Howard Marks on Thoughts on Working through a Dramatic Down Cycle. The conversation with the co-chairman of Oaktree Capital Management, was at the CFA Institute Annual Conference.
1. View market movements constructively
Investors tend to perceive market activity through the prism of boom-and-bust cycles and anticipate future movements based on past patterns. Generally speaking, the cycle is a series of up and down oscillations around a central trend line.
But the conventional terms that describe these market movements — boom and bust, up and down — carry connotations that can influence an investor’s perspective and create a distortive effect. I tend to think of them, more productively, as excesses and corrections.
2. Know what you don’t know
(In the context of intellectual humility and accepting the fact that there are limits to one’s knowledge on any subject).
When it comes to the current pandemic, it is so silly for an investor to build his investment conclusions around his view of what the disease holds when he knows nothing about it. I would argue that you shouldn’t make it up on your own, you should look to the experts.
3. Insist on a margin of safety
For any given investment that you consider making, you evaluate the investment relative to the underlying fundamentals. Investors must consider the company, the stability of the industry, and the underlying predictability of both as well as the lowness of the price.
The expert calibrates the expression of his opinion based on how firm the evidence is. The investor should calibrate his confidence in his investment based on how much margin of safety there is.
4. Know when to get aggressive
Normally, we (at Oaktree) take a very cautious approach to our risk asset classes. That’s the concession we make to what we know. Caution is always appropriate when dealing with the unknown.
But we aren’t afraid to get aggressive when we believe we have identified good investments. I think that toggling between aggressive and defensive is the greatest single thing that an investor can do, if they can do it appropriately.
5. Be different, but be correct
Following the market does not lead to outperformance. To generate better investment returns you have to separate yourself from the herd. And you have to be right.
If you think and behave differently from other people — and you are more right than they are, that’s a necessary ingredient — then you can have superior performance.
Rejecting the consensus is an easy reflex, but in investing, that consensus — the market — is right more often not. Knee-jerk contrarianism is certainly not a successful strategy.
6. Get comfortable with discomfort
Every great investment begins in discomfort. If everyone else didn’t hate the investments, they wouldn’t be cheap.
Asset prices drop when nobody wants to buy them. So the investments with the largest margin of safety or the largest gap between their current selling price and their intrinsic value can be the most unwanted. Holding unwanted assets can be uncomfortable.
The challenge comes when the discomfort endures for a long time. Many times, it doesn’t work for months, or maybe years. One of the most important adages in our business is that being too far ahead of your time is indistinguishable from being wrong. And that’s where the discomfort comes from.
Thanks to the global pandemic and its associated financial crisis, uncertainty and discomfort will be major components of financial markets for the foreseeable future. The toll of the disease and the economic impact of fighting it will last for a long time.
This will play out over the next several quarters, if not years.
Also read Professor Aswath Damodaran’s presentation.
