Billionaire investor Howard Marks (Trades, Portfolio) has published a handful of his famous investor memos over the past few months. In a time of extreme uncertainty, these memos have been a breath of fresh air for me.
Marks is one of Wall Street's most experienced investors in distressed securities. He's made a fortune being greedy when others are fearful. Thus, his advice for investing in uncertain times is highly welcome.
The future is uncertain
Marks' recent memos have all had one core message: the future is uncertain. No one knows how this crisis will end, or when the next one will begin. All we can do is plan for the worst and invest whenever a good opportunity presents itself.
Of course, this requires a certain level of predictive power. To find undervalued securities, investors need to be able to predict future cash flows, and that means predicting future trends. To stay ahead of the market, you need to know something the rest of the market does not, or be in a growth sector the rest of the market is missing.
This is the topic of Marks' latest memo. In the memo, he noted that "only above average forecasts" lead to "above average returns," but it's very hard to make these "above average forecasts" because everyone else is trying to do exactly the same.
He went on to note that one of the primary reasons why forecasts tend to be so bad is because "very few people are content to invest while practicing agnosticism with regard to the macro future." To put it another way, most analysts and investors' view of the future are based on their own biases.
Ignoring or denying biases can be "one of the biggest mistakes an investor can make," Marks went on to add. One of the most influential biases on investor sentiment is confirmation bias:
"Our biases may be insidious, but they are highly influential. When I read articles about how difficult it will be to provide adequate testing for covid-19 or to get support to small businesses, I'm pleased to see my wary views reinforced, and I find it easy to incorporate these things into my thinking. But when I hear about the benefits of reopening the economy or the possibility of herd immunity, I find it just as easy to come up with counter-arguments that leave my concerns undented. This is a clear example of "confirmation bias" at work."
As a reminder, confirmation bias is the desire for investors to seek out information that confirms their existing views rather than taking a balanced view of all available facts and arriving at a suitable conclusion.
Overcoming this bias isn't an easy process. It's not something you can switch on and off. However, it is much easier to control and understand if you understand what it does in the first place.
Overcoming the bias
Marks provides guidance on how investors can get around this problem in his memo, but to sum everything up, I will highlight the process Charlie Munger (Trades, Portfolio) uses to get around these problems, as described by value investor Mohnish Pabrai (Trades, Portfolio):
"The first hack is being aware. Just being aware of these facts is a huge advantage. So being aware of the fact that we have a lot of biases, and our mind can play games and tricks on us. Being aware of that and being rational. Charlie Munger (Trades, Portfolio) often says that he isn't successful because he's smart, he's successful because he's rational."
Taking this small first step is the easiest way to get around what could potentially be a huge issue for investors.
Disclosure: The author owns no share mentioned.
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