In October 1991, an unknown hedge fund manager published a book. A tight 249 pages, Seth Klarman’s Margin of Safety was by all contemporary standards a commercial flop. His publisher, he said, “didn’t do a very good job. Didn’t advertise it. Editors kept getting fired—I don’t think because of me—and by the third editor we finished the book, and then it sold about 5,000 copies and it died out. It was dead. It died.”
Except that it didn’t.
As the 25th anniversary of the hardcover’s publishing approaches, few investing books are more coveted than Klarman’s. Of the 5,000 original copies, Amazon lists only 13 for sale. The cheapest version of the once-$25 book, in “acceptable” condition with only “minimal highlighting/markings,” is a relative bargain at $1,396.77. “Very good” copies run nearer $2,000. “New” copies—whatever that means for a book out of print since the twilight of the Cold War—go for $2,899.95. My copy—advertised as “used, good, book & dust jacket are in good condition” and shipped to my offices in New York City—cost $1,601.99.
Opening that package this past July, I found the book—my book—in seemingly pristine condition. The aforementioned dust jacket, a geometric mix of blue, gray, red, and white, was miraculously unblemished. The spine sat unbroken. Picking it up, I gingerly turned its pages. No dog ears marked its corners; in fact, there was no indication that it had ever been read.
And then I saw it. Blue Bic cursive, inside cover: S. Roy Malk—maybe?—e.
Who was S. Roy Malke, and why had he defiled a masterpiece?
This masterpiece starts slowly. In the annals of literature, Margin of Safety‘s opener—“Investors adopt many different approaches that offer little or no real prospect of long-term success and considerable chance of substantial economic loss”—will not rank highly. Nor will Seth Klarman’s invectives win him any popularity contests: The opening pages are punctuated with references to “where other investors go wrong,” “undisciplined investors,” and claims that “interplanetary visitors… would no doubt question the intelligence of the planet’s inhabitants”—the implication being that Seth, like a visiting alien, is questioning ours.
“I STARTED TO SEE EVERYTHING AS I IMAGINED SETH SEEING IT. WHAT IS A DUCK BREAST BUT THE PHYSICAL EMBODIMENT OF CALORIES? DOES TASTE HAVE VALUE? AM I SPECULATING IF I BUY A DUCK BREAST?”
Still, Klarman credits early those who came before him. “Value investing is not being discussed here for the first time,” he writes. The idea of a margin of safety, after all, belongs to Benjamin Graham and David Dodd, the founding fathers of value investing—a grand system of bargain shopping that has produced some of the wealthiest people on the planet, including Seth Klarman.
The essence of Graham and Dodd’s philosophy, laid out in their 1934 classic Security Analysis (cost: $17,000), is this: Price and value are very different things. Price is what someone is willing to pay; value is what something is actually worth. Investors should only buy individual stocks, bonds, or other assets when the price is significantly lower than the value. The difference is your margin of safety, and only when you have it can you adequately protect yourself from the value investing sin of losing money.
Seth Klarman took to this strategy at his “first real job” after graduating from Cornell University. Under the Mutual Share Company’s Max Heine—also a Graham disciple—he made his first value trade: buying into a liquidated parent company, Telecor, in order to cheaply acquire shares of its newly public Electro Rent unit. “My learning in the two years under Max and Mike [Price] probably eclipsed what I learned in the subsequent years at Harvard Business School,” he writes in Margin of Safety. Yet those two years at Harvard provided the singular opportunity of his lifetime. Instead of heading to Wall Street, Klarman so impressed his professors that four of them hired him to manage their personal money. The Baupost Group—Baupost being an amalgam of the professors’ last names—was born, with Klarman earning $35,000 to manage $27 million in value style. The year was 1982.
By 1991, Klarman managed $400 million and was ready to talk. “The idea of Margin of Safety came when a business school classmate called me up and said, ‘Hey Seth, Virginia Smith here, I’m working for HarperCollins… and they’ve asked me to find aspiring authors. Would you like to write a book on investing?’” Klarman told celebrity interviewer Charlie Rose in 2011. “And I said I’d think about that. So I took the chance and wrote the book.” Nothing much happened, and Klarman went back to his knitting. Through the 1990s and 2000s, Klarman’s fund grew to more than $25 billion, making Baupost among the largest in its class. Like many value investors but unlike the vast majority of hedge funds, he often sat on billions in cash, waiting for his margin of safety—all while returning nearly 20% a year since his business school graduation ceremony.
As Klarman and his investors got rich, something else was happening. Margin of Safety, long out of print, began to take on a life of its own. As Klarman says, the book was “starting to get a cult following.”
Value investors tend to view the world in binary terms: You’re one of them, or you’re not. To be one of them is to be an investor; everyone else, in their view, is speculating.
“Investors believe that over the long run security prices tend to reflect fundamental developments involving the underlying business,” Klarman writes in his opening chapter. Speculators, on the other hand, “buy and sell securities based on whether they believe those securities will next rise or fall in price.” To outsiders, this is a subtle difference. The first group is focused on the difference between price and value; the second, simply price. “Speculators are obsessed with prediction—guessing—the direction of stock prices,” he writes. “Every morning on cable television, every afternoon on the stock market report, every weekend in Barron’s, every week in dozens of market newsletters, and whenever business people get together, there is rampant conjecture on where the market is heading.” Like people buying sardines not to eat but simply to trade on to someone else, speculators are dependent on “the next greatest fool.” Eventually, he believes, the next greatest fool will be you.
Klarman also believes that the majority of those who work on Wall Street are mere speculators. (Jamie Dimon, CEO of JP Morgan and Klarman’s Harvard classmate, likely disagrees.) “What’s good for Wall Street is not necessarily good for investors,” Klarman writes. Its occupants are “plagued by conflicts of interest and a short-term orientation.” They’re “paid primarily for what they do, not how effectively they do it.” Investors, he warns, “must never forget that Wall Street has a strong bullish bias, which coincides with its self-interest.” And in one of many prescient remarks, he stresses that new financial products “in most cases… address only the needs of Wall Street, that is, the generation of fees and commissions.” Nearly 17 years ahead of the 2008 financial crisis, Klarman singles out the mortgage securitization market as ripe with conflict. Everything, he argues, must be taken “with a grain of salt.”
His condemnation spares almost no one, not even clients. The ascendant retirement and endowment funds that make up the investor base of most hedge funds—including Baupost, now an endowment favorite—have “developed in ways that are detrimental to the returns generated on the money under management. The great majority of institutional investors are plagued with a short-term, relative-performance orientation and lack of long-term perspective.” They are “dogs chasing their own tail.” If it “weren’t so horrifying,” he writes, “it might actually be humorous.”
Klarman seems unable to hold his pen or tongue. A sampling of his targets: Stock brokers, investment consultants, the US Securities and Exchange Commission, the Federal Reserve, crowd psychology, academics who “are so entrenched in their theories that they cannot accept value investing works,” leveraged buyouts, the “entire venture capital universe,” the “simplistic notion” of portfolio insurance, insurance companies, junk bonds, Michael Milken, EBITDA, tactical asset allocation, the hugely common and “dangerously flawed” belief in indexing, the theoretical underpinnings of modern finance that are “at best silly and at worst quite hazardous,” the “frenetic lunacy” that is “ubiquitous cable television coverage of the stock market,” as well as “sound-bite culture” and the “hysterical tenor” of channels like CNBC where “a commentator with a crazed persona [can] become a celebrity whose pronouncements regularly move markets,” famed private equity investors Kohlberg Kravis Roberts, hedge funds that unlike Klarman “make investments based on macroeconomic assessments,” and value “pretenders” who masquerade as “true value investors” but are actually “charlatans who violate the conservative dictates” of his tribe. Even Warren Buffett—is nothing sacred?—attracts Klarman’s shade for his near-heretical willingness to recognize the value of intangible assets such as “soft-drink formulas.”
Needless to say, Seth Klarman—at least in writing—can be a bit of a buzzkill.
By page 114, I was having value dreams. The first was about Chief Investment Officer itself. If liquidated, what would it be worth? We don’t own many tangible assets. Seth would be unimpressed.
I started to see everything as I imagined Seth seeing it. What is a duck breast but the physical embodiment of calories? Does taste have value? Am I speculating if I buy a duck breast? Perhaps—but the next greater fools are my tongue and stomach, and I am fine with that. I began to look scornfully at everyday items. That imported German car? No margin of safety. The townhouse on the corner? Those bricks and mortar don’t nearly add to $15 million. Items of fashion became focal points of contempt. Everyday purchases became difficult to justify. Rabbit holes, it turns out, are dark places.
I needed a break from Klarman, or at least someone to commiserate with. Perhaps S. Roy Malke could provide a diversion. Malke himself probably hadn’t sold me the book. A “Ron at rrsbooks” had been the seller–a name tantalizingly close to but probably not actually Roy, but perhaps Ron remembered from whom he’d bought it. I wrote Ron.
“I bought the book at an estate sale. Thank you for your order,” he replied.
Could he tell me whose estate sale? I crossed my fingers that it wasn’t Malke’s.
“I’m sorry I can’t remember the specific sale,” he wrote back. “I attend several weekly.”
Could he at least tell me where he was based?
“Southwest Florida.”
The staccato conversation, and trail, ended there.
Art by Kevin Hong
The second half of Margin of Safety is where Seth Klarman nerds out. It’s also where the reader must decide whether or not to join what is perhaps the world’s most nonthreatening and lucrative cult.
‘Cult,’ for its negative overtones, is simply a small group bound by a unique set of beliefs that outsiders regard as strange. You may already be a member. The cult of value has quietly permeated modern culture—nowhere more so than in American sports.
Most people know value investing through baseball players, not stocks and bonds. If you’ve paid any attention to the sport in the last 15 years (or read Michael Lewis’ Moneyball), you’ve witnessed the secular shift from instinct to analytics. Pioneered by the Oakland Athletics, this system seeks to take advantage of the margin of safety between what teams pay a player and how many games he can help them win. It was originally a controversial approach, scorned by traditionalists who felt they knew better. Now, few teams in any major sport league would proclaim anything but absolute allegiance to data and deals over old-fashioned hunches. Which, of course, can quickly shrink the margin of safety in their investments.
The same has happened in investing since Klarman wrote his book, not least because so many people have read it. “The value-investing community is no longer the small group of adherents that it was several decades ago,” he wrote in a 2009 introduction to a new edition of Security Analysis, one of the only other major pieces of writing he’s produced outside of regular—and well-guarded—letters to investors. “Competition can have a powerful corrective effect.” Yet he still sees opportunities: There remain suckers aplenty (“market participants with little or no value orientation”); most money managers still invest on an “absurdly short investment horizon”; and there exists today a “broader and more diverse investment landscape” in which value investors can ply their trade. Also, he notes, “human nature never changes.”
Despite being agnostic of how broader markets move, value investors often view roaring bull markets as unfavorable. Klarman himself may have mistimed markets—although judging broad market gyrations is far from his specialty. “I am more worried about the world, more broadly, than I ever have been in my career,” he told the Wall Street Journal in a rare 2010 interview. The record run-up in equity markets since then doesn’t mean he’s wrong—it just means that he will have had to be very patient for any investments based on this premise to pan out. As he writes in his introduction to Security Analysis, “when bargains are scarce, value investors must be patient.”
Value investing, like cult following, is a lonely endeavor. As one adherent told me: “You either take to it, or you don’t.”
I didn’t. Or at least, by the time I finished the book, I suspected that I lacked a true believer’s passion. Price aside, what separated Margin of Safety from the literally thousands of books proclaiming surefire financial success? Was this actually a masterpiece?
In 1991, James Grant thought so. He still does. Himself the commander of a cult-like following (he’s been publishing Grant’s Interest Rate Observer since 1983), Grant’s testimonial appears prominently on Margin of Safety‘s cover: “Seth Klarman is a brilliant investor who has written a brilliant investing book,” his blurb states. “Consider it a gift to your net worth.”
“I stand by my blurb,” he proclaimed when I spoke to him in late August. I had asked him to re-read his copy—“it’s virginal, well read but not well worn”—and tell me his thoughts nearly 25 years after he first set eyes on it.
“The book is an act of benevolence, of altruism,” he said. “He set out to tell the reader how Wall Street plays the game, even though it was conceivable that he’d be taking a little off his own edge.” Whether it was a gift to anyone’s net worth is another story.
“No. He’s not sentimental, and I’m not sure he’s a book collector. I’m sure he’d just read it online.”
“What struck me in re-reading the book was the edge of anger and irritation Seth felt for Wall Street and what it does to people’s net worths—and how little Wall Street and human beings have changed,” he said. “We haven’t changed our proclivities for buying high and selling low, for not doing our work, for following the herd and seeking the company of momentum. The human foibles that seem to make investing a losing—if entertaining—proposition seem to be just as prevalent as when Seth took up his lance to attack them. I think even he would concede that human nature has not improved in 25 years.”
Yet his “precepts of value investing have stood up well.” Klarman’s “bloody independence of judgment, of mind, and his utter indifference to the casual opinion of people” have proven enduring, as have his predictions. “To give just one of many possible examples, he lamented the yield piggery of the 1980s—well my goodness, what have the 2000s been but one long yield grope?”
“It’s in the same league as The Intelligent Investor,” Grant believes, referencing Benjamin Graham’s less-technical version of Security Analysis first published in 1949 (price: $7,000). “Graham was an amateur playwright and someone who took great pains and pride in his prose style, but there is a little bit of mystery around his investing record. Not Seth’s. Seth is a more accomplished investor, Graham a more accomplished diarist—but Margin of Safety stands up very well.”
Grant only wishes he had held onto more copies. “I used to have cartons of them. In connection to the promotion of the book, I bought a couple hundred for one of our conferences. If only I’d had the foresight [not to give them away], I’d be in Florida leading the good life.”
Grant has company in his adoration. During a conversation with Greg Dowling, an investment consultant at Cincinnati-based Fund Evaluation Group, I casually mentioned that I was reading Margin of Safety.
He paused.
“I first encountered it in 2004 or 2005,” he said. “One of our clients had this insanely oversized investment in a firm called Baupost, which I hadn’t heard of. We’re talking like 40% of the portfolio, which is very unusual. There was this mystique, and there were these letters that got passed around the office written by this man named Klarman, and I found out he had a book. One of our analysts’ dad had the book, and he made a bunch of copies. We had it bound, and handed it out. I still have it.”
More than Grant—and certainly more than Klarman—Dowling believes in an expansive definition of value investing. “This us-versus-them thing, I think it’s overblown,” he said. “Value investing: That moniker is a pretty large tent. You don’t have to be a deep value person to fit. Think of Bridgewater, one of the best fundamental research shops in the world”—and the world’s largest hedge fund, run by Ray Dalio. “They are looking for fundamental truth. They are looking for things to revert back to their mean. To me, that’s not inconsistent with value investing. Their approach, which focuses on a bottom-up analysis of the whole economy, is totally different than what Seth does, but it’s not inconsistent. They both do a lot of research on fundamentals. Neither is just rolling the dice.”
“The ideas in his book are timeless,” he added. “I don’t know if they’re groundbreaking, but it’s a really good sanity check.”
Seth Klarman probably doesn’t care if his work enters the canon alongside Security Analysis and The Intelligent Investor. That my $1,602 copy, originally sold for $25, has a better annual return (19%) since publication than Baupost (approximately 17%) is also of little consequence. True to his philosophy, he would only want to know its value–and whether it was a good investment.
As a current owner of the book, there is cause for concern.
A book, at its most basic, is dead wood and ink. Its value rests entirely with understanding the words printed on the page—an intangible asset if there ever was one. “The problem with intangible assets, I believe, is that they hold little or no margin of safety,” Klarman writes in Margin of Safety as he subtly criticized Warren Buffett for accepting intangible assets in his calculations. “The most valuable assets of Dr. Pepper/7-Up, Inc., by way of example, are the formulas that give those drinks their distinctive flavors. If something goes wrong—tastes change or a competitor makes inroads—the margin of safety is quite low.”
His words in his introduction to Security Analysis are even more explicit. “Some people have attempted to expand the definition of investing to include any asset that… appreciate[s] in price: art, rare stamps, or a wine collection,” he writes. “Because these items have no ascertainable fundamental value, generate no present or future cash flow, and depend for their value entirely on buyer whim, they clearly constitute speculations rather than investments.” Such collectibles, he believes, are “not eating sardines,” but “trading sardines.” Seth Klarman does not trade sardines.
Grant, who has known Klarman for decades, is unequivocal. “No. He’s not sentimental, and I’m not sure he’s a book collector. I’m sure he’d just read it online.”
Which raises the question: With digital bootlegs freely available, why would a book that explicitly denounces collectibles become such an in-demand collectible?
If Seth Klarman would not buy his own book, why did S. Roy Malke? I was increasingly obsessed with the identity, and motivation, of my copy’s previous owner. There seemed no hope, until one victim of that obsession saved me.
“That’s not ‘Roy Malke’,” my managing editor said. “That’s ‘Ray Miller’.”
She was right. The ‘o’ was quite obviously an ‘a’; a small impression far above the second ‘a’ suggested instead an ‘i’; the common end-of-autograph flourish masked a final ‘r’. The rest quickly fell into place. The signature wasn’t that of a S. Roy Malke. It was S. Ray Miller.
Ray Miller is an excruciatingly common name. S. Ray Miller is not. There is in fact just one prominent S. Ray Miller in the internet age: Simon Ray Miller Jr., formerly of Elkhart, Indiana. The founder of Atlas Steel Rule Die (“the largest manufacturer of cutting dies in the US”), Miller was also a collector of valuables. Upon retirement, he started the S. Ray Miller Museum, which housed 39 antique automobiles. He had also moved to Deerfield Beach—just south of Boca Raton, in southwest Florida.
This information was easily acquired because S. Ray Miller is, as I had feared, dead. He died in 2003 (“at 2:55 pm Monday, Aug. 11”), according to his obituary. Published in The Elkhart Truth, it provided a worryingly fragile lineage: “one daughter, Cynthia Gierkey of France.”
I should have stopped there. Miller was a collector of cars; it was completely logical that he would collect other things, including rare books. I had my answer.
I did not stop there. Why would someone who understood the archaic world of collecting intentionally devalue a collectable by signing it?
A search for “Cynthia Gierkey of France” yielded a promising lead: a Provence rental property ad, written in perfect English. Contact details: a phone number for a Cynthia Gierkey. I was relieved when no one answered.
I should have stopped there. I did not. Below the rental property in the search results was another death notice: Norman W. Gierkey of Niles, Michigan, who died on January 2, 2015. According to his obituary—also in The Elkhart Truth—he had moved in 1995 to “Indiana… where he met, and married, Cynthia Miller-Gierkey. Together they traveled the world. After Norm retired… he and Cynthia built a home and moved to La Garde Freinet, France. They returned [to the US] to enjoy their families and the growing number of grandchildren.”
Cynthia Gierkey, location unknown, is hard to find. Cynthia Gierkey of Niles, Michigan, is much easier—and is an adorably pleasant woman. Initially hesitant (“how did you locate my email address?”), she soon warmed to the topic of her father and why he may have owned Margin of Safety. He was, she wrote, simply “a very curious man. He sold his business in Elkhart, and was probably just interested to learn more about investing.”
But I had come too far to leave unsure. Did she happen to have a copy of her father’s signature? No, she said. But she did possess something else: “I was an excellent student and have photographic memory,” she wrote. “At a young age I developed a game of copying things from memory I had seen prior.” Minutes later, a daughter’s forgery of her father’s signature arrived in my inbox.