Speculation and inflation : Excerpts from Seth Klarman's latest annual letter

Billionaire investor Seth Klarman, who helms the Boston-based Baupost firm with assets worth $30 billion under management, in his annual letter to clients highlighted some of the market issues that investors should pay keen attention to in the times to come.

The hedge fund manager and value investing giant is popularly known as the "Oracle of Boston", due to his investing patterns mirroring that of Warren Buffett, who is also known as the "Oracle of Omaha".

Klarman noted the apparently deteriorating state of American democracy, stating that "Democracy is a precious gift that we have inherited from our forebearers. Unfortunately, it comes without operating instructions or a warranty".

"As with anything breakable, democracy must be handled with care. It's time to once again heed Benjamin Franklin's prescient warning about the government that the Founding Fathers were creating: 'A Republic if you can keep it.' An ever-more polarized America, incapable of peacefully bridging our divides, may someday cease to be a reliable destination for investment capital." he further continued.

Highlighting the risks of speculation and complacency to inflation and interest-rate hikes in his letter, he said, "We see today's market as characterized by stretched valuations, deep complacency, and a host of looming risks. Mounting inflation and the related possibility of materially higher interest rates are posing a real danger to financial markets."

"The buying frenzy of the past 12 years has lured many market participants into speculative holdings that someday will seem like roach motels, easier to get into than get out of. "

"Against a backdrop of relentless money printing, a very active Federal Reserve, and fiscal largesse, many investors have been lulled to sleep, unaware of and unfocused on risk. They are like the cat that didn't jump on the hot stove.", the billionaire investor observed about investor speculation.

While most of us may consider volatility to be our foe in the markets, Klarman stated that infact, volatility can become an investors friend. "Because it is a driver of opportunity creation, volatility should more properly be considered a value investor's best friend."

Alongside, the value investing giant also dished out some evergreen investing advice. As he said in his letter, "It only takes one moment of overconfidence, distraction, or sloppiness to undo a lifetime of painstaking compounding."

"We often have success searching through the 'abandoned property' bins of the market. It is said that bull markets always climb a 'wall of worry' as the cautious are left behind while the intrepid get ahead and the reckless lead the pack. But the opposite may also be true - bear markets must inevitably descend a mountain of overconfidence and hubris", he continued.

A vehement proponent of hedging, Klaren said that the importance of hedging is not to achieve gains, but rather to protect your existing assets. "It generally makes sense to insure your home against fire even though it probably won't burn down. No one reasonably laments having paid a modest insurance premium for a casualty that didn't occur", he wrote.