Seth Klarman, one of the most respected value investing hedge fund managers in the industry, told his investors he is satisfied with the fund's market-lagging 2016 performance.
"Fortunately, Baupost was able to find pockets of opportunity in both periods across equity, debt, and private markets, even as we harvested gains in fully priced holdings, all the while maintaining significant hedges and healthy cash balances," Klarman wrote in the investor letter dated Jan. 20, a copy of which was obtained by CNBC. "Baupost posted high single-digit gains across all partnerships for the year ended Dec. 31."
The hedge fund underperformed the 12 percent total return last year. But Klarman insisted the fund did well by generating a decent profit while at the same time protecting against market volatility.
"It may have been a greater accomplishment for Baupost to earn a high single-digit net return with quite limited risk in 2016 than it was for us to have earned higher returns in prior years," he wrote.
Klarman cited the significant rise in hedge fund competition and assets. The alternative investment industry's assets under management have nearly tripled to $3 trillion in the last 11 years, he noted.
In addition "many prominent hedge fund managers posted particularly large" losses for the last two years. He may be referring to Bill Ackman's Pershing Square, which declined 13.5 percent in 2016 and lost 20.5 percent in 2015.
Another factor is simply valuations. With the market indexes near all-time highs, Klarman said it is more difficult to find cheap investments.
"Our strategy is to hunt for bargains, and we typically find more when the market is weak, fewer when it is strong," he commented.
The hedge fund manager is also wary of the potential downside of investing alongside President Donald Trump's economic agenda. He said macro-investing on the new administration's policies may not be a wise move.
"Many investors are now tempted to make top-down bets based on guessing where the Trump administration will take the economy," he wrote. "However, if you can see this, others can too, and maybe it's already reflected in securities prices. It's incredibly hard to develop an edge from such top-down viewpoints."
Instead, the fund is going to stick to its core investment strategy that has outperformed for more than three decades:
"At Baupost, we follow a value approach that seeks out undervalued investments with catalysts for value realization. We differ from other funds as a result of our steadfastly long-term, risk-averse orientation, very limited exposure to short selling, involvement in both public and private markets, willingness to hold cash in the absence of immediate opportunity, and 34-year record of strong performance. We refuse to enter Wall Street's ubiquitous short-term performance derby."
Klarman's fund has reportedly generated annual returns of 16.4 percent and $22.6 billion in net profit for his clients since inception through 2015. Baupost did not return a call and email for comment.
— CNBC's Michael Bloom contributed to this story.