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Getting Lucky - Oaktree's Howard Marks January Memo

January 16, 2014 | About:
CanadianValue

Canadian Value

106 followers

Sometimes these memos are inspired by a single event or just one thing I read.  This one – like my first memo 24 years ago – grew out of the juxtaposition of two observations.  I’ll introduce one here and the other on page seven.  Contrary to my wife Nancy’s observation that my memos are “all the same,” the subject here is one I’ve rarely touched on.

The Role of Luck

The first inspiration for this memo came in early November, when I picked up a copy of the Four Seasons Magazine in my hotel room in Riyadh, Saudi Arabia.  I happened to turn to an article entitled “In Defence of Luck” by Ed Smith.  It’s been in my Oaktree bag ever since.  In his two opening paragraphs, Smith presents a thesis for dismantling:

“Success is never accidental,” Twitter founder Jack Dorsey recently tweeted.  No accidents, just planning; no luck, only strategy; no randomness, just perfect logic.

It is a tempting executive summary for a seductive speech or article.  If there are no accidents, then winners are seen in an even better light.  Denying the existence of luck appeals to a fundamental human urge: to understand, and ultimately control, everything in our path.  Hence the popularity of the statement “You make your own luck.”

That’s all it took to get my juices flowing.  I – along with Smith – believe a great many things contribute to success.  Some are our own doing, while many others are beyond our control. There’s no doubt that hard work, planning and persistence are essential for repeated success.  These are among the contributors that Twitter’s Dorsey is talking about.  But even the hardest workers and best decision makers among us will fail to succeed consistently without luck.

What are the components of luck?  They range from accidents of birth and genetics, to chance meetings and fortuitous choices, and even to perhaps-random but certainly unforeseeable events that cause decisions to turn out right.

In discussing the existence and importance of luck, Smith cites the popular book Outliers by Malcolm Gladwell:

Attacking luck has never been more fashionable.  No matter how flimsy the science behind the theory, popularized by author Malcolm Gladwell, that success must follow from 10,000 hours of dedicated practice, it has hardened into folklore.

Outliers is best known for Gladwell’s observation that it’s this magic number of hours of practice that makes the difference for those who are most successful.  But that’s only part of Gladwell’s message, and people who think his book is all about hard work and practice miss the point.  Having set out the “10,000-hours” thesis, Gladwell largely stops talking about it and turns to spend much more time on something he calls “demographic luck.”  This is actually the antithesis of an insistence that hours of effort suffice.

Demographic Luck

Gladwell’s term for this key ingredient in success has a simpler everyday label: “being born at the right time and the right place.”  Gladwell’s examples are compelling:

  • By the time the first hockey tryouts take place for all the little Canadian boys born in a given calendar year, those born in January will be eleven months older – and thus much bigger and stronger and more coordinated – than those born in December.  They’re likely to be put on better teams, receive better coaching, and spend more time on the ice.  They’re more likely to get 10,000 hours of practice and – all other things equal – to have their skills honed and showcased.
  • When I went to college in the mid-sixties, we inputted computer projects via punch cards; they ran overnight; and we went back for our results the next morning.  But going to a private high school a few years later enabled Bill Gates (Trades, Portfolio) to enter his work via a time-sharing terminal connected directly to a central computer, and to see the results in real time.  Thus he could perform hundreds of iterations a week, not seven, and develop his skills and his ideas much faster.  In addition, the University of Washington was a short bus ride from his home, and his family’s contacts enabled him to use its computer lab.
  • When Joe Flom and his Jewish cohorts graduated from law school in the 1930s, there were no jobs for them with prestigious Wall Street law firms.  They formed their own firm, Skadden, Arps, Slate, Meagher and Flom, but their work was largely confined to matters the “white shoe” firms rejected as unseemly and disreputable.  Thus when proxy fights and hostile takeovers became commonplace in the 1970s and ’80s, Joe Flom had superior experience and became a leader in advising on them, earning multi-million dollar fees. 

It seems like more than a coincidence that not only was Bill Gates (Trades, Portfolio) born in 1955, but his Microsoft co-founder Paul Allen was born in 1953; Sun Microsystems founders Bill Joy and Scott McNealy were born in 1954; Steve Jobs and Eric Schmidt were born in 1955; and Steve Ballmer was born in 1956.  Ten years earlier and there would have been no remote computer terminals for them to work at in high school and college; ten years later and the kids born before them would have beat them to the “new, new thing.”

Likewise, the greatest pioneers of the M&A bar were born at the right time to benefit from the upsurge in corporate activities that the legal establishment had frowned upon: Joe Flom in 1923 and all four founders of Wachtell, Lipton, Rosen and Katz in 1930-31.

During the holidays, I enjoyed spending time with three legends of the pop music business: producer David Geffen, entertainment attorney Allen Grubman, and Robbie Robertson, leader of the group “The Band.”  I was struck by the fact that they were all born in the same year: 1943.  I came along three years later, and I remember my parents picking me up from summer camp in 1956 and telling me about a new singing sensation, Elvis Presley, and a new kind of music called rock and roll.  The three men listed above were born at the right time to become leaders of the newly minted rock and roll industry.  It’s a good thing they weren’t born a few decades later, since cheap downloads and file sharing have now decimated the profitability of the record business.

The bottom line is simple: it’s great to be in the vanguard of a new development.  Talent and hard work are essential, but there’s nothing like getting there early and being pushed ahead by the powerful trends in demographics and taste that follow.

Perhaps the ultimate description of demographic luck comes from Warren Buffett (Trades, Portfolio):

I’ve had it so good in this world, you know.  The odds were fifty-to-one against me being born in the United States in 1930.  I won the lottery the day I emerged from the womb by being in the United States instead of in some other country where my chances would have been way different.

Imagine there are two identical twins in the womb, both equally bright and energetic.  And the genie says to them, “One of you is going to be born in the United States, and one of you is going to be born in Bangladesh.  And if you wind up in Bangladesh, you will pay no taxes.  What percentage of your income would you bid to be the one that is born in the United States?”  It says something about the fact that society has something to do with your fate and not just your innate qualities.  The people who say, “I did it all myself,” and think of themselves as Horatio Alger – believe me, they’d bid more to be in the United States than in Bangladesh.  That’s the Ovarian Lottery.  (The Snowball, Alice Schroeder)

Buffett is insightful enough to realize – and secure enough to admit – that he isn’t solely responsible for his success.  What if he’d been born in Bangladesh instead of the U.S.?  Or a woman rather than a man in 1930, having much fewer opportunities?  Or in 1830 (when there would be no hedge fund industry for a century) or 2014 (when there are smart people crawling all over it)?  Or to different parents?  Or if he’d missed out on studying under Ben Graham at Columbia?  Or if he hadn’t partnered with Charlie Munger?

I’m impressed when people credit others – as well as luck – for the essential part they played in their accomplishments.  And I agree 100% with the following sentiment from Smith’s article:

Michael Young, the sociologist who coined the term “meritocracy,” described the danger of thinking that success must be deserved just because it has happened: “If meritocrats believe, as more and more of them are encouraged to, that their advancement comes from their own merits . . . they can be insufferably smug.”  (Emphasis added)

Did You Do It All Yourself?

Buffett’s mention of “people who say, ‘I did it all myself’ ” reminds me of one of President Obama’s reelection campaign speeches, which included a comment that became a lightning rod: “If you’ve got a business – you didn’t build that.  Somebody else made that happen.”

His remark serves quite poorly when taken on its own.  It suggests he thinks that there’s no such thing as individual success, only group accomplishments.  It denies the efficacy of hard work and grit.  In short, it reflects a very un-American view of success.

It’s hard to be sure that every sentence we speak or write can stand on its own.  When taken in context, Obama’s statement makes more sense:

If you were successful, somebody along the line gave you some help.  There was a great teacher somewhere in your life.  Somebody helped to create this unbelievable American system that we have that allowed you to thrive.  Somebody invested in roads and bridges. If you’ve got a business – you didn’t build that.  Somebody else made that happen.

Clearly Obama omitted a few key words from those two last sentences, perhaps assuming his listeners would carry them over from those that went before.  The addition of just four words (italicized below) would have made his message more palatable: “If you’ve got a business – you didn’t build that alone.  Somebody else provided assistance that made that happen.”

In other words, you were lucky enough to get help.  Weren’t we all?

Did I Do It All Myself?

You may think of me as intelligent, insightful and/or hard-working.  I hope you do.  But when I finished reading Outliers, I was moved to write down for my kids all the ways in which demographic luck contributed to my success.  To illustrate my point, I want to share the list with you:

  • First of all, it was great to be born in America at the very beginning of the “baby boom.”  Baby boomers – the generation born right after World War II – benefitted from the return of servicemen from the war; the ending of war-time limits on consumption; and explosive subsequent growth of the population, which fired strong economic growth.  I was conceived during the war and born just after it ended.  You couldn’t get much closer to the front of the line.
  • I was born to middle-class parents – members of the first generation in their families to be born in America – who encouraged me in education and work.  They made me the first member of our family to receive a college degree.
  • The timing of my birth enabled me to get a good, free education in the New York City public schools.  The schools benefitted from the presence of smart women teachers to whom corporate careers weren’t available, and who liked being on the same vacation schedule as their kids.
  • My high school guidance counselor said my grades weren’t good enough to get me into Wharton, but I was lucky to have had an accounting teacher whose letter of recommendation may have done the trick.  Or perhaps it was the college entrance exams or SATs, standardized tests that had been introduced shortly before to counter the elite universities’ bias against public-school kids. 
  • Regardless of what made it possible, it’s clear that attending Wharton taught me a lot, exposed me to finance (previously I had planned on a career in accounting) and burnished my resume.  Would my career, and thus my life, have been the same if I hadn’t gotten into Wharton and instead had attended my second-choice school, a large state university? 
  • When I went off to college, I’d never heard of something called an MBA.  But the existence of the Vietnam War provided an incentive to stay in school, and three years for law school seemed like too much, so business school it would be.  Turned down by Harvard because of my lack of work experience, I instead attended the University of Chicago, whose theoretical, quantitative approach provided the perfect complement to my pragmatic Wharton undergraduate education.
  • Just as I was lucky to be at the front of the line of baby boomers, my timing was fortuitous in attending Chicago.  I arrived on campus in 1967, just a few years after the new Chicago approach to finance had begun to be taught.  No more than a few hundred students could have beat me to the capital asset pricing model, modern portfolio theory, the efficient market hypothesis, the random walk, and the other components of today’s investment theory.
  • I’m not one of those investors who started reading prospectuses at age ten.  In fact, even as I approached graduation from Chicago in 1969, I was unsure of my career direction.  I accepted a permanent position in investment research at First National City Bank (the predecessor of Citibank), largely because I’d had a good summer job there a year earlier.  Ten years in equity analysis there, including three as director of research, provided an ideal foundation for my investment career.
  • And then, when a new chief investment officer wanted to make room for his own head of research in 1978, he asked me to start up funds in convertible bonds and – in the ultimate stroke of luck – the newly created field of high yield bonds.  How could anyone have been better positioned to participate in the financial developments of the last 35 years?
  • And of course, I was at my luckiest when I teamed up with my wonderful partners – Bruce Karsh, Sheldon Stone, Larry Keele and Richard Masson – between 1983 and 1988.  Bruce had the idea to organize a fund to invest in “distressed debt” at TCW, the first one from a mainstream financial institution.  And then the five of us left to start Oaktree in 1995.  The rest, as they say, is history.

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About the author:

Canadian Value
http://valueinvestorcanada.blogspot.com/

Rating: 4.1/5 (11 votes)

Comments

AlbertaSunwapta
AlbertaSunwapta - 6 months ago

Great memo.

 

This is worth watching - it's not long.
(Lewis discusses a fascinating cookie experiment near the end)

Princeton Baccalaureate 2012: Michael Lewis

https://www.youtube.com/watch?v=CiQ_T5C3hIM

 

 

Warren Buffett on the stock market.  Think of Buffett's article below when you think of demographic luck and the person retiring in the 1960s and cashing out of the market over the next 10 years...

 

http://money.cnn.com/magazines/fortune/fortune_archive/2001/12/10/314691/

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