Howard Marks (Trades, Portfolio)' regular memos should be required reading for every investor. Over the years, he has delivered some incredibly insightful comments about all areas of investing, but mainly value investing as this is where Oaktree specializes.
Marks has been managing money for decades, and his memos are a record of his views during multiple market environments. Of interest are Marks’ commentaries around the dot-com and 2007 bubbles.
Learning from the past
It is easy to look back at events like the dot-com crash and financial crisis and declare the risks were clear from the start and it should have been easy to get out before the top. Without the benefit of hindsight, however, trying to predict market tops or bottoms is almost impossible. This is where the commentary from Marks is invaluable. His memos published during the run-up and after these events help readers develop (or they have certainly helped me) the second-level thinking required to be able to question the market’s moves and current investor sentiment.
In April 2007, just when the market was reaching its pre-crisis peak, Marks penned a memo to Oaktree Clients titled “Everyone Knows.” The subject of the memo was valuation and the critical thinking required to succeed in investing by only acquiring the market’s cheapest stocks. Marks makes it clear from the beginning that (despite the level of the market at the time) valuation should always be the investors’ first area of analysis:
“There is no investment idea so good that it can’t be ruined by a too high entry price. And there are few things that can’t be attractive investments if bought at a low-enough price. When investors forget these simple truths, they tend to get into trouble.”
He goes on to note:
“Large amounts of money (and by that I mean unusual returns, or unusual risk-adjusted returns) aren’t made by buying what everybody likes. They’re made by buying what everybody underestimates.”
To be able to buy what everyone underestimates, the investor must be willing to go against the crowd, a particularly lonely position:
“It should be clear from the first element that the process has to begin with investors who are unusually perceptive, unconventional, iconoclastic or early. That’s why successful investors are said to spend a lot of their time being lonely.”
Some investors might balk at this approach because they believe if you are too early, the risk is high. The reality could not be further from the truth. This is the herd’s mentality to risk and the herd is wrong:
“'I wouldn’t buy that at any price – everyone knows it’s too risky.' That’s something I’ve heard a lot in my life, and it has given rise to the best investment opportunities I’ve participated in. In fact, to an extent, it has provided the foundation for my career. In the 1970s and 1980s, insistence on avoiding non-investment grade bonds kept them out of most institutional portfolios and therefore cheap. Ditto for the debt of bankrupt companies: what could be riskier?
The truth is, the herd is wrong about risk at least as often as it is about return. A broad consensus that something’s too hot to handle is almost always wrong. Usually it’s the opposite that’s true.”
The bottom line is what “everyone knows” is not at all helpful in investing. In times of market exuberance, what “everyone knows” can be more of a hindrance than anything else. If everyone knows, you have got to work hard to find out something they do not know or understand and uncover the opportunities where there is scope to achieve an above-average return.
“The bottom line is that what 'everyone knows' isn’t at all helpful in investing. What everyone knows is bound to already be reflected in the price, meaning a buyer is paying for whatever it is that everyone thinks they know. Thus, if the consensus view is right, it’s likely to produce an average return. And if the consensus turns out to be too rosy, everyone’s likely to suffer together. That’s why I remind people that merely being right doesn’t lead to superior investment results. If you’re right and the consensus is right, your return won’t be anything to write home about. To be superior, you have to be more right than the average investor.”
Being “more right” usually means doing something nobody else is or buying something the rest of the market is avoiding.
