Howard Marks (Trades, Portfolio) gave this great talk at Google about the origins and inspirations of his investment philosophy. The full video can be found here:
https://www.youtube.com/watch?v=6WroiiaVhGo
Below are the big ideas I jotted down and a detailed summary of the Q and A sesseion.
1. Origin and inspiration No.1 - Fooled by Randomness by Nassim Nicholas Taleb. The future consists of a range of possibilities with the outcome significantly influenced by randomness. You can’t tell form the outcome whether the decision was good or bad. This is very important but totally counterintuitive. In the real world with a lot of randomness, good decisions fail to work all the time and bad decisions work all the time. There are a lot of things that can happen and the most probable outcome is far from sure to happen. And even if the most probable outcome does happen, it fails to happen on time. So you can’t just survive on average, you have to survive on the bad days. Overpriced is not the same as going down tomorrow.
2. Origin and inspiration No.2 – John Kenneth Galbraith says forecast is futile. His efforts to be a superior investor are aided by macro forecast. Usually extrapolation works and usually the future looks like the most recent past, but you can’t make money out of it because it’s already priced in. Every once in a while, someone makes a radical forecast and he turns out to be right. But’s it’s very hard to make these radical forecasts and it’s very hard to make them correctly and consistently.
3. Origin and inspiration No.3 – Charles Ellis: If the game isn’t controllable, it’s better to work to avoid losers than to try for winners.
4. Origin and inspiration No.4- Mike Milken says holding survivors, and avoiding defaults is key in bond investing. If you buy below investment grade bonds and they survive, the surprise is likely to be on the upside. “If they survive” is the key assumption. The secret for success in investing is buying things for less than they worth and it has little to do with asset quality. What determines whether an investor is good or not is not what he buys, but what he pays for the assets he buys. It is very important to be in an area that the surprise is likely to be on the upside.
Six tenets of Oaktree’s investment philosophy:
· The primacy of risk control.
· Emphasis on consistency
· The importance of market inefficiency
· The benefit of specialization
· Macro-forecasting not critical to investing
· Disavowal of market timing
Oaktree’s Motto
· If we avoid the losers, the winners take care of themselves.
Marks’ 3 greatest adages:
· What the wise man does in the beginning, the fool does in the end.
· Never forget the six-foot-tall man who drowned crossing the stream that was five foot deep on average.
· Being too far ahead of your time is indistinguishable from being wrong.
Q and A Summary:
Question 1: Maybe humans are generally born to try to find winners, maybe that’s what we’ll always do wrong. But if everybody in the world is trying to avoid losers, maybe the wise investors now should shoot for the winners. How should we think about this self-balancing action?
Answer: I don’t think we need be worried about everybody becoming too prudent or too wise because we are talking about human nature here. Most people want to get rich fast. But you are right in that there are times when most people behave in a prudent and cautious manner. This is when there is a crash or crisis and the security prices are down significantly. This is also the time to turn aggressive and buy. Buffett says the less prudence with which others conduct their affairs, the greater the prudence with which we conduct our own affairs.
Question 2: You said that you don’t predict macro factors in your forecasting but actually macros can affect companies in many ways. Let’s say if interest rates are at 30%, 99% of the companies will be gone. How do you make an investment decision without making macro forecast?
Answer: This is one of the great traps. I say that we don’t invest on the basis of macro forecast, but you have to have an economic framework in mind when you predict the fortunes of individual companies. What we try to do is that it’s one thing to say that oil is at 50 and we are going to invest in this company because it will do fine if oil is at 50, survive if it goes to 30 and thrive if it goes to 70. But it’s another thing to say that oil is at 50, I think it’s going to 110 and I’m going to invest in this company which is going to be great if oil goes to 110 but bankrupt if oil stays at 50. So the question is how radical is your forecast? We try to anticipate a future that looks pretty much like the norm and make allowance for the things that other than the norm can happen.
Question 3: Do you think diversified index fund adequately protect the amateur investors from losers?
Answer: This is a great question. The role of index funds. A lot of people say I’m going to take a low risk approach and invest in an index fund and they are confused. But what the index fund does is that it eliminates the risk of underperforming the index but it also eliminates the possibility of outperforming the index. It doesn’t eliminate the investment risk in that you lose money every time the index fund is down. So it eliminates the benchmark rate but you retain the risk of the underlying assets.
Question 4: Do you think the average investor is doing anything different than 20 years ago?
Answer: There is a minor migration towards indexation. I’ll leave you with a question. Why can’t most people beat the market? Because the market is pretty efficient most of the time. That efficiency is the result of the concerted effort of everybody trying to find the bargains. What happens if they stop trying? So when the interest in active investment management declines because people give up on it, then prices resume their deviation from intrinsic value and it becomes possible to beat the market again. It’s really paradoxical but also counterintuitive. We are not close to that day yet but in theory, it could be some day in the future that there is so little interest in active investing that active investing starts working again.
Question 5: You talk about the gap between value and price but the other dimension is time. How do you estimate the amount of time it takes for that value gap to close?
Answer: You never can. This is another great question. On occasion there will be catalysts such as the pending maturity of the bond. Another catalyst today is the activist investors. But not that many companies will get activism to unlock the value. There are more catalysts in the fixed income world than in the equity world.
Question 6: What was it like when you raised fund for Oaktree?
Answer: By the time we started Oaktree it wasn’t that hard because we had a reputation. But you are right that when we started raising money for our strategies back in 1978, 90% of organizations had a rule against bond investment below investment grade. It was hard to overcome. You had to find a few people and say to them you should do this because nobody else is doing it so the prices are languishing. After it works for a while then the rest jumps on board. It’s interesting that in America people intuitively understand the concept of contrarianism but in many other cultures people will have a hard time understanding contrarianism. We made 23% a year for 28 years investing in distressed debt because it’s counterintuitive to invest in the debt of companies who have filed for bankruptcy and if buy them for what the assets are worth, you make money.
Question 7: The world of distressed debt investing is shut out to amateur investors. Are there any inefficiencies in the distressed debt world that small investors can take advantage of?
Answer: I think the small guys can even be active in the distressed debt world. He can’t get on the board of directors but he can still find superior values. The little guy has advantage as long as they are willing to stay small.
Question 8: Do you see any unhealthy trends in the valuation of the market today in the same way tech or housing was valued in the past?
Answer: Well it’s not as dramatic as the tech or the housing bubble. The market extends from the capital market line which starts with the risk free interest rate. Today that rate is zero. So the capital market line has a parallel downward shift. Before the crisis I had most of my money outside of Oaktree in Treasury and I was getting 6%. I had income and safety. Today you only can choose either one, but not both. Because the things that are highly safe pay no income. All around the investment world today people are chasing return from yield. They don’t like the low return of the safe investments so they go for the gusto mindlessly. So there’s racing to the bottom going on. So you have to be careful. Oaktree’s motto in the past three and half years has been move forward but with caution. Caution has to be a very important component of everybody’s action today.
