Billionaire Seth Klarman blames low rates and 'capitalist excess' for his fund's languishing returns - and says we've only seen the 'tip of the overvaluation iceberg'

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Seth Klarman, president and CEO of the The Baupost Group

• Billionaire Seth Klarman's annual letter to investors was wide-ranging, touching on topics including private equity's pile of unused money, Modern Monetary Theory, WeWork, and foreign policy in the Middle East.
• The 17-page letter seen by Business Insider revealed that the roughly $30 billion fund returned less than 10% in a year when the stock market surged by 30%. Klarman blamed value stocks' continued slump as well as a "few mistakes" that he didn't identify.
• Klarman is not questioning his belief in value investing, writing that "major
  mispricings are eventually corrected - the share price and value of a business tend to converge -
  because short-term illusions are pierced and enduring characteristics become more apparent."
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One of the world's most well-known value investors didn't see much upside from sticking to his guns in 2019.

Billionaire Seth Klarman, the founder of Boston-based Baupost Group, posted returns in the "high single-digit[s]" in 2019 while the broader stock market more than tripled that.

But the underperformance has not shaken the "Oracle of Boston." And that's even after Steve Mandel's Lone Pine Capital told investors late last year that value investing has been changed forever.

"Major mispricings are eventually corrected - the share price and value of a business tend to converge - because short-term illusions are pierced and enduring characteristics become more apparent," he wrote in a 17-page letter seen by Business Insider that touched on a wide range of topics including foreign policy, WeWork's ex-CEO Adam Neumann, and Modern Monetary Theory.

A Baupost spokesperson declined to comment on the contents of the letter.

The effects of low interest rates

In November, fellow hedge fund billionaire Ray Dalio argued at the Greenwich Economic Forum that low interest rates have allowed companies to sell "dreams instead of earnings."

Klarman went a step further, blaming low and negative interest rates for the widening inequality that has allowed populism to rise, and for the boom in private equity and venture capital money that fueled companies like WeWork.

He explicitly linked Neumann's $1.7 billion WeWork exit package as an "epitome of capitalist excess."

On unicorns in general though, he saw holes that are currently being filled by money that might not be around in an economic downturn. He named companies like Uber, Lyft, DoorDash, and Netflix specifically.

"Because of favorable terms offered to preferred shareholders, the common shares of many of these firms are overstated in value, sometimes dramatically so. A skeptic could make the case that this preferred-to-common adjustment is merely the tip of the overvaluation iceberg for these high-flying and often profitless upstarts," he wrote about unicorns that have been funded by venture capital.

Klarman is not only concerned about seemingly limitless money flying around the private sector; he called Modern Monetary Theory, an economic theory supported by people like Rep. Alexandria Ocasio-Cortez, "a new madness."

"Running massive budget deficits in a period of strong economic growth puts the U.S. on the road to MMT and money printing without end, in service of a permanent prosperity that has always eluded mankind. MMT, in the hands of astonishingly short-term oriented and self-serving politicians, would raise the risk of out of control inflation, the loss of public confidence in money and, indeed, in government itself, and potentially accelerate the unraveling of social cohesion," he wrote.

The Trump-'Big Bang Theory' analogy

Klarman appears to have been a fan - or at least caught a few episodes - of CBS' long running sitcom "The Big Bang Theory."

In the letter, he compared a constant target of his criticism, President Donald Trump, to an ongoing gag on the show, known as Anything Can Happen Thursday (in the show, Klarman explains, the characters decide to eat somewhere different on Thursday, when anything can happen.)

"'Anything can happen' is not limited to Thursdays, and the subject isn't dinner but democracy, prosperity, global alliances, societal institutions, and truth itself. These days, literally anything can happen in foreign policy, immigration policy, cabinet appointments, and White House staff turnover. One day, the president is distracted by the size of his crowds; another day, it's a debate over who said what about the path of a storm or the demand to acquire Greenland from Denmark," he wrote.

A longtime Republican donor before the Trump administration, Klarman donated heavily to Democrats in the 2018 elections. He still calls out Democrats in the letter, though, noting that "with Democrats and Republicans evidently focused largely on preventing each other from claiming victories or accomplishing anything, there is a ubiquitous sense that nothing can get done in Washington."

He blames presidential candidates Elizabeth Warren and Bernie Sanders for pulling the party too far too the left, calling proposals like a marginal tax rate of 70%, the Green New Deal, Medicare-for-All, and the "possible imposition of a wealth tax" impractical and unaffordable.

"The left's response to the extremism of Donald Trump may be an equal and opposite reaction of extremism, in the form of an aggressive attack on the corporate sector and the wealthy without concern for the inevitable implications on economic growth and job creation."

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