At TAMIM, we believe investing is as much about managing risk as it is about pursuing returns. In fact, one of the most critical frameworks in our investment process is a concept introduced nearly a century ago by Benjamin Graham and deeply embedded in the work of Seth Klarman: margin of safety.

In a world that often prioritises speed, speculation, and sentiment, Klarman’s Margin of Safety reminds us that true long-term outperformance is built on prudence, patience, and protection of capital.

This is not simply theory. It’s a blueprint for navigating both opportunity and uncertainty, especially relevant for Australian investors navigating today’s complex environment in equities, credit, and property.

The Core Principle: First, Do No Harm

Klarman’s fundamental belief is that successful investing starts with avoiding permanent loss. Returns matter, but only if you protect the capital base they are built on.

To illustrate this: an investor who compounds at 16% annually for 10 years will outperform someone who compounds at 20% for 9 years and then suffers a 15% loss in year 10. The compounding effect is powerful, but it is also fragile.

This is why TAMIM places such a strong emphasis on downside risk management. Before we assess upside, we consider what can go wrong and how we would be positioned if it does.

Investing vs Speculating: Know the Difference

Klarman distinguishes clearly between investing and speculation. Investors focus on cash flows, valuations, and business fundamentals. Speculators focus on price movements, narratives, and momentum.

The rise of retail trading, short-termism, and thematic ETFs has made speculation more accessible but also more dangerous. As Klarman puts it, many market participants are not buying assets because they are undervalued, but because they believe someone else will pay more for them later.

At TAMIM, we invest in businesses, not stories. We seek to understand what a company is worth, not what the market might temporarily believe.

Absolute Returns Over Relative Games

Another key theme in Margin of Safety is the importance of absolute performance. Many managers obsess over relative returns, “Did we beat the ASX200?”, even if their portfolio delivered a negative return.

We take a different view. The goal is not to beat a benchmark. The goal is to preserve and compound capital in real terms.

This philosophy requires discipline. There will be times when markets rally on speculative sentiment, and we may hold elevated cash positions or avoid popular sectors. But over a full cycle, this mindset protects capital and positions us for better long-term outcomes.

Cash is Not Failure Rather It’s Optionality

Klarman is unambiguous: when no attractive investments are available, the rational choice is to hold cash. Cash provides flexibility, liquidity, and the ability to act when mispricing occurs.

Buffett does the same. Holding cash is not a sign of indecision. It is a conscious choice to wait until the market offers a sufficient margin of safety. When opportunities do arise as they often do in moments of dislocation, cash is what allows an investor to act with confidence.

Beware of Accounting Shortcuts

One of the more technical but important observations in Klarman’s work is the caution against relying on accounting shortcuts like EBITDA as a measure of profitability.

Depreciation and amortisation are real economic costs, especially in capital-intensive businesses. Ignoring them can distort true cash flow and lead to overvaluation.

At TAMIM, we focus on free cash flow, return on invested capital, and underlying business quality, not just headline earnings or cosmetic multiples.

Valuation: Three Practical Tools

Klarman outlines three main valuation methods that remain essential today:

1. Net Present Value (NPV): Used when future cash flows are reasonably predictable.
2. Liquidation Value: A conservative assessment based on tangible assets, useful in distressed or asset-heavy companies.
3. Market Comparables: Useful for understanding how peers are valued, though to be used cautiously.

We use all three, depending on the business in question, and always with a focus on conservatism. Forecasting is inherently uncertain which is why we prefer to anchor our assessments in reality, not optimism.

Quality Over Quantity: Concentrated Portfolios

Klarman advocates for focus. You do not need 50 or 100 positions to be diversified. Twenty to thirty well-understood investments diversified across sectors, geographies, and risk factors can be sufficient.

At TAMIM, we construct concentrated portfolios by design. We believe true conviction comes from deep understanding. Over-diversification, in contrast, can dilute returns and hinder active management.

Market Inefficiencies Are Real

While markets are often efficient, they are not always so. Klarman identifies several areas where disciplined investors can find mispricing:

• Forced selling (e.g. spinoffs, index exclusions)
  
• Illiquidity or low coverage (e.g. small caps)
  
• Temporary disruptions (e.g. macro shocks or earnings misses)
  
• Distressed assets (e.g. corporate restructurings or bankruptcies)

These are often areas where short-term investors, index funds, or institutional mandates cannot or will not participate. That creates opportunities for long-term investors with patient capital.

Portfolio Management: A Disciplined Framework

Klarman’s approach to buying and selling is methodical:

• Buy when the margin of safety is wide, not based on forecast optimism.
  
• Sell when the valuation converges with intrinsic value or the investment thesis changes.
  
• Hold cash when valuations are stretched or opportunities are limited.

At TAMIM, we follow a similar discipline. Every holding is reviewed continuously, not just on performance, but on the validity of the thesis and valuation. And we are comfortable holding elevated levels of cash or reducing position sizes when required.

Investor Psychology: The Hardest Part

Much of what Klarman outlines requires not just analysis, but temperament. The ability to be patient, to resist herd behaviour, and to act decisively when markets are panicked.

This is where many investors struggle, not because they lack information, but because they are not emotionally prepared for volatility.

Our role at TAMIM is not only to construct portfolios, but to remain clear-headed and calm when others are not. Margin of safety is a mindset as much as a metric.

TAMIM Takeaway

Seth Klarman’s Margin of Safety is not a trendy framework. It is a timeless one.

In a world where short-termism dominates and risk is often mispriced, the principles of capital preservation, valuation discipline, and thoughtful portfolio construction remain as relevant as ever.

At TAMIM, we adhere to these principles, not because they are fashionable, but because they work. Through every investment cycle, our goal is the same: to protect capital first, and grow it responsibly over time.

If you’d like to learn more about how we apply these principles across equities, credit, and property or how they inform our current asset allocation, we’re always happy to engage.