Transcript
Andy: Now we would like to formally turn over the program to our host for the next two segments, Mr. Alan Bond. Many of you know Alan well. He is a managing director and portfolio manager with Jensen Investment Management, as well as a past president of the CFA Society of Portland. At Jensen, Alan is vice chairman of the Investment Committee and conducts fundamental research on both portfolio and potential companies, as well as monitors portfolio companies.
Alan joined Jensen from Washington Mutual where he held the position of credit analyst. Prior to Washington Mutual, he was a high yield credit analyst and trader for Columbia Management Group. Alan began his career as a trader at Ferguson Wellman Capital Management. He earned a Bachelor's in business and MBA from the University of Oregon and is a CFA Charterholder. We think all of this experience makes Alan an excellent person to interview our keynote speaker. Alan, please take it away.
Alan: Okay. Well, thanks Andy. Thanks Lisa. Thank you Howard Marks. Andy and Lisa told me to trust that Howard is listening right now, even though we can't see him yet. So I'm just gonna start going. We are really fortunate to have Howard Marks here. Lisa kind of mentioned at the outset that we'd been planning with Howard to join us for over a year, and due to some personal matters he wasn't able to join us in person, unfortunately. But he did volunteer to do this via video link, and I think it'll be a neat experience and something we're looking forward to.
For those of you that don't know, Howard Marks is the co-chairman and co-founder of Oak Tree Capital Management. Oak Tree is a Los Angeles based investment management firm, but it's truly a global business with a real expertise in what I would kind of consider exotic credit instruments and investing. And they manage nearly 130 billion in assets under management. So clearly one of the largest asset managers in the world, and kind of the joke I've been telling folks, especially people who may not be familiar with our industry quite so well is that, the more I've learned about Howard Marks, I kind of consider him the Warren Buffet of distress debt investing.
Very similar styles and approaches, but very different asset class. I'd be curious what he thinks when he comes on here about that. Hopefully that's a complimentary comparison, but we're really lucky to have Howard. And I'm hopeful that he will come through on video here really soon. I think what's ... There he is. Hello?
Welcome, Howard Marks. First of all, can you hear us and see us okay?
Howard: Fine, and you?
Alan: Thank you for joining us. I did a brief intro, a brief bio about your background. The first thing I wanted to ask you is, just kind of in your words for those of us that aren't real familiar with distress debt investing, high yield investing, can you just give us a high level of what those markets look like and how they shape your views on overall market cycles and things of that nature?
Howard: Well, you know, I started off spending my first 10 years in the business on the equity side, from 1968 to '78. Alan, raise your hand if you can hear me. Good. Okay. So I was in equities from '68 to '78, and I became Citibank's director of research. And then when it was time to move on to money management, the timing coincided with the creation of the high yield bond world, and I was very fortunate to join it at its inception in 1978.
Prior to that, bonds, first of all, you could not issue a low rated bond. They had to be investment grade in order to be issued. Secondly, bond analysis was done on the basis of current and historic figures, not future analysis, and that was a big change for the bond world. And fortunately, it called on my experience in equities because that's what we do in equities. We look at the future, not so much the past.
So I was lucky to join at that time. I was lucky that my experience prepared me, and you know, we didn't talk about credit in those days. We talked about something called fixed income, and fixed income was primarily high grades and sovereigns and treasuries. And all you were doing is betting on the direction of interest rates, and obviously, with those entities, the credit worthiness didn't matter much because they were assumed to be eminently credit worthy.
So you know, I describe what we do, to finally answer your question, as fixed income investing, where, how the company does matters. It matters a lot, and you know, if you invest in a direct debt or in high yield bonds, or especially in distress debt, you better have the outlook right. So that's what we do.
Alan: Okay. Well thank you for that. I guess the first question that I wanted to ask you is based on your most recent book about investing with a market cycle mindset, and I wanted to ask you about the current market cycle. And I know your focus is more on the credit side of the cycle, but there tend to be correlations between credit investing and equity investing. I wanted to talk to you about your view of the current cycle in the context of what we've just experienced in terms of an uptick in volatility. We had nearly a 20% draw down in the equity markets recently, and specifically, just what factors are you watching? And how are thinking about the evolution of the current cycle?
Howard: Sure. Before I respond to that Alan, I just want to say for everybody there, that I really appreciate your permitting me, and Lisa and Andy and everyone in the audience, permitting me to do this tonight by video. I've been looking forward to this visit to Portland for a long time. I've been visiting Portland to see clients for almost 30 years. I love Portland and my annual trip to Powell's Bookstore, and Lisa made a veiled reference to personal considerations. And the good news is that my son is gonna have his first child within the next couple days, certainly within the next week, and I just couldn't be out of town at this time. So it's great to be able to do it by video, and I appreciate that.
I'm a big believer in the CFA. I've held that charter for, oh I don't know, 45 years I guess, and I think the charters are now up to 140 or 150 thousand. And my number is 3730. So you can imagine I've been toting it around for a long time. I'm glad to support the CFAs and especially Portland.
Now, in answer to your question, I don't believe in macro forecasts. That's number one. It is one of the views that I hold most strongly. I heard you mention a comparison in the introduction to a guy from Omaha, and it would be a daunting comparison. And I certainly don't put myself in his class. He told me that for a piece of information to be desirable, it has to satisfy two criteria. It has to be important, and it has to be knowable. The macro is certainly important. The macro drives the markets these days and does so to a much greater extent than ever in the past, and so yes, important. But in my opinion, not knowable.
I don't think anybody can consistently know the economy, interest rates, currencies, and the direction of the markets better than anybody else. So I swear off forecasting, and one of the elements in Oaktree's investment philosophy is that we do not base our investments on macro forecasts. That doesn't mean we're indifferent to the macro, and our approach is, rather than depend on forecasts of the future, we depend on reading the presence. I believe one of the greatest predictors of what the market's gonna do, or influences on what the market's gonna do, is where it stands in the various cycles, and if we can have an idea when the market is at an extreme position, I believe that can help us increase or decrease our aggressiveness or defensiveness in a timely fashion.
And you know, the subtitle of the book I like a hell of a lot more than the title. The subtitle is 'Getting the Odds On Your Side', and that's what I think ... You know, we never know what's gonna happen in the markets. We never can be sure of an outcome, but I think we can get the odds on our side by understanding where we are in the cycle. Now that's all a preface to your question. Where are we in the current cycle? Well, you know, I put out a cautionary, I wouldn't say bearish, but a cautionary memo in July of '17, and then I repeated it again in September or October of '17 and then again in July of this year.
I didn't say get out. I never say anything as flatly negative as get out, but I did say that I thought it was a time to move ahead with caution. That's been our mantra at Oaktree for the last several years, and it was through then, move ahead. Invest. It has been our goal to be fully invested. We have not shied away from investing, but with caution. We consider ourselves cautious investors in our various asset classes, and with caution means even more caution than usual. Now, why? Putting all those memos together, the three that I mentioned. Number one, we're in the advanced stages of an economic recovery? [11:36 inaudible]
Number two, we are in, we have been in one of the longest and more recently, the longest bull market, and number three, in June of '17 stocks were selling at unusually high PE ratios. Bonds were selling at low yields and tight yield spreads. Private equity was taking place at high transaction multiples. Real estate was selling at low capitalization rates. So everything told us that on the quantitative side that assets were expensive, and then I spend a lot of time looking at the qualitative side and the behavioral side. And I felt that the market was dominated by optimism and belief rather than skepticism and pessimism.
It's important to know that, and when optimism and belief are in the ascendancy, I think that's the time for caution. So what were some of the things I looked at? In addition to merely the PE ratios and such, things like the FANG stocks, which I thought reflected a high degree of optimism. The willingness of investors to lend money to emerging markets, to lend money to Argentina for 100 years. The willingness of people to put money into Bitcoin and beat it up 1,400% in 2017. The willingness of some people to invest in SoftBank's Vision Fund, as an extreme example.
So when you put together the quantitative measures of evaluation and the qualitative indicators of behavior, I thought that the results called for caution. Now, of course, a little bit of the bloom is off the rose. So I summed this all up in a memo, September 26th of last year. The book was coming out October 2nd. I wanted the memo out before the book, and of course the memo, eventually, if you wait long enough, you're gonna have good timing. So that September 26th memo was good timing, as the market started to turn down on October 4th, but if you read that memo, I think you'll see the reasons for my caution.
And of course, now we've had something of a correction. Some of the optimism has been trimmed. A year ago, nobody could think of anything that could go wrong. Now they can. These are actually healthy signs for a market, and obviously, by definition, we need a little less caution today than we did for 12 months ago.
Alan: The follow-up question I had to that statement, and you talked just now about sounding, so maybe the yellow flag or the alarm bell, back in the summer of 2017. And it took over a year, at least, to get some signal, that directionally, your feelings were affirmed. I think in your book you talked about that Oak Tree started investing more aggressively in September of 2008 after Lehman Brothers collapsed. Both those time periods, those calls, at least certainly the 2008 call, was ultimately proven to be correct, but you had to have kind of a strong stomach to put up with a lot of pain before that call materialized in your favor.
And what I wanted to ask you about is patience and the importance of patience because in your book, I don't know if you explicitly say it but you're talking about the market cycle, which implies market timing, but I know you're not talking about market timing. So you have to ... so there's this element of patience that has to ... 'cause you could be right, you know, early, and then have to wait for some time. So I'm just curious about how you've been able to have that patience. Is it process? Is it personality? Is it people? What's driven your success with that?
Howard: Oh, that's a very good question, Alan. Patience is one of the most important things in our business, and what I like to point out is, that sometimes we have a sense for what's gonna happen. We never know when. Most of the important things that happen in our business like the events of the last three months are primarily attributable to changes in psychology, not fundamentals. The fundamentals did not change very much on October 4th, just the market decided to go down 20%, and that was psychology. And psychology cannot be predicted and certainly cannot be timed.
So clearly we don't know when anything is gonna happen, and I use a lot of adages in my books, my memos. The first great adage that I was taught in the early 70s was that being too far ahead of your time is indistinguishable from being wrong, and you know, we've all had that experience. I've had it many times, and so we have to live with that. By the way, I'm gonna make lots of references to my memos tonight, and anybody in the audience who wants to read them, they're all available at OakTreeCapital.com, under the heading of insights. The price is right. They're free, and I would be happy to have-
PART 1 OF 3 ENDS [00:18:04]
Howard: ... and I would be happy to have you read them. I wrote one in 2014 called “Dare To Be Great II”. I had written Dare To Be Great in '06. This was the followup. What I pointed out is that if you wanna be a superior investor, number one, you have to be willing to be different. Obviously, you have to depart from the average investor, or from the crowd, in order to be a superior investor. And if you do that, you have to be willing to be wrong. Deviating from the crowd cannot be done with 100% batting order. Finally, you have to be willing to look wrong because even the things that you do right directionally are not gonna be right timing wise. You will look wrong for one [inaudible].
Patience and the ability to live through tough periods, until you are eventually proved right, is extremely important. Now, I think that what it allows me to do it, number one, I was wise enough to early condition my clients to expect me to be wrong in this regard. Client education, client preparation, the inculcation of reasonable expectations is one of the most important things we can do in our business. I always say the three most important words to me are "I don't know". If a client asks me a question I don't know the answer I tell them I don't know the answer.
Now, there may be a guy down the block who says he does know, but if they make a few tips down the block they'll figure out that he doesn't know either. We don't know what's gonna happen in our business. We shouldn't claim to know. We should prepare our clients for our own imperfection. If we do we can get through tough periods. Now, as you know from having read the book, Alan, I think it's very important in everything we do to not be dominated by our emotions. I think that the greatest investors I know, starting with Warren Buffett, are unemotional. It's a gift in our business. Most of the errors in our business are errors of emotion. Certainly, the consensus swings far too radically. We can do much better, but the starting point has to be that our emotions are under better control than those of the crowd.
Alan: Okay. Well, thank you. Just real quick I want to remind everybody that there is a microphone right over there if anyone wants to get up and ask a question live to Mr. [Marks]. Otherwise, I've got one question from the audience so far, but please feel free to use the note cards at your table and we'll try to get them queued up as fast as we can here. With that, I wanted to move on, and one of the things you talk about in your book, and it's kinda towards the end, it felt almost like a side note, but I've heard you talk about it before and I thought it was a really interesting distinction that's really important and it's not always obvious, and it was about the difference between a quality asset and a quality investment.
I was just hoping you could share your thoughts on that with the room here tonight because I thought it was a really interesting topic.
Howard: Sure. Well that's an easy one. My first job in the investment research department of Citibank was in 1968. When I got there, the bank and most of the New York banks ... the banks did most of the investing in the world in those days. There were very few independent money managers. The bank trust departments were it. The bank’s practiced something called nifty fifty investing. They bought the stocks of the 50 greatest, fastest growing companies in America, Xerox, IBM, Kodak Polaroid, Merck, [Lily], Texas Instruments, Hewlett Packard, Coca-Cola, AIG, Avon, etc. These were companies that were so fabulous that it didn't matter what you paid for them and so fabulous that nothing could ever go wrong. As a consequence, they moved the PE ratios in the range of 60/70, 80/90, PE ratios. Everybody said that this was such great companies that price didn't matter.
If you bought the stocks the day I got there and if you held them firmly with the discipline that I've been advocating here, and you held them firmly for five years, you lost almost all your money in the best companies in America. That said quality alone is not a protection against loss. Then, as I mentioned in response to your first question, Alan, in 1978 I joined the high yield bond world and then, all of a sudden, I'm investing in the worst companies in America, in terms of public securities, and I'm making money steadily and safely. What that says is that risky ... high quality companies can make bad investments, risky companies can make good investments, and the way I put it is it's not what you buy it's what you pay, and that good investing is not a matter of buying good things, but of buying things well. That's an important distinction.
Any time anybody presents anything to you saying you should buy this company or that company, this is happening at that company and this is gonna happen at that company, the first question to answer is, "Yes, but at what price?" It may be a great company, but there is no company that is so great that stock or bonds can't be overvalued and become a terrible investment.
Alan: Okay, so I'm gonna start here with some of the questions we've gotten from the audience. Again, I just encourage folks to continue to think of questions and we'll get through as many as we can here. First one here, I think this is interesting, it's a question we probably all ask ourselves from time to time, what investment mistake have you made that comes to mind and what did you learn from it?
Howard: Well, I think that I have a bias, and we all have biases, and I think my bias is towards conservatism. It's not the worst thing in the world. It keeps you alive when others get carried out, but it causes you to underperform for long periods of time, especially, for example, the last 10 years, in a couple of months we'll be at the 10th anniversary of the low point of the equity market, March of '09. This has been a challenging time for a cautious investor. Now, most of our clients hire us because we're cautious and retain us, despite the fact that we may trail the indices a little bit.
I think that it would be wonderful to not have the bias toward either optimism or pessimism. I don't know if it's human to not have a bias, but clearly I could've done better over my career if I'd been less cautious. Of course, I might not be sitting here. I might've carried out in the last crisis.
Alan: Okay, so next question from the audience. This is a reader of your first book, The Most Important Thing, and the question is: do you now know what the most important thing is? The question is based on the conclusion of your book.
Howard: Well, there are many, many things which are essential. If something's essential ... if you have 10 things that are essential, if you say one's more important than others if they're all indispensable I don't know. I think that the two most important things, to duck the question, Alan ... well first of all risk. I think that the job of the professional investor is risk management. It's easy to make money in the market. It's especially easy to make money when the market does well and the market does well most of the time, so making money itself is not a distinguishing characteristic. Making more money than average is not necessarily a distinguishing characteristic because some people do it merely by taking on more risk than average. The measure of a great professional is making money with the risk under control. I believe that strongly.
As your questioner knows from reading the first book, I had three chapters in there on risk, understanding risk, recognizing risk, and controlling risk. I do think that risk is the most important thing, but where does risk come from? I think that risk comes primarily from where we stand in the cycle. When we're high in the cycle risks are high, prospective returns are low. If we're low in the cycle prospective returns are high and risks are low. I think that understanding where we stand in the cycle is also the most important thing, and I find it very hard to choose between the two.
Alan: Okay. Next question, this actually dovetails on a comment I think you talked a bit about in your first answer about the market cycle. The question is about what you're observing right now in the high-yield bond market and how that impacts your expectations for let's say the next year or two. What I wanted to add to that was I think one of the things you mention in your book is sort of signs that the market might be getting a bit ahead of itself or a bit frothy. One of the things you talk about is the quality of bond issuance and the high-yield markets, and the distress debt arena and that recently we've seen, and I think the Federal Reserve commented on this frankly a few months ago, that the quality of issuance has really slipped. Covenants have gotten weaker. Credit quality's gotten weaker. I'm curious about your perspective on that, as it pertains to the market cycle and, perhaps to answer the question, how that shapes your view of the next year or two?
Howard: Sure. One of the most important chapters in the book is on the credit cycle. Most people don't think about the credit cycle very much. Of course, those of us who deal in lending do more so. The credit cycle is really very important and it is one of the fastest moving cycles. Very important and very volatile. What credit cycle is mostly about is about the availability of credit and the terms. Sometimes the credit window is too wide open, too many people wanna lend money, and when they compete to make the loans the loan goes to the person who will take the lowest quality and the least yield. That's a dangerous condition. I call it the race to the bottom. At other times the credit window closes, credit is not available or it's only available on very high cost and very tight terms, that's the great time to be an investor.
I think you have to be very cognizant of that. I think that one of the things that worried me a lot, and caused me to write my cautionary memos that I described, was the race to the bottom and the deterioration of lender behavior that I was seeing over the last few years. My last memo, that I mentioned to you, September 26th of last year, the title was “The Seven Worst Words In The World”. What are the seven worst words in the world? They are too much money chasing too few deals. When you have too much money chasing too few deals you get, as I said, low yields and high risk, and that's what we had. Your question was framed in terms of the high-yield bond market, but the worst violations were not taking place in high-yield bonds. They were taking place in leverage loans. Leverage loans are a new market, as you know. Twenty years ago banks would make loans to companies and syndicate them to three or four of their fellow banks.
About 15 years ago they started to syndicate them broadly in a process that looks like the issuance of a stock or a bond. In recent years, the money's been flowing to leveraged loans like water. Number one, because they are senior in the capital structure and, number two, because they have floating interest rates. When people started to worry about interest rates increasing under a quantitative tightening and so forth they said, "Wouldn't it be great if we had floating interest rates and our interest rate would go up when the interest rate in the environment went up?"
Yes, okay, floating rate is great. Seeing it in the capital structure is great. Remember what I said a couple questions back? At what price? People began to pay too high a price for those virtues. In the memo Seven Worst Words I give examples of about a dozen bonds that arguably were too generous, to give empirical evidence for where we stood in the credit cycle. Now, again, the good news is that the events of the last three months, starting, again, October 3rd, scared the bejesus out of a lot of people, made them much more demanding of their credits, made them shy away from investing. In December, we had the first month, I believe in about nine years, when there was zero issuance of high-yield bonds. It tells you we went from having too much money chasing too few deals to having no money available for deals and that's why no deals got done.
You look at the yield spread, which measures people's risk aversion or their demand for compensation for bearing risk and the yield spread on the high-yield bond market broadened considerably over the last three months. Again, there is still risk in all these markets. The correction, if you will, of the fourth quarter did not eliminate the risk, but I think it went a fair way to adjusting the situation and providing increased risk compensation.
Alan: Okay. Thanks, so I'm gonna turn over the microphone here in a minute. First thing I wanna say is I've gotten a handful of political questions or politically-oriented questions. I'm not gonna ask them up here. If you wanna ask them go to the live mic. They're all interesting questions, but I think we wanna keep it out of the way here a bit. Anyway, go ahead. Chris, you're on the mic there.
Chris: Howard, can you hear me?
Howard: I do. Yes.
Chris: Okay, good. Howard, like you, I've been coming to Portland for over a decade, meeting with institutional consultants and clients. I think it's a great area. I just joined Jensen as our head of institutional ... you and I had competed against each other. I was at Thomas White, some other firms like Thornburg on the international side. I'm curious what you think about value equities and why the cycle has been so elongated against value? Your thoughts there, value versus growth, and those labels maybe we need to throw them away, but I'd like to hear from you, especially given the comments you just made on distress debt and some of those instruments.
Howard: Well, Chris, bear in mind that Oak Tree is not an equity shop and I certainly don't present myself as an expert on equities. Having said that, it won't stop me from answering your question. I would say in general that with value we're paying for the merits today and with growth we're paying for the dreams of tomorrow. Since this has been a 10-year bullish period, in which risk-bearing has been pretty consistently rewarded we would expect pro risk asset classes like growth stocks to do better. I think we would expect growth stocks to do better in a bull ...
PART 2 OF 3 ENDS [00:36:04]
Howard: I think we would expect growth stocks to do better in a bull market, which is certainly what we've had, and '99, if you can think back that far, was as I recall, the biggest year in history for growth to out-perform value, and I think it was 2,500 basis points, and that was the blow off stage of the tech and telecom bubble, and of course, these things were corrected in 2001 and ‘01 and '02, but I think it's the normal behavior.
Now, I also suspect that the trend, which has been so strong, towards passive and index and ETF investing, has perpetuated this bias, as at least one person agrees with me, and I think that if you wanted to start an ETF and you wanted to collect a lot of assets, you would've put in things like Apple and Amazon and stocks like that. You want to have the best-performing, the stocks that have been performing the best, because they attract more capital. Most people want to invest in the things that have been doing well, at least for a while, and so I think that these trends have been, to some extent, self-perpetuating, and have drawn in more money to these market darlings.
Now, people ask me whether indexation and passive investing has put an upward bias on forms of the market. I don't necessarily think so unless people concluded that they could invest without exposure to risk because of them, and I don't know if people do believe that. But what I do believe is that they have biased the performance of which stocks have done well. Think for a minute, if starting today, every penny that went into the equity market over the next five years went into an S&P index fund, and no other form of investing attracted any attention or any capital. What that would mean is that the stocks in the S&P500 would go up continuously, and all the other stocks would languish, and so I think you can see that being included in an index or a passive ETF has the effect of ... If the stocks in the index and the ETF are the ones that have been doing better, I think you can see how the inflows of capital would perpetuate that superiority.
Of course, it can't last forever, and eventually at some point, people start asking that annoying question that I keep coming back to, at what price? But for now, people have been very happy investing in their growth vehicles, and I believe that has perpetuated the out-performance. I'm fairly confident it's not going to go on forever, and of course, one of the things we've seen this year is that the FANGs had pretty substantial declines from their highs, not all in the fourth quarter. Several of them got taken out one at a time in the preceding nine months when a glitch arose in their fundamentals.
One of the things that's the strongest about investing is that when trends get going and keep going for a while, it starts to feel like they're going to go on forever, but the longer they go on, the higher they go, what it really means is that the end is even closer than it used to be. It just never feels that way.
Alan: Okay. A couple, I think, follow-up questions from some of your earlier answers. The first is a question about your statement about being comfortable saying, "I don't know," which I think, honestly, probably a lot of the times, we don't know. I think the question is that a lot of folks aren't comfortable saying they don't know, and would like to be, I suppose, more comfortable doing so sometimes. How have you gotten comfortable with that? How have you gotten over the fear that by saying that, you're going to sound less credible in front of clients?
Howard: I don't know if I can give you an answer to that question, Alan. I was lucky. I started off as a money manager in a period that afforded considerable success, and as I said, being early, one of the first denizens of the high-yield bond world, certainly helped in that regard, and it just created an environment in which I could say, "I don't know." The other thing, of course, is that I would be ... I was extremely uncomfortable in my first 10, 20 years, when I didn't realize I didn't know, and I would say these things about what I thought was going to happen in the economy or market or rates that I at least knew that I had no justification for making predictions, and Mark Twain said, "It ain't what you don't know that gets you into trouble. It's what you know for certain that just ain't true." For some reason, that resonates with me, and I find it easier to admit what I don't know than to persevere as if I did.
Alan: Okay. Second of what I would consider the follow-up questions to one of your earlier comments was about really the key, about being emotionless in terms of your investment decisions, and the question is, how do you get there? For those of us that do get emotional and let our emotions impact us, what has worked in your experience that allows you to keep emotion out of the equation?
Howard: First of all, I have a great partner, Bruce Karsh, we support each other in the things we do. When you're out on your own, I think it's much harder, and the other thing is Bruce and I are kind of different in some ways, and so we don't merely second each other, we also complement each other. I think it's great to have a partner, and kind of like in marriage, a great partner in our business is one of the great luxuries that you can obtain.
I get asked a lot, "How do you become unemotional?" In the first book, I had a chapter on what I call second level thinking, which I think is very important, and I said, "I get the question, how do you learn to be a second level thinker?" And I used the example of basketball because they always say in basketball, you can't coach height. No matter how good a basketball coach you are, you're not going to make your players any taller, and so there's no easy answer on how to be unemotional, but if you accept ... It all comes down to logic. Do you accept that the big errors and the big swings in investing come from psychology or emotion, not from changes in fundamentals?
If you do, do you accept the importance of being on the right side of that? Do you accept that if you behave like everybody else, you clearly can't perform better than the others? In order to out-perform others, which is the goal in our business, you have to do something different, and I think the main difference comes in refusing to be part of the emotional swings, and I hope you'll read the book, I hope you'll buy several copies, but you'll find that what I that as fundamentals get better and better and better and better, people feel more confident, more optimistic, and more comfortable. Now, this increase in optimism and comfort comes just as prices are getting higher and higher and higher. People tend to buy because they feel so good, or certainly not sell, just when they probably should be taking some chips off the table.
But on the other hand, when the market goes down and fundamentals are negative and prices are retreating and people feel worse and worse and worse, that's when they should be buying, but that's when they're getting more and more depressed. So you have to be a contrarian, and one of the ... Contrarianism takes many forms, but I think the most important form of contrarianism is refusing to succumb to the same emotions that are driving the market. We are all, including me, we are all subjected to the same influences. We all read the same news. Well, some of us only read from the left, and some only from the right, but there aren't an infinite number of media outlets. We all hear the same facts, or alternative facts. We all see the market going up or down the same. We all make money or lose money at a given point in time.
So clearly, we're all subject to the same influences, but those of us who are able to resist, it's not because we don't feel those influences. It's because we resist. You have to resist if you are going to out-perform. Now, you may not become an unemotional person, and as I say in the book, lack of emotion is great in investing, but not so great in other forms of endeavor like marriage, but I think you have to spend a lot of effort to get your emotions under control. You may have emotions, but you can't let them force you to do what everybody is doing at a point in time.
Alan: Okay. Last question, and full disclosure, this is either the first or second question that came in, but I saw it and I thought, "Okay. This is the obvious best last question that we should ask, so here it is. “How are you going to invest your grandson's college savings plan?”
Howard: Well, look, it is true that for all the machinations that we professionals attempt, probably the most important thing is long-term compounding, and it may be in the stock market, it may even be in an index fund, unless you're an exceptional [stock] picker. It may be in laddered bonds, in a high yield portfolio. The most important thing is getting in and staying in for the long run, and I can tell you one thing I'm not going to do is trade his account, and I wrote a memo on liquidity. Remember, we started to get very concerned about liquidity. I think it was in the first quarter of '13 or '14, and my son, who works with me on our family investments, gave me a great observation for that memo. He said, "If you see the chart of a stock that has gone up for 25 years, and you say, 'Man, I wish I had that stock,'" he says, "Think of all the days you would've had to talk yourself out of selling."
It doesn't do any good to be a long-term investor in things that crap out, but assuming they don't crap out, staying in, long-term compounding, minimization of transaction costs, minimization of taxes, these are the fundamental secrets to success in investing. The things that we do, what I call asset selection, which is trying to have more money in the things that do well and less money in the things that do poorly, this is embroidering around the edges.
The other thing that I talk about in the book, cycle positioning, which is trying to have more in the market when the market is low in its cycle and about to perform well, and take some chips off the table when it's high in the cycle and not so attractive, again, this is embroidering around the edges. Try to do better, because of course, if you don't do better than average, you're not going to make a living for long in our business, but still, the fundamental secret to investment success is long-term compounding.
Alan: Well, thank you very much. Round of applause. I don't know if he can hear it or not but-
PART 3 OF 3 ENDS [00:51:31]
Transcript by Rev.com
Howard Marks, CFA: Getting the Odds on Your Side
Posted In: Drivers of Value, Fixed Income, Investment Topics, Portfolio Management, Risk Management
What are two of the most important things an investor needs to do to succeed?
Manage risk and understand where we are in the market cycle, says legendary investor Howard Marks, CFA.
He should know. Marks is co-chair and co-founder of Oaktree Capital Management, an investment firm with more than $120 billion in assets. Over his five decades in the industry, he has earned a reputation as one of the world’s most prominent value investors.
His latest book, Mastering the Market Cycle, explores the subject of cycles. As Jason Zweig observed in his Wall Street Journal review, “Mr. Marks admits his book is a kind of tug of war between his certainty that ‘we don’t know what the future holds’ and his belief that ‘we can identify where the market stands in its cycle.'”
“We never know what’s going to happen in the markets,” Marks told the audience at CFA Society Portland’s Annual Investment Strategy Dinner. “We never can be sure of an outcome, but I think we can get the odds on our side by understanding where we are in the cycle.”
Managing Risk
Marks believes the job of the professional investor is risk management. “It’s easy to make money in the market. It’s especially easy to make money when the market does well and the market does well most of the time,” he said. “Making more money than average is not necessarily a distinguishing characteristic because some people do it merely by taking on more risk than average. The measure of a great professional is making money with the risk under control.”
Where does risk come from? Marks believes it depends on what stage of the market cycle we’re in. “When we’re high in the cycle, risks are high, prospective returns are low,” he said. “If we’re low in the cycle, prospective returns are high and risks are low.”
Marks may have a view on where we are in the market cycle, just don’t ask for his macro forecast.
“I don’t believe in macro forecasts,” he said. “It is one of the views that I hold most strongly.”Why so?
Marks said billionaire investor Warren Buffett told him that for a piece of information to be desirable, it has to satisfy two criteria: It has to be important, and it has to be knowable.
“The macro is certainly important,” Marks said. “The macro drives the markets these days and does so to a much greater extent than ever in the past, and so yes, important. But in my opinion, not knowable.”
He explained:
“I don’t think anybody can consistently know the economy, interest rates, currencies, and the direction of the markets better than anybody else. So I swear off forecasting, and one of the elements in Oaktree’s investment philosophy is that we do not base our investments on macro forecasts. That doesn’t mean we’re indifferent to the macro, and our approach is, rather than depend on forecasts of the future, we depend on reading the present. I believe one of the greatest predictors of what the market’s going to do, or influences on what the market’s going to do, is where it stands in the various cycles, and if we can have an idea when the market is at an extreme position, I believe that can help us increase or decrease our aggressiveness or defensiveness in a timely fashion.”
Get Out?
All well and good. But where are we in the current cycle?
Marks began by reminding the audience of some of his cautionary memos from the past two years, beginning in the summer of 2017. “I didn’t say get out,” he recalled. “I never say anything as flatly negative as get out. But I did say that I thought it was a time to move ahead with caution.” He gave three reasons: First, we’re in the advanced stages of an economic recovery. Second, the bull market. And third, in June 2017, stocks were selling at unusually high price-to-earnings ratios, he said, and bonds were selling at low yields and tight yield spreads. He explained:
“Private equity was taking place at high transaction multiples. Real estate was selling at low capitalization rates. So everything told us that on the quantitative side assets were expensive, and then I spent a lot of time looking at the qualitative side and the behavioral side. And I felt that the market was dominated by optimism and belief rather than skepticism and pessimism. So when you put together the quantitative measures of evaluation and the qualitative indicators of behavior, I thought that the results called for caution. Now, of course, a little bit of the bloom is off the rose.”
Marks, of course, is referring to the end-of-year sell-off.
“We’ve had something of a correction,” he said. “Some of the optimism has been trimmed. A year ago, nobody could think of anything that could go wrong. Now they can. These are actually healthy signs for a market, and obviously, by definition, we need a little less caution today than we did 12 months ago.”
Marks has a well-earned reputation for prescience and patience. A decade ago, he and his Oaktree partner Bruce Karsh made a hugely successful bet on distressed corporate debt during the financial crisis. While most asset managers suffered from investor withdrawals, Oaktree was raising money.
Suffice it to say, as moderator Allen Bond, CFA, put it, you need a strong stomach to put up with a lot of pain before a call materializes in your favor. At the very least, you need patience.
“How,” Bond asked, “have you been able to have that patience? Is it process? Is it personality? Is it people? What’s driven your success with that?”
“Patience is one of the most important things in our business,” Marks said. “And what I like to point out is that sometimes we have a sense for what’s going to happen. We never know when. Most of the important things that happen in our business . . . are primarily attributable to changes in psychology, not fundamentals . . . And psychology cannot be predicted and certainly cannot be timed.”
Marks’s memos have a cult following on Wall Street and beyond, and anyone whose read them knows he is fond of adages. And true to form, he pulled out one in response to Bond’s question.
“The first great adage that I was taught in the early ’70s was that being too far ahead of your time is indistinguishable from being wrong. And you know, we’ve all had that experience. I’ve had it many times, and so we have to live with that. If you want to be a superior investor, number one, you have to be willing to be different. Obviously, you have to depart from the average investor, or from the crowd, in order to be a superior investor. And if you do that, you have to be willing to be wrong. Deviating from the crowd cannot be done with 100% batting [average]. Finally, you have to be willing to look wrong because even the things that you do right directionally are not going to be right timing-wise. You will look wrong, for one.”
And this is where patience comes in. “Patience and the ability to live through tough periods, until you are eventually proved right, is extremely important,” he said.
But if you are in a client-facing role, this is sometimes easier said than done. There aren’t too many clients who are unfazed by stomach-churning market gyrations. Patience (as an investor) goes hand-in-hand with client education.
“I was wise enough to early on condition my clients to expect me to be wrong . . . Client education, client preparation, the inculcation of reasonable expectations is one of the most important things we can do,” Marks said. “I always say the three most important words to me are ‘I don’t know.’ If a client asks me a question I don’t know the answer to, I tell them I don’t know the answer . . . We should prepare our clients for our own imperfection. If we do, we can get through tough periods.”
Marks reminded the audience how critical it is not to be dominated by emotions. “I think that the greatest investors I know, starting with Warren Buffett, are unemotional,” he said. “Most of the errors in our business are errors of emotion. Certainly, the consensus swings far too radically. We can do much better, but the starting point has to be that our emotions are under better control than those of the crowd.”
But what about the fear that, by admitting we don’t know an answer, we will sound less credible to clients? And perhaps the hardest question of all, how do we keep our emotions in check?
Marks reminded the audience of the quote, often mistakenly attributed to Mark Twain: “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”
“For some reason, that resonates with me, and I find it easier to admit what I don’t know than to persevere as if I did,” he said.
As for emotions, Marks said, it starts with the question of whether or not you accept that the big errors and the big swings in investing come from psychology or emotion, not from changes in fundamentals. If you do, then ask whether you accept the importance of being on the right side of that. Finally, do you accept that if you behave like everybody else, you clearly can’t perform better than the others?
Clearly the answer has to be yes.
“To outperform others, which is the goal in our business, you have to do something different, and I think the main difference comes in refusing to be part of the emotional swings,” Marks said. “Those of us who are able to resist, it’s not because we don’t feel those influences. It’s because we resist. You have to resist if you are going to outperform.”
And if you resist — and recognize and deal with risk and understand where we are in the cycle — chances are you’ll get the odds on your side.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
Key Takeaways
1. Understand the market cycle and manage risk. “The measure of a great professional is making money with the risk under control.”
2. Be patient. “Patience and the ability to live through tough periods, until you are eventually proved right, is extremely important.”
3. Resist emotional swings. “Most of the errors in our business are errors of emotion.”