the founder and CEO of Third Point LLC. Loeb is a former supporter of President Barack Obama. Based on Crowdpac's analysis, his donations lean slightly conservative but fall near the middle of the political spectrum. Loeb has a reputation for writing strongly worded letters to other executives. In 2012 he aimed his pen at other hedge funders who supported Obama with a missive comparing them to battered wives. Loeb has focused much of his political activism on supporting gay marriage and charter schools. 

13. Bernard L. Schwartz — $2,611,514 

Schwartz is chairman and CEO of his namesake private investment firm BLS Investments LLC. He established the company in 2006 after spending over three decades at Loral Corporation, a defense contractor with billions in revenues, and its successor company Loral Space & Communications. He is a liberal donor who describes himself as a "capitalist" who believes in a "regulatory society." 

14. David E. Shaw — $2,547,417
Computer scientist and computational biochemist Dr. Shaw founded D.E. Shaw Research in 1988. A liberal donor, he was appointed to the President's Council of Advisors on Science and Technology by President Bill Clinton in 1994 and by Obama in 2009. Shaw has served on the computer science faculty at Columbia University. 

15. Bruce Kovner — $2,228,600

Commodities investor Kovner has been described by New York Magazine as "George Soros' right-wing twin." He founded the hedge fund Caxton Associates in 1983. Kovner has sponsored conservative newspapers and think tanks, but based on Crowdpac's methodology he is one of the more moderate GOP backers on this list. 

16. Seth Klarman — $1,851,400

Klarman has been called an "investing demigod" by Forbes. Like Loeb, though Klarman's donations skew slightly conservative, Klarman sits near the middle of Crowdpac's scale. He founded the Baupost Group, which is focused on betting long, in 1982. As of last year, the firm was managing about $30 billion in assets. 

This story was updated on February 12, 2015 to specify the parts of Paloma Partners that were acquired by JPMorgan. 

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Legendary value investor Seth Klarman, who runs Boston-based Baupost Group, had heart bypass surgery last week, Bloomberg News' Sabrina Willmer and Mary Childs report citing an investor letter.

"Last Wednesday, I underwent successful cardiac bypass surgery and am currently recuperating. I expect to be home in a couple of days. I intend to take things at a measured pace as my doctors suggest," the letter said, according to Bloomberg.

Klarman, 57, has running Baupost for 32 years now. The firm currently manages $28.5 billion in assets.

According to Bloomberg, Klarman wrote in the letter that he plans to begin working from home when he's ready and eventually return to the office. 

FYI, here's a definition of heart bypass surgery from the American Heart Association [.PDF]: Coronary artery bypass surgery (CABG) is a heart operation. It uses blood vessels taken from another part of your body to go around or “bypass” blocked or narrowed coronary (heart) arteries. The surgery helps people whose coronary arteries have become narrowed or blocked by fatty material called plaque. The bypass allows more blood and oxygen to flow to the heart muscle.

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There are two types of investing, according to the departing partner of hugely successful and secretive hedge fund Baupost Group: "needle in a haystack investing" and "tide comes in and tide goes out investing."

One type takes rigorous work as you search for a small number of opportunities. The other, "chutzpah."

The partner, Brian Spector, made those comments in a letter to investors in the $27 billion hedge fund.

The letter, included with Baupost's quarterly update, provides a rare glimpse into the Boston-based fund, which is led by iconic value investor Seth Klarman.

Spector, a senior member of the fund's public investment group, will retire at the end of the year after 17 years at the fund to focus on his family and philanthropy, according to the third-quarter update, dated October 15 and obtained by Business Insider.

Klarman, the author of the famed book on value investing "Margin of Safety," described Spector as "an outstanding investor, collaborator, and mentor."

Klarman also asked Spector to write directly to investors.

"Because of his unique perspective and insights, I asked Brian to draft a letter to you that accompanies this letter. He alone determined the content. I hope you find that it furthers your understanding of Baupost," Klarman wrote.

As of the end of last year, Baupost Group had achieved net gains (after fees) of $23.4 billion since its inception in 1982, placing it amongst the top-performing funds in the world, according to data from LCH Investments. 

In more than three decades, it has had only two down years. Right now, the fund is on track for its third annual loss, suffering a "mid-single-digit year-to-date decline" after what Klarman described as a "painful" third quarter.

Dot-com bubble

Spector was 25 when he joined Baupost in May 1998 during the "heart" of the dot-com bubble. It was a tough time to be a value investor — broadly defined as finding stocks that are undervalued by the market and poised to rise.

Back then, some thought that the glory days of value investing had passed.

"Traditional metrics like cash flow and asset values were being blatantly disregarded by the market in favor of newfound metrics such as eyeballs and clicks. High-tech companies were the darlings in a rapidly rising market while less-sexy value stocks significantly lagged," Spector wrote in the letter.

Baupost finished the year down over 12%.

Two years later, though, the dot-com bubble burst, presenting an opportunity for Baupost.

While others were selling off their positions, Baupost continued to buy tech stocks at "remarkable prices."

It wasn't easy. Spector wrote that there were many sleepless nights watching investments they made at bargain prices continue to fall:

The bear market picked up steam and we found a number of stocks trading near or even below their net cash value. We bought baskets of formerly hot technology stocks that were getting pummeled, despite having good businesses with contracted revenues. Although many of these companies were experiencing negative cash flow, their management teams were shrinking headcount to align to the new economic reality and were successfully lowering or eliminating cash burn. It seemed like shooting fish in a barrel. We were buying cash at a discount with an option that the underlying businesses had real value. All we had to do was wait for that underlying value to be recognized. What could be easier than buying cash at a discount?

It turns out buying a dollar for 50 cents is a lot harder than it seems. Every day we added to these positions, thinking we were getting an even better bargain than the day before, only to wake up and watch prices drop further. Other respected investors would often comment about how 'value tech' was a 'value trap,' best to be avoided. It was as if the market was having a 'going out of business' sale and we happened to be the only customer who showed up. While both exhilarating and painful at the same time, what I remember most vividly is exhaustion. After countless late nights at the office, I would head home, collapse on my couch and stare at the ceiling. I was unable to read, watch television, or fall asleep. All I could do was worry about what we might have missed in our analysis.

Ultimately, Baupost was right in its thesis. The market turned, and the stocks they had bought shot up.

What's more, moments like that don't come up too often in the market. It was a "tide comes in and tide goes out" opportunity.

"Most of the time we are in periods of haystack investing," he explained. "We sift through lots of investment ideas to find a few decent opportunities. We sell more securities than we buy and our cash reserves begin to build."

Then, once or twice a decade, the markets "become significantly dislocated" and the tides change. That's when it's time to get in, and it takes nerve.

From the letter:

We see distressed sellers, illiquid securities, huge redemptions, and an excess of paranoia and fear. We quickly find a number of interesting opportunities, deploying our significant cash balances as we trade our precious liquidity for mispriced securities. We may lose money in the short term, as we add to our portfolio while prices are dropping. But when markets turn, we expect multiple years of strong profitability.

Investing in tide markets takes chutzpah. To do so effectively, you need to fly in the face of public opinion, you have to fight normal human emotions, and you have to be prepared to double down on your bets when your conviction is most in question. As Benjamin Graham once said, 'The investor's chief problem and even his worst enemy is likely to be himself.' But most importantly, you have to be at a place that empowers you to succeed—a place that is uniquely situated to take advantage of these market conditions. A place like Baupost.

A typical day at Baupost involves the team sifting through possible investment ideas:

On most days, it offers a menu full of bland, unhealthy, and fully-priced choices. We do enough work on the offerings to make sure we aren’t missing anything and often go home feeling unsatisfied and unproductive.

Then, they find something that's compelling and focus their energy on it:

We work furiously to understand the drivers of the investment. We spend an enormous amount of time focused on the downside and the risk of permanent capital loss. We also try to understand potential optionality and upside. We ask ourselves, 'How and when will the market eventually see the situation differently?' Once we have a hypothesis about why an investment may be interesting, we start down the path of trying to confirm or reject our original thesis. Depending on complexity and price, this process may take days, weeks, or even months. Oftentimes we place investment ideas back on the shelf and wait for a lower price. Only when the investing stars line up will we add the position to our portfolio.

We can do this successfully because we have a culture of patience. Even though we work hard every day trying to uncover the next great investment, we only deploy our capital when we have real conviction that we have found one. When we don’t find interesting ideas, we do nothing and hold cash. For this reason, I’ve often joked that I’m 97% unproductive. While this means I better be damn productive the other 3% of the time, it also means exercising patience often and waiting for great opportunities. On the flip side, when an idea has been analyzed and is fully baked, we drop whatever else we are doing, discuss the investment, and make a decision. Our portfolio decision process must be incredibly efficient, as we recognize that good ideas are scarce and may prove fleeting.

Warren Buffett said, 'Big opportunities come infrequently. When it's raining gold, reach for a bucket, not a thimble.' When a great opportunity comes around, it is imperative to size it correctly.

One key reason the fund is able to invest in those big ideas is it keeps cash on hand:

One of the most common misconceptions regarding Baupost is that most outsiders think we have generated good risk-adjusted returns despite holding cash. Most insiders, on the other hand, believe we have generated those returns BECAUSE of that cash. Without that cash, it would be impossible to deploy capital when we enter a tide market and great opportunities become widespread. Seth has said on a number of occasions in both types of markets, 'If you have great ideas, you will have capital to deploy.' This is incredibly motivating to our investment team.

Aside from discussing how the firm uses the fundamentals of value investing, Spector also delved into the culture of Baupost. Unlike some funds where the environment is super competitive, Spector said that Baupost has a culture revolving around teamwork and confidence in one another.

When a team member finds a good idea, we discuss who should work on it and how it compares to other ideas we are currently finding (as well as other past ideas). This is a complicated management issue. Good ideas are scarce and most investors like to pursue investments they have sourced. At most investment firms, analysts operate as free agents. Their pay is based primarily on the performance of their individual “book.” Rather than cooperating and maximizing investment returns for the firm, they are often incentivized to do the converse. This may breed a culture of mistrust and misplaced motivations.

At Baupost, it is just the opposite. This is an area that I believe makes Baupost exceptional and can’t be fully understood from the outside. People work together to maximize the returns for our clients, partly because they are incentivized to do so, but also because they believe in one another. No one would want to hand off a good idea and watch another analyst drop the ball. But, since our investment staff is accountable to both the partners and the team, they comfortably make hand-offs, root for one another, and try to help in any way possible. This means reviewing investments, exchanging impactful information and opinions, as well as mentoring one another.

It is a running joke in our industry that portfolio managers look enviously at the teams of their competitors, always assuming the other groups are better. Not here. At Baupost, I’ve never thought that I would want to go into 'investment battle' with anyone else. Our team is excellent and I believe it has improved as we have grown. (Quite frankly, I wonder if I would even have the opportunity to interview at today’s Baupost!) We get along, share ideas, support one another, mentor younger analysts, and have a good time together. I know the part I will miss most about Baupost is the daily interaction with my smart, ethical, hard-working, and funny (some intentionally) colleagues.

He noted that you'd never know what the market is doing based on the atmosphere of the fund's trading floor:

We try to maintain a calm working environment. In order to really understand a firm and its decision-making process, one needs to comprehend how it acts in a period of uncertainty and stress. Are people calm or yelling at each other? Does it feel like business as usual or is everyone paralyzed by all the red on their screens? At Baupost, if you were in our trading room, you would not know if the market was up 5% or down 5%. This is by design. It is much easier to make reasoned decisions without someone screaming at you or second guessing your judgment. It’s not always easy, but we try to maintain the same atmosphere and investment process in all markets.

Spector concluded that Baupost's successful long-term track record isn't due to a "silver bullet" of "formula," but rather the 215 people who make up the firm.

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In 2015, The Baupost Group — the $27 billion Boston-based hedge fund — had its third losing year.

Baupost was founded by legendary value investor Seth Klarman, the author of "Margin of Safety."

The fund is known for its secrecy. Klarman doesn't make many public-speaking appearances, and the fund's investment letters rarely get out.

There is next to no information on the fund's website.

In the fund's year-end letter, seen by Business Insider, Klarman wrote that they were "disappointed to post a mid-single-digit decline."

The fund's public-investments portfolio fell 6.7% in 2015, while the fund's private investments gained 2.4%, according to a separate investor update seen by Business Insider.

Meanwhile, the average hedge fund fell 3.64% last year, according to data from Hedge Fund Research.

"2015 was a year of dodging relentlessly falling knives; upon deeper inspection, one superficially tempting investment after another turned out to be worse than they initially appeared. We avoided the great majority of these and were nicked by only a handful," Klarman wrote.

"In investing, however, there is no umpire calling balls and strikes, and in retrospect we could have been even more patient at the plate. What had, for many investors, been a growing pool of red ink during the year turned into a bloodbath by year-end. To repurpose Warren Buffett’s famous quote about managements and businesses, when a talented investment team confronts an exceptionally challenging market, sometimes the market wins (at least in the short run)."

Baupost, one of the world's most successful and secretive hedge funds, saw its portfolio in public equities mainly dragged down from the following investments:

• Cheniere Energy
• Micron Technology
• Keryx Biopharmaceuticals
• Antero Resources

In the other letter to investors, Baupost's head of public investments, Jim Mooney, explained what went wrong:

I believe it is best to think about our 2015 results in two parts: what we brought on ourselves and what resulted from the environment in which we operated. In the first category, we made some mistakes. I will describe the two largest. Our loss on Micron resulted from the fact that we remained overly optimistic about our long-term thesis after it should have become apparent that the company’s widening cost disadvantage compared to its largest competitor, Samsung Electronics, would result in lower than expected profit margins. It also should have been clearer to us that the company was more vulnerable to the decline in PC DRAM pricing than we had believed. By the time we decided to sell nearly all of our remaining position, the stock was lower – a frustrating coda to an otherwise tremendously successful investment that achieved total lifetime profitability of over $900M.

In the case of Keryx, we purchased our initial position at an average price of $14.50 per share based on what turned out to be an overestimation of initial prescriptions for Auryxia, the company’s approved drug to control phosphorous levels in dialysis patients. While we remain confident in the long-term potential of Auryxia, and, thereby, our investment in Keryx, the slower sales ramp through 2015 did have a modestly negative impact on our estimate of intrinsic value. The market, however, took a much harsher view and punished the stock, driving it down to almost 70% in less than three months from about $10 to almost $3 a share. Although this certainly was not good news for our mark-to-market P&L, we believe it was a significant overreaction, and we were able to take advantage of the opportunity by investing additional capital on a private basis at what we believe is an incredibly attractive valuation. This, of course, is a great illustration of the fact that even in circumstances when we reduce our own expectations, price declines can far exceed what we judge to be warranted.

With respect to the broader investing environment, the public markets of 2015 were difficult to navigate. Opportunities for significant gains were largely confined to a small number of broadly-loved (and loftily-valued) companies. Most portfolios without those names moved sideways, at best. Those with exposure to the energy sector performed far worse. Performance in energy names was, obviously, driven by a dramatic decline in commodity prices. Companies with direct commodity exposure, like Antero Resources, fell to levels that ascribed little or no worth to valuable non-producing acreage. Even Cheniere Energy, with limited exposure to oil and gas prices, was significantly penalized by this unforgiving market.

During 2015, Baupost spent $2.2 billion in its public-equity portfolio, adding to 23 of its already existing stock positions. The fund also initiated 22 new positions during the year.

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Legendary value investor Seth Klarman has a warning about Silicon Valley unicorns, the startups valued at $1 billion or more.

Here's Klarman in his fund's 2015 year-end letter:

Another area that has been especially bubbly is venture capital, resulting from highly visible and rapidly growing companies like Uber, now "ubervalued" at $70 billion.

A voracious appetite for tech startups has driven prices sky-high, giving rise to the term "unicorn," meaning privately held firms worth $1 billion or more. In today's overheated environment, "unicorns" are no longer a rare breed: there were an estimated 143 extant at year-end, up from 45 two years ago.

This constitutes an enormous potential pipeline of future public offerings that could someday overhang the stock market. With investors sitting on large paper gains (the estimated combined value of the unicorns is $513 billion), but having experienced few monetization events, it seems likely that many unicorns will be drawn into the public market zoo.

Unicorns also need to be fed, gobbling large amounts of cash as they grow. A change in investor psychology could impair people's willingness to continue to pour in capital at high and growing valuations. Recently there have been downward revisions in the valuations of several of the unicorns held by major mutual funds, a sign, perhaps, that excesses in that sector are in the process of being corrected, that the herd is about to be thinned.

Klarman, who founded the $27 billion Boston-based hedge fund The Baupost Group, is spot on here.

As Business Insider's Portia Crowe reported, betting on unicorns has been like flipping a coin lately. Of the seven unicorns that went public in 2015, three ended the year down, while one was flat and three traded up.

And Business Insider executive editor Jay Yarow reported last week that Jim Breyer, the venture capitalist who made a fortune investing early in Facebook, thinks that 90% of the unicorn startups will be repriced or die and 10% will make it.

Baupost Group has one of the best long-term investing track records. In 2015, however, Baupost suffered its third losing year in its 33-year history.

Its public investments lost 6.7%, while its private investments gained 2.4%.

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The Baupost Group, the $27 billion hedge fund led by value investor Seth Klarman, has been buying distressed debt, or the bonds of companies that are in or near bankruptcy.

In an investor update, Jim Mooney, the head of the Baupost's public investments group, said the credit market has become a "key area of focus" for the fund. 

Here's Mooney (emphasis ours): 

Although the equity markets garnered most of our attention throughout the year, the credit markets have reemerged as a key area of focus. In last year’s addendum, I discussed how synchronized selling often precedes a significant decline. The October 2014 swoon to which I was referring quickly reversed and left little permanent damage. The sell-off we are experiencing today feels more ominous and has already claimed several prominent investors as victims. The fear we expressed over the last several years about the draining of liquidity from the high-yield market appears to be materializing. In conversation after conversation, dealers make it clear that they have neither the balance sheet nor the institutional mandate to absorb selling pressure. The traditional “risk” bid from Wall Street trading desks is all but gone. Further, existing holders frequently have very little appetite or, often, capacity to add to their holdings. In fact, these holders frequently are faced with their own pressure to sell into a declining market in order to satisfy redemptions. This dynamic is particularly acute in cases of ratings downgrades or deteriorating performance. Any demand for a bid on more than $1 or $2 million of bonds is likely to make the prior market price unattainable, in some cases, laughably so. The next (generally much lower) level is likely to be a bid from Baupost, or one of our competitors.

While the opportunity in credit is not yet a torrent, in the last three months, we have begun to accumulate the bonds of several companies in the energy complex as well as in other areas, including some non-energy commodities businesses. We even had a chance to play an anchor role in a refinancing transaction for an energy company after it became obvious that the deal would price more than 500 basis points wider than the underwriters had anticipated. In that case, we expect to earn a low teens return on secured paper that we believe is covered by more than two times in our downside case and even more robustly in a near-term liquidation. In the fourth quarter, we added just over 2% of partnership assets in distressed/stressed credit to the portfolio.

Baupost isn't the only big name investor looking to put money to work in the distressed debt and energy sector. Business Insider reported last month that a number of big name investors were looking for a bottom in the oil price, and were getting ready to pile in. 

In Baupost's year-end letter dated January 20, Klarman noted that they have "ample cash reserve" and have been putting it to work lately.  

Many of the hardest hit names in the equity and debt markets continue to fall. The S&P 500 Index, for example, lost a record 6% the first week in January 2016, and another 2.2% last week. The Russell 2000 Index has now plunged 23% from its peak. Consequently, our opportunity set has been expanding, and our Public Investment Group analysts in particular are as busy as they’ve been in a number of years. We’re certainly glad to have ample cash in reserve (41% of the portfolio at year-end), though we’ve been putting some of it to work recently. We feel fortunate to be in a position where we have been able to add – at increasingly steep discounts – to many of our most compelling positions.

Baupost Group has one of the best long-term investing track records around. In 2015, however, Baupost suffered its third losing year in its 33-year history.

Its public investments lost 6.7%, while its private investments gained 2.4%. 

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Billionaire value investor Seth Klarman is one of the most successful hedge fund managers of all time.

Klarman, the 58-year-old founder of $27 billion Boston-based Baupost Group, ranks No. 4 on the all-time list, according to a new report from LCH Investments.

Since his fund's inception in 1983, he has made his investors net gains of $22.6 billion.

During his career, he's only had three losing years, including 2015. Baupost's public-investments portfolio fell 6.7% in 2015, while the fund's private investments gained 2.4%, according to an investor update seen by Business Insider.

In his fund's year-end letter, Klarman explained what it takes to be a successful investor:

Did we ever mention that investing is hard work — painstaking, relentless, and at times confounding? Separating relevant signal from noise can be especially difficult. Endless patience, great discipline, and steely resolve are required. Nothing you do will guarantee success, though you can tilt the odds significantly in your favor by having the right philosophy, mindset, process, team, clients, and culture. Getting those six things right is just about everything.

Complicating matters further, a successful investor must possess a number of seemingly contradictory qualities. These include the arrogance to act, and act decisively, and the humility to know that you could be wrong. The acuity, flexibility, and willingness to change your mind when you realize you are wrong, and the stubbornness to refuse to do so when you remain justifiably confident in your thesis. The conviction to concentrate your portfolio in your very best ideas, and the common sense to nevertheless diversify your holdings. A healthy skepticism, but not blind contrarianism. A deep respect for the lessons of history balanced by the knowledge that things regularly happen that have never before occurred. And, finally, the integrity to admit mistakes, the fortitude to risk making more of them, and the intellectual honesty not to confuse luck with skill.

As Klarman puts it, "You don't become a value investor for the group hugs."

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Billionaire value investor Seth Klarman is one of the most successful hedge fund managers of all time.

Klarman, the 58-year-old founder of $27 billion Boston-based Baupost Group, ranks No. 4 on the all-time list, according to a new report from LCH Investments.

Since his fund's inception in 1983, he has made his investors net gains of $22.6 billion.

During his career, he's only had three losing years, including 2015. Baupost's public-investments portfolio fell 6.7% in 2015, while the fund's private investments gained 2.4%, according to an investor update seen by Business Insider.

In his fund's year-end letter, Klarman explained what it takes to be a successful investor:

Did we ever mention that investing is hard work — painstaking, relentless, and at times confounding? Separating relevant signal from noise can be especially difficult. Endless patience, great discipline, and steely resolve are required. Nothing you do will guarantee success, though you can tilt the odds significantly in your favor by having the right philosophy, mindset, process, team, clients, and culture. Getting those six things right is just about everything.

Complicating matters further, a successful investor must possess a number of seemingly contradictory qualities. These include the arrogance to act, and act decisively, and the humility to know that you could be wrong. The acuity, flexibility, and willingness to change your mind when you realize you are wrong, and the stubbornness to refuse to do so when you remain justifiably confident in your thesis. The conviction to concentrate your portfolio in your very best ideas, and the common sense to nevertheless diversify your holdings. A healthy skepticism, but not blind contrarianism. A deep respect for the lessons of history balanced by the knowledge that things regularly happen that have never before occurred. And, finally, the integrity to admit mistakes, the fortitude to risk making more of them, and the intellectual honesty not to confuse luck with skill.

As Klarman puts it, "You don't become a value investor for the group hugs."

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Baupost Group's Seth Klarman is worried about what the election of President Donald Trump means for global markets.

In a private letter to investors dated January 20, reviewed by Business Insider, he starts with three quotes:

• "In matters of style, swim with the current; in matters of principle, stand like a rock."— Thomas Jefferson
• "The world, that understandable and lawful world, was slipping away."— William Golding, "Lord of the Flies"
• "Do I really look like a guy with a plan? You know what I am? I'm a dog chasing cars. I wouldn't know what to do with one if I caught it. You know, I just ... do things."— The Joker, "The Dark Knight"

The rest of the letter serves as an explanation for the inclusion of those three quotes. Klarman runs through his thoughts on Trump, volatility, and the stock market. You can read more about the letter at The New York Times.

Baupost, the Boston-based hedge fund firm, managed $29.2 billion as of mid-2016, according to the Hedge Fund Intelligence Billion Dollar Club ranking. A spokeswoman for Baupost didn't immediately respond to a request for comment.

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• Investors are realizing the tax cuts and pro-business reforms will take longer to materialize than they expected.
• In the meantime, stocks and bonds are correlating with President Donald Trump's popularity (or lack thereof), Credit Suisse says.
• Adding to this pressure, stock valuations are high by any measure.

Ever so slowly, Wall Street is being shaken from the trance of President Donald Trump's promises of deregulation and tax reform.

As this happens, an entire industry known for sharing notes and trading tips is starting to worry whether it has been working off of the wrong playbook.

"When Trump's favorability initially rose after the election, equity investor optimism was driven by an intense focus on how to position for rising interest rates and improving prospects for economic/earnings growth driven by corporate tax reform, infrastructure spending, and regulatory relief," analysts at Credit Suisse wrote in a recent note. "But since Trump's favorability peaked in mid-December, that optimism has been replaced by a wait and see approach among many investors, along with a healthy dose of frustration."

The fears that are rattling the "Masters of the Universe" are varied: Baupost's Seth Klarman is worried about Trump's tax cuts and spending plan. He is also, along with Bridgewater's Ray Dalio, scared of populism and trade wars. Greenlight Capital's David Einhorn is worried about inflation, and Elliott Management's Paul Singer worries that the world has gone complacent.

He's right. It has. That means it's time to be afraid of the stock market.

First things first; next things, perhaps never

The "frustration" Credit Suisse is describing comes from the fact that investors don't know when the plans they like will actually be enacted, while measures that are actually disconcerting to investors — immigration bans, trade-war mongering, and healthcare uncertainty — have taken center stage.

They are also frustrated that details of plans they thought they liked could hurt some industries. Think, for example, what the border-tax element of Trump's plans — essentially a tax on importers — could do to retailers like Kohl's, Lululemon, and Urban Outfitters that make their products abroad and sell them at home.

Messages from the administration have not been reassuring. Peter Navarro, the head of Trump's National Trade Council, dismissed as "fake news" Wall Street analysis that concluded retailers would be hurt and jobs would be lost through the border-adjustment tax.

Navarro has, so far, been the clearest messenger of Trump's — and top adviser Steve Bannon's — vision for the economy: taking resources away from the services economy we have, and recreating the manufacturing economy we used to have, to save jobs.

"We envision a more Germany-style economy, where 20% of our workforce is in manufacturing," Navarro told CNBC in a recent interview. This comment, as we've pointed out before, compares apples to oranges. The US manufacturing sector alone would be the eighth-largest economy in the world. Germany's entire economy is the fourth largest in the world.

This is not an idea Wall Street signed up for.

Trading on Trump

But let's say Wall Street does get a few things on its wish list, even though House Speaker Paul Ryan says they won't materialize until 2018.

In that event, according to Credit Suisse, we still have a problem: "Investors have been asking how valuations look on 2018 EPS, when it is becoming more likely ... that stock market friendly policy changes in Washington could materialize. On current 2018 expectations, US stocks still look highly overvalued."

The charts below trace forward-looking price-to-earnings ratios all the way back to the mid-1980s:

Perhaps more disconcerting to Credit Suisse — and this correspondent — than any of these things is that the stock market and a few macroeconomic indicators are actually trading on Trump's favorability right now. (For more on that, see the slides below).

It seems as if Wall Street has given up the difficult work of picking stocks and making models, of calling experts and building theories. Instead it is allowing the market to try to figure out whether the president can handle his new job. Of course, it's unclear how long that will take.

As a result, 10-year Treasury yields, the dollar, crude oil, small-cap stocks, financial stocks, high-tax-paying stocks, and more are correlated to Trump's favorability.

This is a delicate state, to say the least. The American people don't like it when their president is rattled, and we know it doesn't take much to rattle Trump – a skit on "Saturday Night Live," poor sales at his daughter's company, The New York Times reporting the truth. It could be anything.

And you don't want to be in a stock market that can move on just anything.

Stocks and yields are correlated to Trump's favorability. (Red is Trump's favorability rating, blue is the market).

The US dollar and crude oil also appear to be trading on Trump.

Large-cap stocks also seem to have caught the bug, depending on what they pay in taxes. It seems as if low-tax payers get hurt when Trump's favorability is high — a sign the market thinks it will be easier for him to pass tax reform.

At some presentations I gave last week in included the following slide:

These quotes come from an interview legendary hedge fund investor Seth Klarman gave to the Wall Street Journal. Klarman isn’t as well known to the general investing public as some of his peers but his track record ranks right up there in terms of the greatest of all-time. When someone like Klarman makes these types of warnings it’s hard to ignore.

But here’s the kicker — Klarman made these comments in May of 2010. The S&P 500 is up almost 170% since then. The economy hasn’t gone off the rails. The European Union didn’t fall apart.

Seeing that he’s a hedge fund manager and all, he did hedge these comments somewhat by saying his ideas, “on bottom-up opportunities in undervalued securities are more likely to be accurate than my top-down views on what’s going to happen in the world at large.”

The point here is not to show a poor macro forecast by a well-known investor to make myself feel better. I am simply trying to point out the fact that markets are really, really hard. You can be at the top of the game for a long time and still have no clue what’s going to happen.

It may be hard to remember this now but at the time it wasn’t quite so clear markets would see such a strong recovery with the onset of the European debt crisis, double-dip recession worries, and the memory of the worst financial crisis since the Great Depression fresh in investor memories.

Plus, Klarman makes his living buying distressed assets. He buys securities that most investors can’t or won’t buy. Lately, he’s been having a hard time finding distressed assets since there hasn’t been much distress in the markets.

Per Bloomberg, Klarman is returning capital to investors:

Seth Klarman’s $30 billion Baupost Group plans to return some capital to investors by year end because the hedge fund doesn’t see enough opportunities in the market.

Investors were told in recent weeks that the firm expects to return capital for the third time in its history, according to a person with knowledge of the matter. Boston-based Baupost is holding 42 percent of its assets in cash and wants to balance the money it manages with potential opportunities, said the person, who declined to be named because the information is private. It is unclear how much will be given back.

Hedge funds have taken it on the chin in recent years but I think investors can learn a lot from these two stories about Seth Klarman:

Watch what they do, not what they say. Klarman doesn’t make many public statements but plenty of other high profile portfolio managers do. Most of the time what they say in public has little-to-no bearing on how they manage assets.

Macro tourism has really ramped up since the financial crisis so everyone feels the need to share their opinions on the state of the world. Client letters, TV appearances, interviews and speeches tell you a lot about a fund manager’s personal opinions but usually very little about actual investment insights.

The majority of investors will never be able to access the best hedge fund managers. I saw Klarman speak to a group of foundations and endowments in 2009. Everyone in the room, many with multi-billion dollar portfolios, wanted to invest with Baupost Group. Klarman rarely opens up his fund to new investors and when he does there’s a queue of institutional investors on a waiting list to get in.

The paradox of active management is that there are investors out there who can beat the market and have done so handily for years but they probably don’t want or need your money. And finding the next Seth Klarman might be even harder than finding your way into his fund.

Treating your investors right is more important than fee revenue. Some fund firms may not agree with me here but one of the reasons Klarman’s track record is so phenomenal is because he’s selective about who he lets into his fund and tries to keep assets at a manageable level. Sending money back to investors when there aren’t enough opportunities in the markets may seem like madness to some portfolio managers.

I think it’s a highly respectable practice. Klarman runs a unique style of investing. He’s giving his investors the chance to allocate their funds elsewhere while he has a dearth of options with his opportunistic style. I’m sure he’ll open things up again when assets are on sale yet again, whenever that may be.

If history is any guide, no one knows when that distress will hit.

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(Reuters) - Baupost Group, one of the world's biggest hedge funds, owns nearly $1 billion in Puerto Rican sales tax debt, a spokeswoman confirmed on Wednesday as the island's debt tumbled in the wake of suggestions from President Donald Trump that it may be erased.

Baupost, which invests $30 billion for endowments and other wealthy investors, owns roughly $911 million in Puerto Rico's so-called COFINA bonds, which are backed by a chunk of the island's sales-tax receipts, spokeswoman Diana DeSocio said.

Investors' prospects of recouping their money dimmed after Trump on Tuesday toured the hurricane-ravaged island and said the debt would have to be "wiped out." White House Budget Director Mick Mulvaney later backed away from that statement.

Most hedge fund investors' identities were revealed in July as part of the island's bankruptcy proceedings, but Baupost's name came to light only this week. The Boston-based fund, run by Seth Klarman, made its bets through a Delaware-based corporation called Decagon Holdings, thereby shielding its name.

"Baupost Group is a holder of COFINA bonds through the Decagon entities. Baupost regularly makes investments through subsidiary holding entities," DeSocio said in a statement.

Baupost's identity was first reported by online publication The Intercept.

Two months ago, the group of hedge funds that hold about $3 billion of CONFINA bonds detailed who owns how much with Decagon Holdings being listed as the largest owner.

GoldenTree Asset Management, Tilden Park Capital Management, and Canyon Partners were the next biggest owners.

Investments in Puerto Rico have long been risky. In May the U.S. territory filed a form of bankruptcy under the federal 2016 rescue law known as PROMESA as it struggled to repay more than $70 billion of debt. Its problems were compounded when two hurricanes raked the island in the past weeks, with Hurricane Maria knocking out power to the island's 3.4 million residents.

Puerto Rican bonds on Wednesday tumbled after Trump visited the island and saw the devastation firsthand.

"We're going to have to wipe that out," he told Fox News in reference to the debt owned to Wall Street as well as Main Street investors. "You can say goodbye to that. I don't know if it's Goldman Sachs, but whoever it is, you can wave goodbye to that."

Baupost's DeSocio declined to comment on Trump's remarks. (Reporting by Svea Herbst-Bayliss; Editing by Jonathan Oatis)

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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 April in a 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 with the start of the 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's largest hedge fund firms, with some $30 billion under management. He has a huge following on Wall Street — investors named his book, "Margin of Safety," their favorite investment book in a recent SumZero survey. A used copy on Amazon costs more than $900.

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 proposed tax cuts, for instance, which could considerably raise the government's deficit.

Markets have rallied since Trump was elected in November, as Wall Street expressed confidence in the president's plans to cut taxes, roll back regulations, and boost infrastructure spending. Even as the Trump administration faces notable headwinds — investigations into Russia's influence on the election, flubs in passing healthcare reform — 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."
• Investors focusing on the short term and trend following, and restrictions that are supposed to limit risk but prevent outperformance.

As for potentially missing the Trump rally by continuing to hedge and focus 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 $30.3 billion at the start of the year, according to Hedge Fund Intelligence's Billion Dollar Club ranking. A spokeswoman for the firm declined to comment.

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• Seth Klarman, the founder of The Baupost Group, a $30 billion hedge fund, is concerned about growing nationalism in the US and abroad.
• Klarman says investors should be worried.
• He wrote that President Donald Trump "puts the U.S. at risk of both grave strategic miscalculation and reduced global influence" that could undermine markets.

The founder of one of the world's largest hedge funds says the global political climate poses a grave threat to democracy and international markets.

The Baupost Group's Seth Klarman dedicated two pages in his annual client letter to a scathing critique of President Donald Trump, global nationalism, and concerns about the rise of Russia, China, and North Korea, saying all could forebode market upheaval.

"Xenophobia, racism, and anti-Semitism are literally on the march," Klarman wrote in the year-end letter, a copy of which was reviewed by Business Insider.

He cited Trump's election win, Brexit, the Scottish referendum for independence, Catalonia's crisis with Spain, and two Italian regions' vote for greater autonomy from Rome. He also cited concerns about a demise of American democracy, with polls showing "a disturbing number of young people with anti-democratic views."

He added: "From Charlottesville to Poland, neo-Nazis, while still limited in number, are resurgent. Clearly the world has tilted off its axis, and we believe owners of capital should be increasingly worried. Amidst the tsunami of growing discontent and upheaval, soaring share prices and subdued volatility seem especially peculiar."

Bernie Sanders' rise in the 2016 US election should also alarm investors, Klarman said, because it shows that a significant number of Americans have "moved away from the center, an ominous trend for an already divided and increasingly angry nation."

Klarman has long criticized Trump, and he holds no punches back in his most recent letter, writing that Trump "has displayed few of the character traits required in a US president and no aptitude for or interest in developing them."

He added that Trump put the US "at risk of both grave strategic miscalculation and reduced global influence." He continued:

"Indeed, the loss (or sever diminution) of what had been America's unquestioned position of leadership on the world stage impairs our ability to influence world events in a manner that promotes stability and democracy. This is bad for the U.S. and could also undermine markets in the long run."

Klarman is also worried about how countries that hold US debt will react should they become concerned about the future of US democracy or question the country's status as a haven, saying "no one is obliged to buy our bonds."

Baupost, which manages about $30 billion, gained in the mid-single digits in 2017 and held 36% of its portfolio in cash at year-end, according to the letter.

Klarman also said that good investing opportunities are harder to come by, and that Baupost "will have to work harder with less to show for it."

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Seth Klarman's Baupost Group will be returning money to investors at year-end.

As II Alpha reports, though the amount has yet to be determined, this would be only the second time the hedge fund has returned money in the firm's 31-year history.

With the world of asset managers, as we recently noted, increasingly become herd-like beta-chasers, it seems Klarman - just as he noted earlier in the year - will return capital unless investment opportunities dramatically increased - and that hasn't happened. 

Via II Alpha, 

Seth Klarman’s Baupost Group has decided to return some money to investors at year-end, but it has not yet determined the amount, according to a person familiar with the firm’s plans.

This would be only the second time Baupost returned money to investors in the Boston-based investment firm’s 31-year history. The previous time was in 2010, and Baupost subsequently raised money in early 2011.

...

In a letter dated April 29, Klarman said the goal is “to better match our assets under management with the opportunity set we see for new investments.” The decision was made, in part, after a series of discussions with clients on the firm’s quarterly webcasts with investors. The firm’s goal is to keep assets under management at $25 billion, according to the person familiar with Baupost.

... 

Baupost’s performance is even more impressive given its penchant for holding large amounts of cash. It has averaged 33 percent of assets in cash, and its cash balance can reach as high as 50 percent. It is now in the mid-30 percent range, up slightly from 32 percent at year-end.

... 

However, the firm does not use leverage to try to boost returns.

...

“Our willingness to invest amidst falling markets is the best way we know to build positions at great prices, but this strategy, too, can cause short-term underperformance,” Klarman explained in an investor letter earlier this year. 

and Klarman's previous thoughts:

To wit:

If the economy is so fragile that the government cannot allow failure, then we are indeed close to collapse

And the rest of Klarman's sermon, serving as the perfect counter to the voodoo shamans operating their Keynesian religion in the Marriner Eccles building. From Seth Klarman of Baupost: 

Is it possible that the average citizen understands our country's fiscal situation better than many of our politicians or prominent economists?

Most people seem to viscerally recognize that the absence of an immediate crisis does not mean we will not eventually face one. They are wary of believing promises by those who failed to predict previous crises in housing and in highly leveraged financial institutions.

They regard with skepticism those who don't accept that we have a debt problem, or insist that inflation will remain under control. (Indeed, they know inflation is not well under control, for they know how far the purchasing power of a dollar has dropped when they go to the supermarket or service station.)

They are pretty sure they are not getting reasonable value from the taxes they pay.

When an economist tells them that growing the nation's debt over the past 12 years from $6 trillion to $16 trillion is not a problem, and that doubling it again will still not be a problem, this simply does not compute. They know the trajectory we are on.

When politicians claim that this tax increase or that spending cut will generate trillions over the next decade, they are properly skeptical over whether anyone can truly know what will happen next year, let alone a decade or more from now.

They are wary of grand bargains that kick in years down the road, knowing that the failure to make hard decisions is how we got into today's mess. They remember that one of the basic principles of economics is scarcity, which is a powerful force in their own lives. 

They know that a society's wealth is not unlimited, and that if the economy is so fragile that the government cannot allow failure, then we are indeed close to collapse. For if you must rescue everything, then ultimately you will be able to rescue nothing. 

They also know that the only reason paper money, backed not by anything tangible but only a promise, has any value at all is because it is scarce. With all the printing, the credibility of our entire trust-based monetary system will be increasingly called into question. 

And when you tell the populace that we can all enjoy a free lunch of extremely low interest rates, massive Fed purchases of mounting treasury issuance, trillions of dollars of expansion in the Fed's balance sheet, and huge deficits far into the future, they are highly skeptical not because they know precisely what will happen but because they are sure that no one else--even, or perhaps especially, the  policymakers—does either.

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Value investor Seth Klarman, the founder of Boston-based hedge fund Baupost Group, thinks this market looks like the 1998 Jim Carrey movie "The Truman Show."

In the film, Carrey's Truman Burbank lives a peaceful suburban life, but his world collapses upon realizing he's the star character in a massively popular reality show.

His entire life — from his father's death to convenient product placements — has been orchestrated by the show's creator, Christof (played by Ed Harris).

"As Truman starts to unravel the truth, his anger erupts and chaos ensues," Klarman writes to clients in his latest letter.

In Klarman's telling, Ben Bernanke and Mario Draghi play the "creators" who have "manufactured a similarly idyllic, if artificial, environment for today’s investors." Check out an excerpt from the rather bearish letter (via ZeroHedge):

But there is one fly in the ointment: in Bernanke’s production, all the Trumans – the economists, fund managers, traders, market pundits – know at some level that the environment in which they operate is not what it seems on the surface. The Fed and the Treasury openly discuss the aim of their policies: to manipulate financial markets higher and to generate reported economic “growth” and a “wealth effect.” Inside the giant Plexiglas dome of modern capital markets, just about everyone is happy, the few doubters are mocked and jeered, bad news is increasingly ignored, and markets go asymptotic. The longer QE continues, the more bloated the Fed balance sheet and the greater the risk from any unwinding. The artificiality of today’s markets is pure Truman Show. According to the Wall Street Journal (12/20/13), the Federal Reserve purchased about 90% of all the eligible mortgage bonds issued in November.

...Every Truman under Bernanke’s dome knows the environment is phony. But the zeitgeist so so damn pleasant, the days so resplendent, the mood so euphoric, the returns so irresistible, that no one wants it to end, and no one wants to exit the dome until they’re sure everyone else won’t stay on forever.

A marketplace of knowing Trumans seems even more unstable than the movie sound stage character slowly awakening to reality. Can the clued-in Trumans be counted on to maintain their complicity or will they go off-script? Will Fed actions reliably be met with the desired response? Will the program remain popular? Could “The Truman Show” be running out of material? After all, even Seinfeld ended.

"When the show ends, those self-deluded Trumans will be mad as hell and probably broke as well," Klarman concludes. "Hopefully there will be no sequels."

Read the full letter at ZeroHedge »

SEE ALSO: 12 Brilliant Insights From Investing Legend Seth Klarman

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Seth Klarman, one of the most successful investors in history, recently returned $4 billion of capital to his clients. He also reportedly has 40% of his portfolio in cash.

Why?

Because Klarman can't find anything he is comfortable investing this money in.

Klarman recently sent a letter to his clients explaining his view of the world. This view can be described as "confident that these good times will come to an end."

Klarman doesn't say stocks are "a bubble." He doesn't say prices are "ridiculous." He doesn't say the things that some of the louder doom-and-gloomers are howling about the coming devastation. 

But he certainly thinks that what's happening now is, in large part, the result of unsustainable easy-money policies from the Fed, and that it is too good to last.

One of the most important things you can do as an investor is to try to seek out smart arguments that lay out the opposite side of the views that you hold. In other words, if you're bullish, you should seek out smart bears, and vice versa.

So every investor who is bullish on stocks should read Seth Klarman's recent letter.

And if you just don't have time to do that — if you're so sure that stocks are just going to keep going up and that anyone who voices caution is a moron — then at least read Klarman's conclusion below.

And don't just read it. Actually think about it.

Someday, financial markets will again decline. Someday, rising stock and bond markets will no longer be government policy – maybe not today or tomorrow, but someday. Someday, QE will end and money won’t be free. Someday, corporate failure will be permitted. Someday, the economy will turn down again, and someday, somewhere, somehow, investors will lose money and once again come to favor capital preservation over speculation. Someday, interest rates will be higher, bond prices lower, and the prospective return from owning fixed-income instruments will again be roughly commensurate with the risk.

Someday, professional investors will come to work and fear will have come to the markets and that fear will spread like wildfire. The news flow will be bad, and the markets will be tumbling.

...

Six years ago, many investors were way out over their skis. Giant financial institutions were brought to their knees...

The survivors pledged to themselves that they would forever be more careful, less greedy, less short-term oriented.

But here we are again, mired in a euphoric environment in which some securities have risen in price beyond all reason, where leverage is returning to rainy markets and asset classes, and where caution seems radical and risk-taking the prudent course. Not surprisingly, lessons learned in 2008 were only learned temporarily. These are the inevitable cycles of greed and fear, of peaks and troughs.

Can we say when it will end? No. Can we say that it will end? Yes. And when it ends and the trend reverses, here is what we can say for sure. Few will be ready. Few will be prepared.

In that last paragraph, Klarman reveals the full extent of his wisdom: He admits that he doesn't know when the current euphoria will end. 

In an environment when market pundits are supposed to have a black-and-white, minute-to-minute view of what the market will do next, this admission is startling. And it's also true.

No one knows that the market will do next.

Some people, though — Jeremy Grantham, Seth Klarman, John Hussman, Robert Shiller, and many others — are looking at the current level of stock prices and comparing them to average prices over the past 150 years. And, based on these prices (and other factors, like the Fed), they are concluding that stocks have a lot of downside risk. So much so that, Klarman at least, is forgoing fees to avoid getting clobbered by this risk.

Klarman, et al, may be wrong. We may still be in the early stages of an amazing new bull market. Stocks may climb this little "wall of worry" and march much, much higher from here. They may never return to historical averages again.

But if you are confident that that's what stocks will do, at least do yourself the favor of thinking carefully about why you believe that—that you're not just optimistic because the last 5 years have been so good and that you have a strong fundamental thesis to support your views. And be comfortable with the 40%-50% downside that you might experience if you are wrong.

Because hope is not a strategy. And no one benefits from ignoring smart folks on the other side of the trade.

You can read a long excerpt from Seth Klarman's letter a Zero Hedge here >

SEE ALSO: Anyone Who Thinks Stocks Will Keep Going Up If The Economy Keeps Growing Should Brush Up On History

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