Oaktree Capital’s Howard Marks is one of the clearest thinkers on Wall Street. He has excoriated the Efficient market Theory in his regular memos, and has stressed the importance of second level thinking in his memos and book, “The Most Important Thing.” Marks typically releases about a half dozen missives per year, in addition to the firm’s investor letters. On June 20, his most recent memo came out, entitled “It’s All a Big Mistake.” You can get Marks’ memos going back to 1991 on Oaktree’s website. I encourage you to do so. They will make you a better investor.
Here are 12 takeaways from “It’s All a Big Mistake:”
1. Investors rarely discuss how mistakes are an important part of the investing process. All outperformance comes from taking advantage of others’ mistakes.
2. The Efficient Market Theory assumes things not practiced and contributes to mistakes being made. All investors are motivated to make money, but not all are intelligent, and barely any are objective and rational, especially during volatile times.
3. Along those same lines, Marks says that active investing should only be done if the investor believes that pricing mistakes occur. Secondarily, then, they also have to believe that they or their managers are capable of identifying and taking advantage of those pricing mistakes.
4. In a rational world, investors would buy underpriced assets and sell overpriced assets. This often doesn’t occur. Marks identifies four reasons why: Bias, capital rigidity, psychological excess, herd behavior. Those reasons don’t appear to be disappearing.
5. Oaktree’s managers, both in equities and distressed debt, make profiting from others’ mistakes a primary mission.
6. One way to do this is to better understand the business cycle. Investors tend to model flawed assumptions forward: Too optimistic in good times, and too pessimistic in bad times.
7. Profiting from others’ mistakes is more clear with distressed debt investing. Good distressed debt investors do well because they buy in after problems have come to light when debt trades at a significant discount. The assets become too cheap because the pendulum swings too far and investor psychology becomes too negative.
8. Despite more information and respect for behavioral finance, Marks thinks these opportunities will continue. The 2008 crisis provided some of the best opportunities in his career.
9. Marks said you need two things in investing: an opinion, and the probability that your opinion is correct. Mistakes often occur because people are too confident in their opinions. The largest mistakes occur when people are most confident in their opinion.
10. Marks discusses J.P. Morgan’s (JPM) hedging loss and identifies fours ways in which hedging can go wrong: Hedging with the wrong thing, hedging in the wrong amount, time risk, and insufficient liquidity. It’s not much different than other types of investing and sometimes can compound or create a loss, when the intention was to reduce the chances of it.
11. On the subject of risk control, he best describes it as a mindset, not an action.
12. There’s only one way to do better than the overall markets, and that’s to be good at identifying the mistakes. To outperform over the long term, investors have to profit from the mistakes of others while limiting their own. We would be well-served to remember that.
Disclosure: No positions.
Also check out:
- Howard Marks Undervalued Stocks
- Howard Marks Top Growth Companies
- Howard Marks High Yield stocks, and
- Stocks that Howard Marks keeps buying
About the author:
Steven KielSteven Kiel is the president and chief investment officer for Arquitos Capital Management, a Virginia-based investment management firm. He is a graduate of George Mason School of Law and a captain in the Army Reserves. He manages two spoke funds, The Freedom Fund, a value-oriented portfolio, and The Hayek Fund, a portfolio dedicated to free market principles. He can be contacted at email@example.com or through the firm's website at www.arquitos.com.