Howard Marks: The Opportunity for Value Investors

Latest memo contains an interesting takeaway

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Jul 05, 2018
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Howard Marks (Trades, Portfolio)'s memos are always full of insightful comments and food for thought. His latest offering is no exception.

The memo dated June 18 tackles the issue of passive investing and automated quant investing. When I say tackles the issue, the memo considers the pros and cons of these developments, and how investors can profit in the current environment.

Increasing competition

While the whole memo is fascinating, the last paragraph has really stuck with me:

"Finally, I view this situation kind of like index investing: if the day comes when intelligent machines run all the money, won't they all (a) see everything the same, (b) reach the same conclusions, (c) design the same portfolio, and thus (d) perform the same? What, then, will be the route to superior performance?"

This was interesting because it says a lot about Wall Street today. Even without computers, Wall Street is populated by some of the brightest minds in the world, all of whom are fighting each other to achieve the best investment results.

The smartest minds and fastest computer models race each other to calculate the intrinsic value of businesses and invest accordingly. This implies that Marks' comment does not just apply to computerized trading. If every top Wall Street analyst is using the same calculations and models, won't they too "(a) see everything the same, (b) reach the same conclusions, (c) design the same portfolio, and thus (d) perform the same?"

It is an interesting question to ask, and one that I certainly don't have the answer to.

Without a doubt, markets have become more efficient over the past few decades and over the past 10 years, the advent of high-power computers has only sped up the process of efficiency. This is possibly one of the reasons why active investing has fallen out of favor so quickly since the financial crisis -- there are just too many smart investors chasing too few opportunities.

Marks signed off his latest memo by wondering what advantage investors have against the onslaught of computers. "What, then, will be the route to superior performance? Humans with superior insight. At least that’s my hope," he said.

In some respects, this is not far removed from the circle of competence theory used over the years by Warren Buffett (Trades, Portfolio) as a way to focus investors on operating only in areas they know best.

Building an edge

Unfortunately, this is not an easy solution to the problem. It requires hard work and effort to build a circle of competence and gain an in-depth understanding of a particular sector. Still, it's an edge we investors can build into our strategies. We can also use our experience in the real world to gain an edge over Wall Street and computers.

Wall Street tends to see the world through rose-tinted glasses because the Street needs to win clients. Without this need, we can view the world with a more critical eye.

What's more, institutional investors tend to dislike uncertainty, which presents another opportunity for the average investor. Wall Street generally overlooks high-uncertainty. low-risk opportunities, but the average investor who has time to wait, and experience investing in these trades, can profit significantly.

And the final edge average investors have over computers and Wall Street is time. Time arbitrage is now one of the invaluable tools available to long-term investors. While the tech revolution has completely changed the world for the better, it has dramatically shortened attention spans, especially for investors who can now trade around the clock. Operating a business never has been and never will be a fast profits process despite what short-term investors might want.

In conclusion, yes markets are becoming more efficient, but improving efficiency is also opening up avenues for success. There are always opportunities for profit; you just need to look for them.

Disclosure: The author owns no stock mentioned.