Seth Klarman's super-secretive hedge fund had its third losing year — here's what happened

Getty / Scott Olson

In 2015, The Baupost Group — the $27 billion Boston-based hedge fund — had its third losing year.

Baupost was founded by legendary value investor Seth Klarman, the author of "Margin of Safety."

The fund is known for its secrecy. Klarman doesn't make many public-speaking appearances, and the fund's investment letters rarely get out.

There is next to no information on the fund's website.

In the fund's year-end letter, seen by Business Insider, Klarman wrote that they were "disappointed to post a mid-single-digit decline."

The fund's public-investments portfolio fell 6.7% in 2015, while the fund's private investments gained 2.4%, according to a separate investor update seen by Business Insider.

Meanwhile, the average hedge fund fell 3.64% last year, according to data from Hedge Fund Research.

"2015 was a year of dodging relentlessly falling knives; upon deeper inspection, one superficially tempting investment after another turned out to be worse than they initially appeared. We avoided the great majority of these and were nicked by only a handful," Klarman wrote.

"In investing, however, there is no umpire calling balls and strikes, and in retrospect we could have been even more patient at the plate. What had, for many investors, been a growing pool of red ink during the year turned into a bloodbath by year-end. To repurpose Warren Buffett’s famous quote about managements and businesses, when a talented investment team confronts an exceptionally challenging market, sometimes the market wins (at least in the short run)."

Baupost, one of the world's most successful and secretive hedge funds, saw its portfolio in public equities mainly dragged down from the following investments:

• Cheniere Energy
• Micron Technology
• Keryx Biopharmaceuticals
• Antero Resources

In the other letter to investors, Baupost's head of public investments, Jim Mooney, explained what went wrong:

I believe it is best to think about our 2015 results in two parts: what we brought on ourselves and what resulted from the environment in which we operated. In the first category, we made some mistakes. I will describe the two largest. Our loss on Micron resulted from the fact that we remained overly optimistic about our long-term thesis after it should have become apparent that the company’s widening cost disadvantage compared to its largest competitor, Samsung Electronics, would result in lower than expected profit margins. It also should have been clearer to us that the company was more vulnerable to the decline in PC DRAM pricing than we had believed. By the time we decided to sell nearly all of our remaining position, the stock was lower – a frustrating coda to an otherwise tremendously successful investment that achieved total lifetime profitability of over $900M.

In the case of Keryx, we purchased our initial position at an average price of $14.50 per share based on what turned out to be an overestimation of initial prescriptions for Auryxia, the company’s approved drug to control phosphorous levels in dialysis patients. While we remain confident in the long-term potential of Auryxia, and, thereby, our investment in Keryx, the slower sales ramp through 2015 did have a modestly negative impact on our estimate of intrinsic value. The market, however, took a much harsher view and punished the stock, driving it down to almost 70% in less than three months from about $10 to almost $3 a share. Although this certainly was not good news for our mark-to-market P&L, we believe it was a significant overreaction, and we were able to take advantage of the opportunity by investing additional capital on a private basis at what we believe is an incredibly attractive valuation. This, of course, is a great illustration of the fact that even in circumstances when we reduce our own expectations, price declines can far exceed what we judge to be warranted.

With respect to the broader investing environment, the public markets of 2015 were difficult to navigate. Opportunities for significant gains were largely confined to a small number of broadly-loved (and loftily-valued) companies. Most portfolios without those names moved sideways, at best. Those with exposure to the energy sector performed far worse. Performance in energy names was, obviously, driven by a dramatic decline in commodity prices. Companies with direct commodity exposure, like Antero Resources, fell to levels that ascribed little or no worth to valuable non-producing acreage. Even Cheniere Energy, with limited exposure to oil and gas prices, was significantly penalized by this unforgiving market.

During 2015, Baupost spent $2.2 billion in its public-equity portfolio, adding to 23 of its already existing stock positions. The fund also initiated 22 new positions during the year.

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