Seth Klarman: "Don't Be A Yield Pig"

Tyler Durden's picture

While we are told that history doesn't repeat, it seems Baupost's Seth Klarman is oddly prophetic in his rhyming reality vision of the markets from over 20 years ago. This brief 'warning' from one of the most independent-thinking asset managers of our time sum it up perfectly:  

"Caution has not been a profitable investment tactic for a long time now. I strongly believe it is about to make a comeback."


Don't Be A Yield Pig

Seth Klarman, Forbes 1992

I have thoroughly reviewed the U.S. Constitution (and the Bill of Rights for good measure) and, contrary to popular belief, there is no mention of a right for savers to earn high rates of interest on government-guaranteed principal. Nevertheless, it comes as a terrible shock to a lot of people that some current short-term interest rates are only one- third of early 1980s levels. The correct response to this shock can be crucial to your financial health.

There is always a tension in the financial markets between greed and fear. During the 1980s investor greed frequently got the better of fear, with the result that yield-seeking investors, known among Wall Streeters as "yield pigs," were susceptible to any investment product that promised a high current rate of return, the associated risk notwithstanding. Naturally, Wall Street responded by introducing a variety of new instruments--junk bonds, option-income mutual funds, international money market funds, preferred equity return certificates (PERCS)--anything that promised high current yields to investors.

Unless they are deluding themselves, investors understand that to achieve incremental yield above that available from U.S. government securities (the "risk-free" rate), they must incur increasing levels of principal risk.

There is no risk-free yield enhancement on Wall Street.

The painful result: Higher risk investments often erode one's capital and produce lower returns--the worst of all investment worlds. Higher-returns-for-higher-risks only applies on average and over time.

Investors must carefully examine alternative investments to assess when they are being adequately compensated for bearing risk and when they are not. When the yield differential between riskless and more risky securities is sufficiently large, even a conservative investor might reasonably venture beyond U.S. government securities. Thus, for example, it made sense to buy the Federated Department Stores senior-secured bonds, Harcourt Brace debentures and Manville preferred stock when panic hit the junk bond market in late 1990 and early 1991.

These days, however, I don't believe investors are being compensated sufficiently to venture beyond risk-free instruments. Yield spreads between government bonds and corporate credits have contracted sharply this year from levels a year ago. Some bonds of such highly leveraged issuers as Burlington Industries and Unisys now trade above par. A year ago they sold at substantial discounts from par.

Yield-starved investors also have been bidding up the bonds of such deeply troubled issuers as Chrysler, Stone Container and Marriott. The General Motors PERCS--a newly created instrument that only a yield pig could love--recently traded at a level so high that the common stock became a better buy no matter where GM common traded and no matter what action GM's board took on its dividend.

Some investors, desperate for better yield, have been reaching not for a new Wall Street product but for a very old one--common stocks. Finding the yield on cash unacceptably low, people who have invested conservatively for years are beginning to throw money into stocks, despite the obvious high valuation of the market, its historically low dividend yield and the serious economic downturn currently under way.

How many times have we heard in recent months that stocks have always outperformed bonds in the long run? Funny, but we never hear that argument at market bottoms. In my view, it is only a matter of time before today's yield pigs are led to the slaughterhouse. The shares of good companies and bad companies alike are vulnerable to sharp declines. Moreover, many junk bonds that have rallied will tumble again, and a number of today's investment-grade issues will be downgraded to junk status if the economy doesn't begin to recover soon.

What if you depend on a higher return on your money and can't live on the income from 4% interest rates? In that case, I would advise people to ignore conventional wisdom and consume some principal for a while, if necessary, rather than to reach for yield and incur the risk of major capital loss.

Stick to short-term U.S. government securities, federally insured bank CDs, or money market funds that hold only U.S. government securities. Better to end the year with 98% of your principal intact than to risk your capital roofing around for incremental yield that is simply not attainable.

I would also counsel conservative income-oriented investors to get out of most stocks and bonds now, while the getting is good. Caution has not been a profitable investment tactic for a long time now. I strongly believe it is about to make a comeback.

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TheEdelman's picture

Everyone get out of stocks and bonds, per seth, and get ready be workin weekends from here on out.

Thomas's picture

I am quite confident that retirees have gotten the memo to consume principal: what else could they do?

fonzannoon's picture

Thomas the majority of my new clients lately are 65 plus. They are going into stocks. MLP's etc. I have kept more money than usual in cash, and I am catching shit for it from them.


zjxn06's picture

Had dinner with Mom last night.  She's 82 years old and slowly dying of skin cancer and congestive heart failure.  She was feeling fine last night.

After dinner she asked me to look at something.  She shoves a Chase Bank (JP Morgue) account statement in front of my face and asks if it looks right.

I serve as her financial advior and executor of her estate.   Didn't even know she had this account.  

She had rolled over a CD paying zero interest and the bank thief rep had advised to her to put into a JPM bond fund to "get a better yield".

Since beginning of year bond fund had lost principal due to rising interest rates, but here is the kicker...

These guys had been consistently charging her $50 a month, yes, that's right $50 a MONTH, to "manage" her measley account.  Current balance $13,500. $600/year (4.4%) in management fees for the privelage of losing her hard earned money?  

I was livid and asked If she wanted me to call this asshat up and ask him why he was stealing my $82 year old mothers money.

She convinced me that she would do that herself.  Think she saw the anger in my eyes and was worried what I might do.  This won't make a difference in her short remaining life.

The boldness of these thieves is extraordinary.  


fonzannoon's picture


In what way was the $50 fee shown?

Did the rep purchase her the fund in class A shares? If so that fee would be a one time charge (still ridiculous in many ways). If it is a rolling $50/month charge, that makes no sense. I don't know of anyone who puts 13k into an advisory account and slaps a 4.4% fee on it.

I don't see how their compliance would let that through.

HedgeHammer's picture

But everyone's watching to see what you will do!

fonzannoon's picture


5 years of zirp and the advice now is to consume principal.

People watch every avenue of yield dissipate and when they reach for the one place left they are told they are being greedy.

Only in today's world.

NidStyles's picture

Risk-Free.. LMAO!

RockyRacoon's picture

Update:  For the two of you who care that is.  Kudlow still missing.  Now the time slot is called something else.  Weird thing is he left mid-show.  My guess is that he knew his days (hours) were numbered so he walked out to keep from breaking down on air.   But I always was the sentimental sort.

Inquiring minds wanna know.  I'm in the "Who Cares" camp.

kaiserhoff's picture

So does everyone else at CKGB lock arms, and walk out singing It's a long way to Tipperary, like the Mary Tyler Moore show?  That would be fun.  God I'm old to remember that.

BandGap's picture

You're not alone, I remeber her and Ted and Maury and Mr. Grant hitting the road.


RockyRacoon's picture

The MTM show closed in 1977.   Not that long ago.  I was 29 years old!

Kudblow was a sellout anyhow:

Maybe they'll let him keep his little radio gig.  I've never heard it.

Dagny Taggart's picture

Mary Tyler who? Jk, I saw reruns lol.

Say Rocky, that Kudlow fellow should be just fine. His books sold so well that only has one hardback copy left for $49.98 of his latest.


Jam Akin's picture

He must have had a Scientologist buying group working for him.

buzzsaw99's picture

Unimaginative. Uninformative. What is the author's thesis for the future? My advice:

Flip chinchilla pelts on ebay.

Garage sale junky

High quality munis

Oil leases

Hot dog stand

Recycle used vibrators

Man whore


After reading this piece it sounds like lay down and die is the advice.

TheEdelman's picture

"terrible shock to a lot of people that some current short-term interest rates are only one- third of early 1980s"...

If rates were a shock to people in 92...  what are rates doing to people now?  You may be right buzz... people are just waving the white xanax flag

One And Only's picture

Seth Klarman and Kyle Bass are both awesome. Period.

It's strange though in how their theories are so antithetical in foundation.

While the two countries I'm about to allude to are not identical by any means, the central banking policies are in fact identical.

Kyle Bass says shorts Japanese government debt because there is a bubble and "all the bond convexity in the world lays in Japan" Yield's there, he prognosticates, are unsustainable. The conclusion: Sell JGB's.

Seth Klarman says don't chase yield buy UST's (no need to elaborate, explanation is in this article).

However, both countries have a fractional reserve banking system where the central bank can buy government bonds to produce ultra low yield ad infinitum. Both countries share the same exact monetary policy: create money out of thin air to buy the obligations of immoral politicians (gvt bonds).

So if it can't work for Japan (Kyle's view) how can the same thing work for the US (Klarman's view)?

At the end of the day it's the same shit in another toilet.


Spitzer's picture

Bond bubble

The reality is that US debt has no yeild at all.

1eyedman's picture

Bass:   sell  longer dated JGBs

Klarman:  buy short term, near cash US govt bills

two very different vehicles

One And Only's picture

I guess I look at it differently.

Both governments have central banks that are buying their debt.

Long/Short of the yield curve doesn't matter, think see saw. The act of intervention through the printing of money effects ALL aspects of the bond market.

And at the end of the day...printing money to buy debt is printing money to buy debt, doesn't matter if it's one day or 10 years, or 50 years. If the conviction of a CB is to print money that's it. Seeing as we have crossed the rubicon into the zero bound realm I find it unlikely we ever leave (like Japan)

q99x2's picture

Take a prosac and BTFD

Spitzer's picture

international money market funds, preferred equity return certificates (PERCS)

PERCS ? Fuck yeah

MeelionDollerBogus's picture

don't say it so loud! The vicodin Viking, Rush Limbaugh, will sense a disturbance in the farce and come calling!

random shots's picture

I would also counsel conservative income-oriented investors to get out of most stocks and bonds now, while the getting is good.

Lets see how Klarman's call played out in the following three years:

S&P 500

1993: 10.08%

1994: 1.32%

1995: 37.58%

Barclays Aggregate U.S. Bond Index

1993: 9.75%

1994*: -2.92%

1995: 10.47%

*Worst year on record for intermediate-term bond market on record!




knukles's picture

a.k.a. not too fuckin' good

Diogenes's picture

Predictions are always dangerous, especially when they concern the future.

resurger's picture

Funny no mention of Gold!

But overall, good article.

zjxn06's picture

"Funny no mention of Gold!"

Latest Baupost SEC Filing:

21.7 million shares of NovaGold Resources

Klarman is second largest shareholder. Second only to..... drum roll please......John Paulsen.

BullyBearish's picture

Can't dispute history...for the last 4 years to make money in the market all one had to do is B T F D !!!  Is this the final capitulation/set up to get everyone "all in" before a huge crash or is this yet another continuation in Bernank's strategy to destroy all asset classes but equities in the hope of finally reaching escape velocity?

Big Ben's picture

Stick to short-term U.S. government securities, federally insured bank CDs, or money market funds that hold only U.S. government securities. Better to end the year with 98% of your principal intact than to risk your capital roofing around for incremental yield that is simply not attainable.

In 1992, the S&P was around 400 and the country was only 10 years into the great 30 year bond bull market. So, in retrospect, this probably wasn't the best advice for the time. Is it good advice now? I wish I knew! We shall see ... (But by then it will be too late.)



The Count's picture



robilla's picture

I'm long hookers and short dwarfs... Positive carry trade since the hookers can carry the dwarfs on the job

WTFUD's picture

fonz send me that 'spare' cash your 'oldin' onto and if i don't lose it all in the casino will pay you an interest rate of 15.6%.

fonzannoon's picture

I don't want to be greedy.

alamoillini's picture

Consider purchasing life insurance from a mutual life insurance company.

guaranteed return rate 2.75% tax free

non guaranteed rate 4.70% tax free

tax free withdrawls via policy loans

tax free dividends on whole life policies

tax free interest on universal policies

guarantee of protection of principal




My Days Are Getting Fewer's picture
I thank and applaud ZH for re-printing this 21 year old article.    I stopped trading three years ago and have parked my savings in bullion and a couple of gold miners.  Hopefully, my grandchildren will thank me for doing that.   


I have always under-spent my income and lived free of debt.  I continue to generate good income. Am sickened by zero interest on my fiat savings in US Dollars, but will not move one Dollar from the Vanguard Prime Portfolio.  The advice from Baupost is sound - if you need spending money - take it out of principal and preferably in cash.  Do not game the system.  Generate positive cash flow from the income sources you understand.  Your bullion will take care of itself.  And, when you feel cash heavy - like my mom said - the money is going burn a hole in your pocket - buy bullion and stuff it and re-accumulate surplus cash.
ShrNfr's picture

Yep out in 1992 got you where again? No thanks. I am not a bull on anything in general, but if I had done that I would be retiring on $1.98 a month from my IRA. You have to have two pots of money. One is for speculation right here, right now. The other is for keeps. When you make money in pot 1, you take some of it and put it into pot 2, but you always keep some in pot 1. If nothing else, you can go short on things using the pot 1 resources. Doing a barbell on risk keeps you from losing it all, and avoids overpaying for middle risk objects. They usually do not return enough to make them worth your while. Risk not thy whole wad, but keep some cloth around to ram down the barrel around the ball. You kill more and eat better.

Haloween1's picture

Why is this even here on ZH?  Klarman's article was published in 1992.  Maybe someone should here should go back and look at the charts. 

Anybody who went into stocks at the time of the article made out very well.  Those who bought the treasuries, not so much.

Why is ZH so adamant on spreading fear that they went back 20 years and dragged out an old article that didn't even have any relevance back then?  Sheesh!



Dubaibanker's picture

The US Treasury 10 year yield was 5.39% in Mar 1992 and today is at 2.56% which is a massive move.

A 30 year UST bond issued in 1992 is currently at 143% value so one can sell the USD 100 bond at USD 143 plus having earned a coupon of a ridiculous 7.625% every year ever since. Patience is indeed a virtue!

I am sure US Govt is very unhappy in paying this 7.625% rate (probably to the Chinese or Japanese) no wonder China and Japan keep smiling despite their massive debt because they are holders of these long term debt for decades now, but saying in 1992 that search for yield was not a good idea is not a good idea. I would give that even with hindsight no one would have known the problems over such a long time that rates COULD go to a low of 2.5% level on the 30 year UST either in 2008 or in 2012.

Many a times history rhymes but does not seem to be rhyming in 2013 with the ideas of 1992.

There may not be yield today and we are at a turning point in history with downgraded AAA's of Europe and America, currency wars being played out, huge unemployment everywhere, civil war and unrest in dozens of countries in Middle East, Latin America to Europe, de-globalization, insulation from European banks and US banks for rest of the world due to their lack of lending abilities and being thrown out for causing harm from Libor to Swiss tax evasion or incurring heavy losses and changing regulations, remarkably slow GDP growth worldwide for almost 5 years now despite rapidly growing global population, magnified losses due to leveraging for all and sundry, ageing populations in Europe and US which provided the fastest growth in history for the last few decades, failed EUR currency being kept artifically alive just like the zombie US banks being kept alive, extreme volatility in all asset classes ranging from real estate to bonds to stocks to gold/commodities to interest rates to FX, dilipidated infrastructure worldwide combined with rising pollution and traffic congestion and medical scares, things will get a lot worse in the days ahead.

Only one thing will play out in the days ahead which is insulation from each other and if countries are insulated then they may survive or not get impacted as much as they did in 2008 because many of the US banks and European banks have left the shores worldwide and all Govts are cautious of fund flows which they gladly used to accept just a few years ago and China being the smartest does not allow any US or European bank to integrate into their banking system or allow foreign Govts to preach them or let too much FDI or FII inflows and have major restraints on foreigners buying real estate or invest in their domestic stock and bond markets. If there is no hot money in China or smart countries then of course it cannot flow back in times of crisis which is what we saw in Cyprus and Dubai, for example. Only one country may learn from the mistakes of the global financial crisis because it has the money to afford the changes, and this is China, despite all its negative points. Others like India continue to ask for FDI or issue sovereign bonds for the first time due to desperate situation. Latin Americans may smarten up after the Snowden plane bringing down episode of the Bolivian Preseident (I mean wow!) and I really hope so for their sake. Russia seems to be smartening up very fast. In today's age the communists, for all their faults have one very good thing in their favour - which is fast decision making and quick implementation which democracies simply cannot have, despite Obama's autocratic moves. Future is not about terrorism, it is about protecting from financial terrorism!

Perhaps Klarman will be right this time when yields actually start rising which they most likely will from such centuries lows and will be proven right for the 1992 article, finally!

Rodders75's picture

Just before the biggest bull market in history. Nice one.