Saturday, May 30, 2009

Margin Of Safety: Chapter 14

In this the final chapter, Klarman discusses the various avenues individual investors may exercise in managing their investments. Klarman argues that investing properly is a full-time job, and that it would be very difficult for individual investors to manage their own money if they have other employment. This leaves them two options:

1) Mutual Funds
2) Money Managers

Open-end mutual funds offer the investor access to both liquidity and the ability to sell for net asset value. On the other hand, many funds are driven by relative performance and often grow to sizes where market-beating returns are not possible. Since managers are compensated by assets under management, they are also prone to follow short-term trends in order to avoid falling behind their peers in the near-term which could trigger a mass exodus of investors.

Closed-end funds do not offer investors ready liquidity at net asset value, however, they may be prudent investments when they trade at substantial discounts to their net asset values. Under the mutual fund banner, Klarman recommends the Mutual Series Funds and the Sequoia Fund.

In evaluating money managers, Klarman suggests individual investors raise the following questions which will help select a manager:
  • Do they manage their own money in parallel with their clients'?
  • Has the size of the portfolio grown exceedingly large?
  • What is the investment philosophy of the manager? Does it make long-term sense?
In evaluating investment results, investors must look deeper than a manager's historical investment returns. For example, any manager can generate phenomenal returns within a certain period of time. Are the returns described over at least one full business cycle? Also, were the returns generated using leverage, or were they generated despite the portfolio holding large amounts of cash (in which case risk is much lower)?

Klarman concludes the book by recommending that investors adopt a value-oriented investment approach. If they do not have the time to manage their money full-time, he recommends finding a trustworthy manager who employs this philosophy.

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