Billionaire investor Howard Marks is one of those rare people whose words pack a rare combination of wisdom and elegant common sense. When he speaks, both Wall Street and Main Street listens.
He is most well-known for his letters to his clients, affectionately known as the ‘Oaktree Memos’, which have been compiled into a book titled “The Most Important Thing“. It is a tremendously insightful book, packed with years of wisdom from professional investing via a contrarian, value-orientated philosophy.
So naturally, I was (really) thrilled to find out that the CAIA Association invited him for a short discussion session at the Singapore Management University on the 3rd of November 2017, while Marks is doing his rounds in Asia. Without any hesitation, I grabbed a fellow CAIA member-friend and together we headed down to attend the event.
The session covered everything from his current views on the financial markets to his firm’s (Oaktree) investment philosophy as well as the tough work of professional money management.
During the session, Marks was asked what was needed to become a successful investor. He paused momentarily, organising his thoughts, and replied with the following:
(I) Crystallise your creed
Marks emphasised that to be successful in the financial markets, one needs to have a creed or an investment philosophy. While an obvious point, Marks stressed that this investment philosophy has to be clear, and it has to reflect your beliefs about the financial markets. He advices all investors to write down their way of running things, and it has to include not just business/investing-related matters, but also a comprehensive and overarching view of the value-adding process, management, and even any possible philanthropy.
He shared his own experience when he first started Oaktree and how his partners and him penned down their investment philosophy and tenets, crystallising the principles that would guide them for the decades ahead. His six main tenets were:
- Control risk (make money with controlled levels of risks)
- Consistency in investment performance (drive out the losers to survive over the long term)
- Market efficiency exists in various degrees (be cognisant; be more active in less efficient markets)
- Develop a high degree of specialisation (develop niches over time)
- No macro forecasting (stick to trying to understand companies and industries)
- Do not market time (adjust stance between offence and defence over time)
With the tenets, they could execute with discipline what they truly believe will work for them, guiding them through both good and tough times. What is your investment philosophy and what are your tenets?
(II) Understand that investing is not a pure science – it’s messy and frequently random
Marks mentioned that investors have to acknowledge that investing is not a pure science. It is not governed by the rules of science (i.e. laws of physics). He says that “you have to get used to the inherent uncertainty, the messiness and the imprecision surrounding everything.” Crucially, one has to understand this intuitively and on a practical level – one’s investment process has to take this into account.
Marks brought up the example that author Nassim Taleb wrote about in Fooled By Randomness, that in fields such as dentistry or engineering, clear cause-and-effect relationships exist in the nature of their processes, and practitioners could improve their results by rigorous practice and constantly refining their process. However, the investment practice is different due to the amount of randomness and uncertainty affecting outcomes (you could easily have a valid process in place but at times still producing undesired outcomes).
Marks also opined that academia equates risk as volatility as it is easily quantifiable (making it easy to serve as model inputs), but he has his doubts if risk could be that easily quantified in the real world.
Defining risk as ‘the possibility of losing money’, Marks poised a rhetorical question to the audience: “How does one measure risk? … Could you do it? Is there one collective way to really measure risk exactly?” Marks hammered this point further by asking if one can be confident enough to say a ‘sure bet’ is less risky than a ‘probable bet’ in hindsight after a certain trade/investment has yielded a decent profit. Could one do it?
In essence, Marks stressed that it’s important to take into account the role of randomness and luck when investing in the financial markets.
(III) It’s essential to understand cycles!
Marks opined that everything in financial markets move in cycles, and it’s all part of the world that we live in. The perennial problem throughout financial market history is that a majority of market participants tend to forget that things move in cycles, particularly at the critical turning points, subsequently leading to sub-optimal decisions and actions.
Whether its the economic or business cycle or debt and credit cycles, if one seeks success in the markets, one has to have an idea where we are and which stage we are at. Valuations of various asset prices vary and change as we move through various transition points on a cycle. Ignore them at your own peril.
(IV) Keep your emotions in check
Marks emphasised that to be successful in the markets, it’s important to keep your emotions in check and stick to your investment plan. He says that “you’ve got to be unemotional – all the successful investors I know are unemotional”.
When asset prices rise, investors tend to get excited, leading them to take on more risks than what they are comfortable with, which pushes valuations beyond what their fair levels. When asset prices are crashing, most market participants will panic and despair, consequently being carried out by the chaos and turmoil and missing the opportunities and bargains that depressed markets offer as valuations get pushed down beyond what is deemed as fair. Between these two situations, the emotional waves are extreme, with “the pendulum swinging between ‘flawless’ and ‘hopeless'”.
Marks makes the point that if one seeks success, one has to attempt to be in control and maintain composure and discipline at all times, to ensure that one does not get influenced by the herd or gripped by one’s own fear.
He brought up his own experience of investing during the previous cycle (2002 – 2008), whereby he and his associates at Oaktree turned cautious in 2007 and were shifting their exposures to a defensive stance as markets were exuberant and valuations were stretched. However, they also turned offensive when valuations were heavily beaten down at the end of 2008, deploying around US$ 600 million of their capital into assets that they like within just 1 week! That takes nerves of steel and a ton of discipline (in sticking to the action plan)!
If you missed the event, don’t fret!
Marks has his famous memos all uploaded on Oaktree’s website, very much like how the Oracle of Omaha (Warren Buffett) releases his annual letters to his shareholders on Berkshire’s website. These memos are filled with his abundant insights and wisdom gathered over three decades, and all are available for reading to any who is interested. Marks’ memos are highly recommended reading for both the experienced and the inexperienced!
*image credits to http://www.beyondproxy.com/*