Seth Klarman's notes on investment
Oct 22, 2025
WIthin 1 year of the Great Sub-Prime housing Meltdown (2008) shockingly speculative behavior was observed by Seth, where protfolio managers leveraged high-grade bond holdings. The meltdown of the scale should have staved off such behaviour for a longer time, one would expect. Seth remarked that either the lessons were never learnt or blatently ignored
Here's a compilation of 20 lessons from 2008, as shared by Seth (rewritten for clarity)
Things that have never happened before are bound to occur with some regularity. You must always be prepared for the unexpected, including sudden, sharp downward swings in markets and the economy. Whatever adverse scenario you can contemplate, reality can be far worse.
People find false sense of security in liquid economic enviorments. The liquidity migrates to global markets and causes adverse selection for investors. When liquidity dries up, leverage unwinds faster and there's Co-realtion of performance observed between asset classes.
RIsk shouldn't take a back-seat to returns. Investors shouldn't stretch out their investment to make every last penny. Conservative positioning entering a crisis is crucial. Hedges need to be in place before the crisis hits. It's not possible to reliably or affordably increase hedging when a market is rolling off. This enables long-term oriented clear thinking, focus on oppourtunities while others are distracted.
Risk is not inherent in an investment; it is always relative to the price paid. Uncertainty is not the same as risk. Indeed, when great uncertainty – such as in the fall of 2008 – drives securities prices to especially low levels, they often become less risky investments.
Do not trust financial market risk models. Reality is always too complex to be accurately modeled. Attention to risk must be a 24/7/365 obsession, with people – not computers – assessing and reassessing the risk environment in real time. Despite the predilection of some analysts to model the financial markets using sophisticated mathematics, the markets are governed by behavioral science, not physical science.
Do not accept principal risk while investing short-term cash: the greedy effort to earn a few extra basis points of yield inevitably leads to the incurrence of greater risk, which increases the likelihood of losses and severe illiquidity at precisely the moment when cash is needed to cover expenses, to meet commitments, or to make compelling long-term investments.
The latest trade of a security creates a dangerous illusion that its market price approximates its true value. This mirage is especially dangerous during periods of market exuberance. Pricing the company as if it were a private co. is the proper valuation method. It is possible for market prices to be greatly skewed during ebulliant times and warrent higher degrees of skepticism.
A broad and flexible investment approach is essential during a crisis. Opportunities can be vast, ephemeral(temporary), and dispersed through various sectors and markets. Rigid silos can be an enormous disadvantage at such times.
Editor's Note - You need to have a list of stocks ready, with target cost price and/or PE ratios. Do not use current market multiples as benchmark, but rather median or pessimistic. You should have clarity on priority of alloation, right from sector to
You must buy on the way down. There is far more volume on the way down than on the way back up, and far less competition among buyers. It is almost always better to be too early than too late, but you must be prepared for price markdowns on what you buy.
Editor's Note - Effectively, don't make 100% of your allocation to a particular security in one go, always have earmarked cash to cost average. You'll never know when the price hits bottom tick
Financial innovation can be highly dangerous, though almost no one will tell you this. New financial products are typically created for sunny days and are almost never stress-tested for stormy weather. Securitization is an area that almost perfectly fits this description
Ratings agencies are highly conflicted, unimaginative dupes. They are blissfully unaware of adverse selection and moral hazard. Investors should never trust them.
Be sure that you are well compensated for illiquidity – especially illiquidity without control – because it can create particularly high opportunity costs.
At equal returns, public investments are generally superior to private investments not only because they are more liquid but also because amidst distress, public markets are more likely than private ones to offer attractive opportunities to average down.
Beware leverage in all its forms. Borrowers – individual, corporate, or government – should always match fund their liabilities against the duration of their assets. Borrowers must always remember that capital markets can be extremely fickle, and that it is never safe to assume a maturing loan can be rolled over. Even if you are unleveraged, the leverage employed by others can drive dramatic price and valuation swings; sudden unavailability of leverage in the economy may trigger an economic downturn.
Many LBOs are man-made disasters. When the price paid is excessive, the equity portion of an LBO is really an out-of-the-money call option
Financial stocks are particularly risky. Banking, in particular, is a highly lever- aged, extremely competitive, and challenging business.
Having clients with a long-term orientation is crucial. Nothing else is as important to the success of an investment firm.
When a government official says a problem has been “contained,” pay no attention
The government – the ultimate short-term-oriented player cannot withstand much pain in the economy or the financial markets. Bailouts and rescues are likely to occur, though not with sufficient predictability for investors to comfortably take advantage. The government will take enormous risks in such interventions, especially if the expenses can be conveniently deferred to the future. Some of the price-tag is in the form of backstops and guarantees, whose cost is almost impossible to determine
Almost no one will accept responsibility for his or her role in precipitating a crisis: not leveraged speculators, not willfully blind leaders of financial institutions, and certainly not regulators, government officials, ratings agencies or politicians.
Editor's Note - you're out on your own.
