Speaking at a recent event at Chicago’s CFA Society, Oaktree Capital founder Howard Marks (Trades, Portfolio) had some remarks on how to invest in a low-return world. Since the financial crash of 2008, central banks around the world have brought down interest rates, forcing investors to take more risks in order to generate an acceptable return on investments. Gone are the days when Treasury bonds could yield between 4% and 5%. For the last 10 years, investors have had to look to riskier assets in lieu of fixed income securities. How does one prosper in such an environment? Marks has the answer.
Do what others are unwilling to do
“How are high returns achieved with low risk? The answer, in my experience is: investors make money most safely and most easily when they do things that are other people are unwilling to do. That’s the history of my career. I started Citibank’s (C, Financial) high-yield bond portfolio in 1978 when no one else would do it, and it was considered unfiduciary and imprudent to buy an investment-grade bond. We started the distressed debt fund at TCW in 1988 when people said “are you crazy? You’re going to buy the debt of bankrupt companies? How can that end?” Nobody one else would do it - that’s how you get bargains.”
Marks is known for his strategy of pursuing the debt of bankrupt companies, a notion that has scared away many a competitor. The dearth of buyers in the market for distressed debt makes it comparatively easier to find cheaply priced assets. Conversely, markets with a high level of interest are much more likely to be overbought, as buyers compete for the limited pool of assets and bid up the price in excess of what intrinsic value dictates:
“When investors are unworried and glad to make risky investments, or worried but investing anyway because the low-risk alternatives are unappealing, which is more descriptive of the last 10 years, asset prices will be high, risk premiums will be low and markets will be risky. That’s the result of too much money and investors who are too eager.”
Rules for survival
Like many other value investors, Marks has a list of rules that he adheres to. A strict set of rules can protect you from yourself and remove the temptation of chasing after risky plays.
“What will help us avoid the extremes of the markets? The keys to avoiding mistakes are simple: awareness of history, belief in cycles rather than unabated, unidirectional trends, skepticism regarding the existence of free lunches - there just aren’t that many opportunities to make a lot of money without risk, regardless of how often they are pandered - insistence on low prices that provide lots of room for error. Attention to all of these things will invariably cause you to miss the most feverish parts of bull markets, which is when prices go from fair to extreme, but they will also make you a long-term survivor…you can’t have it both ways - you can’t guarantee participation in a heated bull market and be prepared for its reversal.”
In other words, rigid adherence to a code will inevitably mean that you will lose out on some opportunities to make money. Even the most robotic and unemotional investor may find it difficult to stay out when so many people are making money around them. In such situations, it is particularly important to remind oneself of the large potential losses that can occur during a reversal of an extreme bull market. Better to stand on the sidelines than risk getting wiped out.
Disclosure: The author owns no stocks mentioned.
