We’ve been fortunate to have had numerous opportunities to learn from Howard Marks over the years, both in exclusive interviews with The Manual of Ideas and in keynote Q&A sessions at MOI Global Online Conferences.
Howard also shares his wisdom periodically in his memos, which reveal timeless insights while relating them to the realities of the market environment. The memos should be a key component of any value investing curriculum. Howard is also author of the instant classic, The Most Important Thing as well as Mastering the Market Cycle.
We are grateful to have further opportunities to learn from Howard when highly praised author William Green interviewed him at Latticework 2016 and when value investor Ethan Berg interviewed him at Latticework 2018.
Howard Marks has been one of the most generous value superinvestors in terms of sharing his knowledge and experience with the value investing community. In this regard, he has paralleled great investors like Benjamin Graham (book, lectures), Warren Buffett (book, letters), and Joel Greenblatt (book).
It may be worth noting that the willingness to share wisdom, which Howard Marks, Warren Buffett, Charlie Munger, Mohnish Pabrai, Guy Spier, and others have shown, is not automatic. It takes time and effort as well as an altruistic view of the world, in which every investor has the potential to learn and improve. Better capital allocation ultimately benefits all of us because it channels capital more efficiently toward its most productive uses.
We had the distinct pleasure of sitting down with Howard several years ago to discuss his book, The Most Important Thing.
Howard has honed his investment approach primarily in areas of the market other than public equities. Yet, his insights apply very much to those of us who focus on public equity investing. As a distressed debt investor, convertible debt investor, high-grade debt investor, and control investor, Howard has developed unique insights into investing across the capital structure. Debt investors, especially distressed debt investors often develop a more acute sense of the financial risks of a company than do equity-only investors. In this context, Howard shares an invaluable perspective in the interview we conducted with him in London in 2013.
Howard was extremely generous in letting us pick his brain on the concepts discussed in The Most Important Thing. We spent almost an hour going through the key concepts in the book and soliciting more color on them. As always, Howard was articulate and insightful, revealing many nuggets that complemented the wisdom in the book. In the following videos, we show some of the highlights of the conversation, although the entire hour could be considered a highlight.
Howard Marks on the Most Dangerous Thing to Neglect
I think it is risk consciousness. I think that the great accomplishment in investing is not making a lot of money, but is making a lot of money with less-than-commensurate risk. So you have to understand risk and be very conscious of it and control it and know it when you see it.
The people that I think are great investors are really characterized by exceptionally low levels of loss and infrequency of bad years. That is one of the reasons why we have to think of great investing in terms of a long time span. Short-term performance is an imposter. The investment business is full of people who got famous for being right once in a row. If you read Fooled by Randomness by [Nassim] Taleb, you understand that being right once proves nothing. You can be right once through nothing but luck.
The law of large numbers says that if you have more results, you tend to drive out random error. The sample mean tends to converge with the universe mean. In other words, the apparent reality tends to converge with the real underlying reality. The great investors are the people who have made a lot of investments over a long period of time and made a lot of money, and their results show that it wasn’t a fluke — that they did it consistently. The way you do it consistently, in my opinion, is by being mindful of risk and limiting it.
Howard Marks on the Twin Pitfalls of Overconfidence and Lack of Ego
It is not an algorithm. It is a mindset. I think that we always try to stress the danger of overconfidence. I forget if I put it in the book, but it is better if you invest scared, if you worry about losing money, if you worry about being wrong, if you worry about being overconfident because these are the things you want to avoid. They should be foremost in your mind. The most dangerous thing is to think you got it figured out, or that you can’t make a mistake, or that your estimates are right because they are yours. You have to always recheck your information, bounce your ideas off of yourself and others.
On the other hand, it is really not a good business for people who don’t have some ego because you have to do the things that Dave Swensen describes as lonely and uncomfortable. I think it was [Jean-Marie] Eveillard who said it was warmer in the crowd, in the herd. But if you only hold popular positions, you can’t do better than average, by definition. And I think you will be very wrong at the extremes.
You have to be strong enough in ego to hold difficult unusual positions and stay with them. As I say in the book, you have to have a view that is different from the consensus, and you have to be willing to stay with it, and you have to be right. If you have a non-consensus position and you stay with it and you are wrong, that is how you lose the most money.
I keep going back to what Charlie Munger said to me, which is none of this is easy, and anybody who thinks it is easy is stupid. It is just not easy. There are many layers to this, and you just have to think well. I can’t tell you how to think well. Some people get it, some people don’t.
Howard Marks on Why All Investors Should Be Aware of the “Temperature of the Market”
There is no secret method for any of this stuff. You just have to be aware of concepts, smart in their application, and it helps to be an old man so that you have the experience that helps, or an old woman…
If you are a value investor and you invest whenever you find a stock which is selling for one-third less than your estimate of intrinsic value, and you say, I don’t care about the macro, nor what I call the temperature of the market, then you are acting as if the world is always the same and the desirability of making investments is always the same. But the world changes radically, and sometimes the investing world is highly hospitable (when the prices are depressed) and sometimes it is very hostile (when prices are elevated).
I guess what you are saying is we just look at the micro; we look at them one stock at a time; we buy them whenever they are cheap. I can’t argue with that. On the other hand, it is much easier to make money when the world is depressed, because when it stops being depressed, it’s like a compressed spring that comes back.
If you buy a cheap stock when the market is high, it is a challenge because, if the market being high is followed by a general decline in prices, then for you to make money in your cheap stock, you have to swim against the tide. If you buy when the market is low, and that lowness is going to be corrected by a general inflation, and you buy your cheap stock, then you have the tailwind in your favor.
I think it is unrealistic and maybe hubristic to say, ‘I don’t care about what is going on in the world. I know a cheap stock when I see one.’ If you don’t follow the pendulum and understand the cycle, then that implies that you always invest as much money as aggressively. That doesn’t make any sense to me. I have been around too long to think that a good investment is always equally good all the time regardless of the climate.
Howard Marks on Adjusting Your Level of Aggressiveness Based on the Environment
If you have flexibility in where you invest, it stands to reason that you should be able to make adjustments that enable you to reach your goals. This goes back to what we said before. You said some value investors are willing to ignore the macro. They say if stocks are selling for one-third less than intrinsic value, I am going to buy it. But the question is, do you want to be equally aggressive all of the time, or do you want to play offense some times and defense at others?
I would argue that you should adjust your activities based on the climate of the market. So, that is what we do. Sometimes in a distressed debt portfolio, we want to be at the very top of the capital structure. That may be because that is where the best bargains are, it may be because the macro environment is threatened and we don’t want to live with macro uncertainty. At other times when these things are cheaper and when the environment seems less treacherous, maybe we’ll drop down into the second level on the balance sheet or maybe the third. Historically, we don’t go to the bottom of the stack very often, but I think these adjustments are worth making.
It is a great dilemma because, on the one hand you want to stick to your circle of competence. On the other hand, it is probably a mistake to say, “I do this. I don’t do that.” Because, at the same time that you want to capitalize on your expertise, you want to be flexible enough to pursue the bargains where they are, and you don’t want to be so dogmatic that you say, “I only do this,” which implies, I do it whether it’s cheap or not. So this is one of the great dilemmas.
You asked earlier where inefficiencies come from. Largely they come from people who say, “I do this, and I don’t do that.” What they are basically saying is, “I don’t do that regardless of how cheap it is.” Well, that is silly because then you just leave bargains for others. If you say, “I do this, but I don’t do that regardless of how cheap it is,” you are basically saying, “I do this regardless of how expensive it is.” That doesn’t make much sense either. This is why I think you have to be realistic. You have to be sensitive to conditions in your world, and you should adjust your tactics — offense and defense — based on conditions in your environment.
Howard Marks on Oaktree’s Circle of Competence in Distress-for-Control Investing
When I was talking about circles of competence, I think one of the elements on our side is that we have been doing it for a long time. We have a lot of experience in the things I have been discussing, and I think experience is very important. You have to learn the hard lessons. One thing I mentioned in one of my memos is that the human mind is very good at blotting out bad memories. Unfortunately, most important learning is from bad memories. We have enough institutional memory to retain the lessons of the past.
We organized our first distressed fund in 1988 and then branched out into our first distressed-for-control fund in 1994. We figured that we could identify cases — we spun that fund out because we had done it in the past — we invested in big chunks of the debt of smaller companies so that when the debt was exchanged for equity we ended up as the controlling shareholder.
The question is, number one, is this a company that you would like to control? And number two, is this a company where the creditors will get control? And then number three, which creditors? Because usually there is something called the fulcrum security, which is the first impaired class. The unimpaired will get their money. The first impaired class may get the company, and the lower impaired classes may get nothing. So it is the fulcrum, the one in the middle there, we try to identify that. We try to figure out if it will get control and how much it will have to pay for control. If it gets control at that price, will that be a successful investment? It is a very interesting area — of course, more moving parts to go wrong. The investments are by definition less liquid. I would say it’s the difference between dating and getting married. When you are a distressed debt investor, you are dating; but when you try for distressed-for-control, you get married. You have to live with the consequences, for better or for worse, richer or poorer. But, it can produce some good outcomes.
Howard Marks on How to Apply “Second-Level Thinking” to the European Crisis
…anything which has gone down in price a lot is potentially a source of opportunity. But the question is, has it declined sufficiently relative to reality? If a stock was efficiently, fairly priced five years ago at X. Today the stock is down half, but in some sense reality is also down half — then the stock is only fairly priced, lower in price but not cheaper.
What the investor has to do is weigh out on the one hand price and on the other hand reality. Everybody thinks very dire thoughts about Europe and the Euro, and I would be the last person in the world to argue against that position. Then the next question is, European assets are lower in price because of the macro conditions, but are the macro conditions being viewed too pessimistically? The answer is, how do you know? Go back to second-level thinking. Are you capable of thinking different and better about the fate of Europe? I don’t think so. I don’t think I can. I don’t think anybody really has a good handle on what is going to happen in Europe. So then, how can gaming the Europe situation give you an edge?
If you don’t have control over something, superior insight — I don’t see control in the sense of being able to make it work — if you don’t have superior insight, then how can something be to your advantage? One of the tenets of our philosophy — you named number one, which is risk control — number five is, we don’t bet on macro forecasts. It is very hard to consistently be above average in correctness with regard to the macro.
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Since the formation of Oaktree in 1995, Mr. Marks has been responsible for ensuring the firm’s adherence to its core investment philosophy; communicating closely with clients concerning products and strategies; and contributing his experience to big-picture decisions relating to investments and corporate direction. From 1985 until 1995, Mr. Marks led the groups at The TCW Group, Inc. that were responsible for investments in distressed debt, high yield bonds, and convertible securities. He was also Chief Investment Officer for Domestic Fixed Income at TCW. Previously, Mr. Marks was with Citicorp Investment Management for 16 years, where from 1978 to 1985 he was Vice President and senior portfolio manager in charge of convertible and high yield securities. Between 1969 and 1978, he was an equity research analyst and, subsequently, Citicorp’s Director of Research. Mr. Marks holds a B.S.Ec. degree cum laude from the Wharton School of the University of Pennsylvania with a major in finance and an M.B.A. in accounting and marketing from the Booth School of Business of the University of Chicago, where he received the George Hay Brown Prize. He is a CFA® charterholder. Mr. Marks is a Trustee and Chairman of the Investment Committee at the Metropolitan Museum of Art; Chairman of the Investment Committee and Board of Trustees of the Royal Drawing School; and an Emeritus Trustee of the University of Pennsylvania where from 2000 to 2010 he chaired the Investment Board.