5 Investing Lessons From Seth Klarman

Value investors continually compare potential new investment with their current holdings in order to ensure that they own only the most undervalued opportunities available. Investors should never be afraid to reexamine current holdings as new opportunities appear, even if that means realising losses on the sale of current holdings.In other words, no investment should be considered sacred when a better one comes along.In a similar vein, nowhere does it say that investors should strive to make every last dollar of potential profit; consideration of risk must never take a backseat to return.

The cheapest security in an overvalued market may still be overvalued. You wouldn't want to settle for an investment offering a safe 10% return if you thought it very likely that another offering an equally safe 15% return would soon materialise.An investment must be purchased at a discount from underlying worth. This makes it a good absolute value. Being a good absolute value alone, however, is not sufficient for investors must choose only the best absolute values among those that are currently available. A stock trading at one-half of its underlying value may be attractive, but another trading at one-fourth of its worth is a better bargain. This dual discipline compounds the difficulty of the investment task for value investors compared with most others.

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.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.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.Price is perhaps the single most important criterion in sound investment decision making. Every security or asset is a "buy" at one price, a "hold" at a higher price, and a "sell" at some still higher price. Yet most investors prefer what is performing well to what has recently lagged, often regardless of price. They prefer full buildings and trophy properties to fixer-uppers that need to be filled, even though empty or unloved buildings may be the far more compelling, and even safer, investments.

When excesses such as lax lending standards become widespread and persist for some time, people are lulled into a false sense of security, creating an even more dangerous situation. These excesses will eventually end, triggering a crisis at least in proportion to the degree of the excesses. Correlations between asset classes may be surprisingly high when leverage rapidly unwinds.Most investors take comfort from calm, steadily rising markets; roiling markets can drive investor panic. But these conventional reactions are inverted. When all feels calm and prices surge, the markets may feel safe; but, in fact, they are dangerous because few investors are focusing on risk. When one feels in the pit of one's stomach the fear that accompanies plunging market prices, risk-taking becomes considerably less risky, because risk is often priced into an asset's lower market valuation.

During a 2010 interview, Klarman stated that he believed investing is the intersection of economics and psychology. "The economics – the valuation of the business — is not that hard. The psychology – how much do you buy, do you buy it at this price, do you wait for a lower price, what do you do when it looks like the world might end – those things are harder. Knowing whether you stand there, buy more, or something legitimately has gone wrong and you need to sell, those are harder things. That you learn with experience. You learn by having the right psychological makeup."Klarman has often stated that a key element in designing a sound investment approach is to consider the competitive landscape and the behavior of other market participants.When observing your competitors, your focus should be on their approach and process, not their results. Short-term performance envy causes many of the shortcomings that lock most investors into a perpetual cycle of underachievement. You should watch your competitors not out of jealousy, but out of respect, and focus your efforts not on replicating others' portfolios, but on looking for opportunities where they are not.