#234 Howard Marks- Episode Transcript
2:03
Sean: Howard, welcome to What Got You There! How are you doing today?
Howard: Good. It’s nice to be with you.
Sean: I’m honored to have you on. I’m always intrigued though how everyone’s always looking for an edge, and I’m wondering, after all these years in investing, is there something that you’ve done pretty much every single day that you think just had the most benefit for you over your life?
Howard: Well, I think being aware of one’s environment, not actually trying to apply something algorithmically or formalistically, but the necessary condition for out performance of others is to do something different, not every day, because there’s not something intelligent to do differently every day, but to be aware of excesses in the environment and be the extremes of the economic cycle or extremes of the market or of investor behavior, and at that time to stand away from the herd.
Sean: Is there anything you do to control your environment to make sure you don’t get caught up in that herd mentality?
Howard: I think the only thing you can really do intentionally is be aware and try to, as I say, to not conform. Emotional control, un-emotionality is essential, because if you are subject to the same emotions as the herd, then you’ll probably do the same things as the herd, not stand away. So by definition then you have to not be emotional, like the herd. People always ask me, Well, how do you be unemotional? And it helps to be born unemotional, and most of the great investors I know are unemotional or have their emotions under control, but that seems harder to me, it seems harder to recognize the importance of emotional control and practice it, given that we’re all subject to the same inputs, and we all see everybody else doing whatever it is they do, seems to me to be harder to practice an emotional control rather than be unemotional by nature.
4:30
Sean: Yeah that makes sense. Well, speaking about standing away from the herd, much of value investing is understanding what the company’s competitive advantage is or the moat I’m wondering for you personally, what do you think your competitive advantage is?
Howard: Well, I’m not investing at the individual investment level anymore, my contribution at Oaktree is more general direction and helping with the perception of the macro environment. So those are the things I’m doing these days. When I was investing, I think that, you know, obviously, we all try to get a better understanding of the company, and you know the market was not so thoroughly researched in those days, so it was really possible to do so. Today, that’s much harder.
Sean: So it sounds like that advantage has transformed as Oaktree has grown and gotten bigger. So I’m wondering if the competitive advantage of Oaktree as you guys have grown bigger, has that become more of an advantage or has that competitive edge become more difficult?
Howard: Well, Oaktree is big, but our individual strategies, we have 25 different strategies, and each of those by definition is not so large, if we have 25 strategies, which until a year ago added up to 120 billion, that means on average they were only five billion, which is not huge in the investment business, and it’s really the size of the strategy, the amount of money we have to manage in each strategy that constrains one’s selectivity and agility. So if you look at the record, it sounds big to have 120 billion now, and now we’re up to 140 billion, but 5 or 6 billion per strategy is not a lot of money on average, and obviously we have strategies that are 20 or 30 within the 140 total, but we have limited our assets under management, and if you look a year ago we were 120, and I think six years ago we were probably also 120, and we thought that the last few years have not been a good time to increase our assets, most people have increased their assets substantially because they could and of course, the more assets you take, the more you get in fees, but we have not increased our assets ’cause we thought it wasn’t a great time to increase assets, we were concerned that the market was vulnerable, what we thought was that the market outlook was that there was a great deal of uncertainty. Prospective returns were low, ’cause interest rates were very low and that’s what dominates that condition. Asset prices were full or high, not bubble crazy, but high, and many people were engaging in what I call pro-risk behavior in order to try to make a good return in the environment that offered low returns, and the main way to do that is to do riskier things. So if you look at that as conditions, uncertainty, low returns, high prices, pro-risk behavior on the part of others, that’s not a great time, in my opinion, to invest. So we constrained our asset total and we didn’t show growth, many people doubled, tripled, even quadrupled their assets over those years, and we did not, and I think that’s a point of distinction, and sometimes it’s great to have a lot of money, ’cause it gives you market power and the ability to influence outcomes and dominate companies, for example, in restructuring of stress, which is a big thing for us, and sometimes it’s good to have a little money, so you’re selective and agile, and we thought that the recent years leading up to 2020 were a good time to have a little money, ’cause we thought that the market was vulnerable to an outside shock, which obviously appeared and it was vulnerable to.
8:45
Sean: I’m wondering Howard, would you have been able to do this earlier in your career?
Howard: No, I don’t think I… Number one, I hadn’t seen so many cycles, and so I didn’t have the, what you might call pattern recognition ability, I’m not sure I would have had the confidence to make that decision. I’m not sure I would have understood its importance.
Sean: So I’d love to dive into pattern recognition. Anyone who’s familiar with your work clearly understands you’ve got above average ability in terms of spotting patterns. I’m wondering, you mentioned a minute ago, was this just due to time and understanding, or were there things you did throughout your career that just helped speed that pattern recognition process up?
Howard: No, I do think Sean, that it’s mostly time and understanding, but then Ray Dalio in his book, recent book, talked about pattern recognition, and so what they did is they studied history and he says, you reach your point where something happens and you say, oh, that’s one of those… It’s not a formal thing. Well, they did it formally, as I say, they did a lot of study in history, I just lived through history, and they went obviously back further than my life extends, but I think that’s the point. If you can get to the point where you say, oh, it’s one of those. And the reason markets go to extremes is that many people fail to say, oh, it’s one of those. Instead, what they say is, this time is different and I first came across that phrase on October 11th, 1987, there was an article in the New York Times written by a woman called Denise Wallace, and the title was something like, This Time It’s Not Any Different. And what she said is that when the market goes to extremes, people always say, oh, this time it’s different, in other words, the old rules don’t apply, this is such a unique experience that the old rules don’t apply, and so the old valuation limitations, you know, well, yes, the normal post war P/E is 16, but it’s selling at 30 now, and that’s fine, because this time it’s different, whether it’s the internet or the nifty fifty 50 or the housing miracle in 2005-6 on this time is different, the old rules don’t apply, and then there’s a correction and people say, oh yes, I guess the old rules do apply. So it’s very important, when you hear people say this time is different, a red light should go on. I think the phrase came from Sir John Templeton, but he said, but sometimes it is different, 20% of the time, it really is different, and the world does change, and if that was true when he said it in the 80s, I think it’s much more true today, maybe it’s 40% or 50%. When I was a kid or even a young man, the world felt like this was a static place, nothing ever changed. I always say that when I was a kid, comic books were 10 cents through my whole childhood. We didn’t have inflation, we didn’t have changing prices, and we didn’t have a rapid technological change or communications that changed everything so rapidly, and we didn’t have the partisan communications that we have now, ’cause communications operated under something called The Fairness doctorate. So the world didn’t change and events played out in front of an unchanging backdrop, shall we say, today, the world changes every day. So it’s much more likely today that things really are different, that was one of the themes of my latest memo, something of value, and so I think it’s important to recognize that today and be more flexible in our approach. So Mark Twain said, history doesn’t repeat but it rhymes, there are some things that are kind of eternal varieties, but there is much more that’s different from the day-to-day.
13:03
Sean: Speaking about things that are different, and then you were even talking about your childhood, what did you think you were gonna be as a kid?
Howard: Well, I wasn’t that purposeful, so I don’t think I had an idea when I was a kid. When I was in junior high is when I started thinking about it and I think the first thing I was attracted to was being a history professor, and then after that, an architect, and then in high school, public schools were better in those days, they offered more, they were not as stretched as they are, so in my high school, they had a course in advanced accounting, believe it or not. So I took that, and I loved accounting because accountings symmetrical, there are always two entries and they balance each other, and I was just attracted to logic, and so I thought I’d become an accountant and my dad was an accountant, and when I went off to Wharton to start it in 63, I thought I would major in accounting, but then I took Finance and I found that much more interesting. So I switched my major.
14:16
Sean: Looking back at the start of your career, would you have been able to predict the success you’ve had?
Howard: Oh, no I wouldn’t even be able to predict what I did. There are a lot of people in accounting who said, Well, I started to read perspectives at 10. And then at 13, I invested my bar mitzvah money and that kind of thing. But I didn’t have any of that certainty, and when I was getting out of grad school at University of Chicago in 69, I didn’t know what I wanted to do, so I applied for six jobs in six different fields, and the City Bank one that I applied for was the only one in investment management of the six, but I had had a good summer working there in the year between years of graduates, in the summer between years of graduate school, and so I went back there and stayed for 15-16 years.
15:16
Sean: So what changed at that time, it seems you were interested in a lot of different things and very broad in terms of what you might be interested in, and then all of a sudden you devoted your life to this, what happened there?
Howard: Well, when I start something, I get attached to it. And it was very enjoyable, although not painless, because when I got there for the summer job in 68, or for the full-time job in 69, the bank was a practitioner of what was called nifty 50 investor, now most of the banks were the big investors, there were no KKR’s, there were no Black Stones, there were no… well, Vanguard did exist, there were a few mutual fund companies, and they were no, what we call now investment boutiques or hedge funds. The banks did most of the investing of the time, bank trust departments, they were called, and that’s where I was working, and most of the, what we called money center banks, that’s what I’m talking about here, the ones in New York and so forth, mostly New York and Boston. They did the investing, and most of them were devotees of what was called nifty 50 investing, investing in the stocks of the 50 best and fastest growing companies in America. Now, this was a kind of company that really came into existence after the war, and thanks to advances in technology and also marketing, you had companies like Xerox, Kodak, Polaroid, IBM, Hewlett Packard, Texas Instruments, meralco, Coca Cola, AIG, Procter and Gamble, that grew faster than the other companies. You didn’t have these rapid growing companies in the 30s or before, and of course, not much was invented on the civil side during the war, so this was opposed to war development and mostly 60s on, and so people went crazy over these stocks, they were considered to be such good companies that A, nothing bad could ever happen, and B, there was no price too high for these stocks because of their wonderfulness. So if you bought them the day I got there from my first job at 69, and if you held them diligently for five years, by the end of 74, you lost almost all your money in the best companies in America. And so I was associated with that, at that time in the late 70s, by 75 I was the director of research. And you know, I was just a kid, I was in my 20s, but for some reason, I was able to do that, be able to before my 30th birthday. And so I was associated with the Nifty-50 practice at City Bank, and the outcome was terrible, the clients lost almost all their money, and we were rather un-diversified, We mostly had only that. So I always say I’m lucky, I didn’t get fired, but I did lose my job as director of research ’cause they brought in a new Chief Investment Officer to pull us out of the slump, and he brought in his own director research eventually, but he didn’t say that I was fired. He said, What do you wanna do? And then I said, well, I’ll do anything except spend the rest of my life choosing between Merk and Lily, because I believe in market efficiency, and I believe that you can’t differentiate, if you offered me a million dollars at the end of the year for saying which Merk or Lily is gonna outperform in the next year, I couldn’t do it. Nobody can do it more than 50% of the time by flipping a coin, and so he said, well, I want you to start portfolio and convertible bonds. They had had a convertible bond portfolio at his old job and on what was called Morgan Garanty at the time, and so I did, and I loved it. And I went from running a huge department with a big budget, and I think 75 people, to working alone with no budget and no organizational importance, and I loved it, and then in the summer, August of 78, I got the phone call that changed my life, it was the head of the bond department saying, There’s some guy named Milken or something out in California, and he deals with these things called high-yield bonds, do you think you can figure out what that is?
So I was smart enough to say yes, and try to keep my job, and I got involved with high-yield bonds at the beginning of high-yield bonds, and as Malcolm Gladwell says in his book Outliers, it’s great to be first in line, that’s what he calls demographic luck. To be at the right place at the right time. And almost everything important that has happened in the investment world in the last 42 years has either come through the high-yield bond world or has applied the mentality that grew up in the high-yield bond world. And I was lucky to be there at the beginning. Now, however, so here we are, you invested in the best companies in America in the end of the 60s, early 70s, and you lost almost all your money, now I’m investing in the worst public companies in the world, and I’m making money safely and steadily. So I drew two conclusions, it’s not what you buy, it’s what you pay. Almost anything, let me say this, there’s nothing so good that it can’t become overpriced and a bad idea, and there are a few things so bad that they can’t be under-priced and a good idea. It’s not what you buy, it’s what you pay. And the corollary of that is that good investing is not a matter of buying good things, it’s a matter of buying things well, and if you don’t understand the difference between buying good things and buying things well, then you shouldn’t be doing this, it’s all a matter of buying things well, and these were my two revelations at the time, and they really shaped what I’ve done since 78.
22:19
Sean: We were talking about pattern recognition earlier, when you come across one of these revelations, I’m wondering what that looks like for you?
Howard: As I said, I spend most of my time thinking about the market in this regard, rather than selecting individual companies or securities. So I think that the pattern is to say, to find when things are overpriced, which is usually a function of there being too much optimism and excesses in the physical environment, and then too much optimism about what’s going on, or too much pessimism when there are craters in the environment and too much pessimism about that. I use a lot of adages, some of my own creation, but mostly other people because they said it so well. And in the early 70s, I was a member of something called the Third Thursday Group, which met on Wall Street for lunch on the third Thursday of every month. And it was for directors of research and senior investors and that kind of thing, and I met a lot of very able people much older than me, and they shared to wisdom and somebody said to me, one of the first smart things I remember hearing is, there are three stages to a bull market, the first stage when very few people, only a gifted few understand that there could be improvement. The second, when most people accept that improvement is actually taking place. And the third, when everybody believes that things can only get better forever, and it is which stage we’re in, and which feelings people are guided by that really determines the status of the market, so are people being too pessimistic in the first stage, that’s when you get bargains, or too optimistic in the third stage, which is when the accesses on the upside are taking place, and when you can really get killed if you participate, so it really comes down, Sean, to a question of how much optimism is there, and if I can only know one thing about every moment and every security it’s how much optimism is in there. When you buy when there’s no optimism, by definition, the price is low relative to the intrinsic value, and that’s when you get the bargains, when you do things, the real easy and big money in investing comes when you are willing to do something that nobody else will do. And when that’s buy, nobody else is willing to buy, you buy, you get a bargain. The real easy way to lose money is when you do what everybody else is doing to access, because clearly, now there’s too much optimism to be realistic, and you pay prices that vastly exceed the intrinsic value, and that’s an easy time to lose money. So I work on that, now, that’s qualitative, and there are quantitative things as well, valuations, PE ratios, bond yields, yield spreads, capitalization rates on real estate, enterprise values on private equity purchase, these are quantitative, but they can mislead, and especially now in this period of great change. The historic valuation ratios may not be that meaningful. And that was another important theme of the recent memo.
26:09
Sean: Yeah, you need to be non-consensus and right. You mentioned at the third Thursday lunches, I love this, you just mentioned a little bit of wisdom you happened to pick up there, any other really meaningful lessons that you picked up from someone much senior to yourself early in your career that stuck with you all this time?
Howard: The first of the great adages that I remember learning was that being too far ahead of your time is indistinguishable from being wrong,but people turn negative because they see things in the environment that are going on that’s coo coo, and you may be in principle, right, but if you do it too soon and it doesn’t work for a few years, everybody says, look at that guy, he used to understand this process, but look how wrong he is, but you’re not wrong, you’re right, but early. But being right early looks like being wrong, and the question is, can you survive in that interim between when you make the decision and when it’s proved out, and these can be very difficult times and you can show terrible performance and lose most of your money under management, even with a decision, which is right, in principle. So actually, I always tell that the first thing I remember learning in Wharton, in 1963, I read a book called Decision-Making Under Uncertainty by oil and gas operators, a guy named C. Jackson Grayson, who later went on to be the first (27:50) energy czars in the 70s after the oil embargo. And what he pointed out was that the sign of a good decision is not that it turns out to be right. And this is counter-intuitive, I believe that most of the things that are important in the investing world are counter-intuitive but the point is, you can make a good decision, and it doesn’t work because number one, nobody knows everything when they make the decisions, nobody has all the facts, and number two, the world is dominated by uncertainty and by randomness, so you can make a perfectly good decision with good data and a good decision process, but it turns out not to work because of some random event, and if you read Fooled By Randomness by Nassim Taleb, it was his first book and a great book, in my opinion, he said, to understand the quality of a decision, you have to understand not only the events that occurred, but the other events that could have incurred but didn’t, what he calls alternative histories, and only when you consider all the possible outcomes from a decision, do you really understand the quality of that decision, not by understanding the one event that did occur, so it’s really important to understand this and to understand that there are lots of good decisions that don’t work, and there are lots of bad decisions that work. We all know about people who are right for the wrong reason, so only when we look at the world that way do we understand who really made good decisions or not. And that’s a very important distinction also, so this is the kind of thing which is so vague and provocative and uncertain that this is why investing is interesting.
29:54
Sean: Maybe this has to do with emotional control, I’m wondering, when you had one of these moments when you were right, you were right early though, which means you look like a fool essentially, how did you handle that?
Howard: Yeah, well, I would say that in the last decade, you know, I turned cautious sometime around, I don’t remember exactly when, sometime around in the middle of the decade, and obviously it took until the pandemic and 2020 to be right. There was a bad quarter here and there, the first quarter of 16, the last quarter of 18 were very difficult periods, but we didn’t really have any bad years until… And that was not a helpful decision until 2020 and the collapse of the market in February, March, and even that didn’t last long because the Fed and treasury pulled it out, so it would have been better to be incautious in the 20 teens, but I was cautious we were fully invested, but cautiously, and that had a price in that decade
31:07
Sean: Throughout your whole career, do you have a decision that you’re just proudest of or just brings a smile on your face every time you think about it?
Howard: Yes, it’s a funny thing when my last book was called Mastering the Market Cycle, and that came out in late 18, and so I was working on that, and I do a lot of my amusing with my son, Andrew, who is also a professional investor and I was talking to him about the book while I was writing it, and I said, You know, I think most of my cycle calls have been right. Now that I think about it, and he says, Yeah, Dad, that’s because you did it five times in 50 years, you can’t make a good decision every day, these calls of a peak or a trough at the extreme of bubble and crash or high and low bull and bear, the decisions, the logic is clear and I think compelling, and the probabilities are on your side, the probability of being right is high, but if you do it in between, you try to do it every day or every week or every month. You try to do it when the market is 2% over value to 4% under value. So it’s very hard to be right. And so I have done it maybe five times in my life, but probably the best is that, and it helps, by the way, not to do these things on your own, but to do them in partnership with somebody else who sees the world the way you do and kind of like Buffet and Munger or something like that. And I’ve been lucky to have a partner in Bruce Karsh, who is my co-founder of Oaktree, worked with me at Trust Company of the West, joined me in 86. Together, we started, I think the first distressed debt fund from a mainstream institution, I don’t know, he joined me in 87, and we started the first distress fund mainstream financial institution in 88 and that was at TCW. We’re almost 40 years together now, and so I’ve been working with Bruce all that time, and we support each other in what we do, it’s kind of lonely to do these things and it’s easy to second guess yourself, and it’s great to have somebody else supporting your logic. But in 05-06, we turned very negative because of what we saw going on in the marketplace, and we really tighten our portfolios and tightened our decision process, raised our selectivity, and in 07 to early 08, we raised a stand-by fund for investment in distress, which turned out to be the biggest in history at that time, it was 10.9 billion, our funds up to that point, had been one or two, maybe three billion, and then in 07-08, we raised 11 billion and we had it standing by when, mostly almost entirely un invested, when Lehman went under September 15th of 08, So we may had made a good decision to be cautious and importantly, on September 18 and 19, I made the decision supported by Bruce that we should invest aggressively and over the remainder of 08, he invested an average of about 450 million a week for 15 weeks at 7 billion during the global financial crisis, and it kinda didn’t matter what you bought, because everything was vastly under-priced and almost everything recovered fine, there were very few bankruptcies, and so the only thing that mattered was that you bought… and we bought a lot, we had much more money than anybody else, and we put it most of it to work in those 15 weeks, seven billion out of 11, and so I think that was our best call, and you know I write the memos to clients and the great thing is that you know, I don’t have to say to people, Well, yeah, I know it. And they say, Yeah, sure, you did. You can read the memos at that time. You can read the memos in 07, which were extremely cautionary until the crisis hit around late July of 07, and then what we did after the bankruptcy of Lehman in late 08 early 09, and you can see that we… I would say we called it right. And very people, did I recount in one of the memos, the fact that, Hey, I was talking to a friend of mine who was a reporter, and he said to me… So what are you doing? I said, We’re buying. He said, You are? like, What are you crazy? And it turned out to be the right thing, so it’s very satisfying.
36:51
Sean: Non consensus and right once again and prepared for those alternative futures, you mentioned your son, Andrew and believe me we’re gonna dive into your latest memo, I love how deep you went on your own thinking, But Andrew is my age, I’m wondering, the advice you’re giving to him, what do you wish you did more of earlier in your career?
Howard: Well, I’ve been too conservative. And he explained to me, and I put in the memo why he thinks I was too conservative, which I had parents who lived through the Depression and were scarred by it. They were adults doing depression, not children, that’s not the important thing of being a child, if you were an adult, you knew what was going on, and so all my life, they would say things like, Don’t put all your eggs in one basket and save for a rainy day, and cautionary things like that, which influenced me, and then I was scarred because my first half decade or a decade in the investment business were affected by the crash of the nifty-50, and that had an influence I’m sure. And then the fact that my greatest successes have come from spying excesses in the market, excessive bull markets, so that became kind of a pattern recognition that resulted in knee-jerk conservatism and skepticism, so I think that I obviously, well, as a fixed income investor, an accredited investor, I think that being conservative was okay,
Sean: I think you made out fine.
Howard: Well yeah, in our fields, the premium is on conservatives because being an optimistic and aggressive fixed income investor is almost like an oxymoron you have to have a bias towards conservatism when you do a fixed income. And I would say that if, rather than if my boss, Peter Virmilyea 1978, rather than say, I like you to start a convertible bond fund had said, I’d like you to start a venture capital fund and find Amazon when it comes into existence, I would have been a disaster because I’m not an optimist, I’m not a dreamer, and it wouldn’t have fit my personality. One of the most important things is to invest as it’s right for you, and for a chicken to try to be aggressive or for a cowboy to try to be conservative is challenging. So I was lucky ’cause I fell into what was right for me.
39:30
Sean: Howard, this is a point I really wanna hit on, know thyself, they could be the most important words in investing. I’m wondering how you were able to go against the grain at times and really truly understand who you were?
Howard: Well, I think that… First of all, I certainly didn’t know who I was in the 60s or the 70s, and you figure it out after a while, and in the 80s, you would have said to me, what are you good at? I would have said I’m good at being analytical and quantitative analysis, and I learned in the 90s and certainly this century, that what I was really good at was more qualitative and conceptual, and seeing the patterns in the market, understanding concepts and theories and especially new products. And concepts, as they evolved as the market evolved and communicating those things, writing, speaking, speaking with clients, and then leadership and leading the organization, millions of people are analytically quantitatively capable, numerat, and I was fine at that. But I think that these latter things, which are more qualitative and conceptual were really my strengths, and you know there’s… My favorite quote of all is from an English writer called Christopher Morley, and I’ve never used this in a memo because it’s never been appropriate, but he said, “there’s only one success to be able to live your life your way”, which is a great concept, but the key for most people is to figure out what their way is, you have to see what really are your strengths and your weaknesses, and what it is that will make you happy, and what will make you unhappy.
41:53
Sean: Figure out your way. I love it. I’m so intrigued then with your latest thinking, I know you write about uncovering a bias of your own, and that’s usually assuming towards mean reversion, how difficult this late in your career when you’ve had so much success, is it uncovering that bias and then not only facing it with your son but then writing about publicly?
Howard: Well, it’s very hard to do it yourself, it’s another thing, I talk about how successful my work with Bruce Karsh has been, it’s another example of the desirability of help. Many of us only understand ourselves when we go to a shrink, when we have gone to a shrink or when we’ve had lengthy talks with a priest or a rabbi or with our wives with our best friend, it’s hard to do it on your own because you wanna see, you wanna understand your biases, but your biases keep you from understanding your biases. And this is very important. So living with Andrew and his family for much of the pandemic was the help I got, and he’s very different from me, and he’s extremely insightful, and he has a very high emotional IQ, and he helped me to see these things, and we spent a lot of time. And so I learned the easy way, which is with help from him and pointing out these things about me, myself and my biases, my history, and about value investing, and keeping an open mind and trying to be modern and so forth. And some of it I learned the hard way, and I recount in the appendix to the memo in a kind of synthetic dialogue between the two of us, and he said, he says, well, I got this and it’s up this percentage. And I said, well, you’re gonna sell something. He said, Oh, it’s a great investment, why would I sell some? I would say ’cause it’s up, He says, Well, why should I sell it ’cause it’s up? I said, Well, it could go down. He says, Well I hold it ’cause I think it’s going up, and so I’m gonna continue to hold it ’cause I think it still has a lot of potential, and about five or six years ago, I wrote a memo, maybe it was six or seven, about liquidity in the market, because everybody was talking about the fact that liquidity was down because the banks had been removed from the investing process by the vocal rule, we said that they couldn’t make risk investments for their own account, because they were kind of public institutions, and the government had an implicit promise to bail them out if they got into trouble, well why should banks be able to make aggressive investments for their own account and get rich if it works, but they get bailed out by the government, if it doesn’t work. Which makes a lot of sense. So the point is that… let me think for a minute. Oh yes, so I wrote a memo about liquidity six or seven years ago, and I made the point that liquidity is not always a good thing because most people trade too much, and in our distressed debt accounts, they’re what’s called closed end accounts, the client permits a certain amount of money to be invested and the funds have a 10-year life, which is subject to extension if needed, and they can’t withdraw their money, they can’t trade too much, which means they can’t sell at the lows and buy at the highs the way most people do. And so I talked about the fact that liquidity isn’t always a great thing, and selling and buying too much and trading too much is not a good thing, and Andrew says, he says… And I quoted him in the memo, he said, if you look at the chart of the stock that’s been up for 25 years, and you say, Man, I wish I had that stock, he said, think of all the days you would have had to talk yourself out of selling it. And it’s true, I mean, the hardest thing in the world is to hold a stock for 25 years and have it see it go from one to 10 to a 100 to a thousand and not sell it, and then watch it go to 10000 and 100000, and that’s how you make the big money, but you have to hold for a long time, and instead most people sell, and I always said, why don’t you just sell some. And I’ve always had this rule that if you sell half, you can’t be all wrong, but you also can’t be all right, and it’s kind of like my favorite fortune cookie, which says that the cautious seldom error or write great poetry. The cautious really have disasters or huge successes, and that was my experience, but of course, in fixed income, there’s no such thing as a huge success because the returns are asymmetric, you can’t make much, but you can lose a lot. So if you’re in a market where you can’t make much but you can lose a lot, then by definition, your protest to be asymmetrical because the possibilities are asymmetrical, and your approach as favorite defense, Graham and Dodd in the Bible security analysis in 1940 called fixed income investing, a negative art, you succeed, not because of what you buy, but because of what you exclude from a fixed income portfolio, so the point is that to hit the big successes, you have to hold for the long term, and Andrew and I had that conversation all the time I would say, Well, why don’t you sell a little, It’s called taking profits. And he said, No, I’m gonna let this run. And of course, so far, of course he’s right.
48:17
Sean: That certainly must be satisfying. I feel like this conversation is just full of so much long-term wisdom and in one of your books, The Most Important Thing, one I really enjoy, centered around investing, I’m wondering if you were writing a book, The Most Important Thing Outside of Investing, what would you have as number one?
Howard: Well, Andrew and I talk about that being my next book and working on it together because we have such a successful dialogue, and when I get the time, I think we’ll do it. But I mean, look, I think that living life your way is the most important thing. And this is how I conclude most of my talks with students on campus, because they always ask me, Well, what should I do? and I said, Well, number one, there’s no right answer for everybody, no size fits all. The worst thing you can do is do what other people tell you to do, or emulate what other people are doing, or what’s popular, or what society says you should do, and certainly you shouldn’t choose a career because you can make the most money. For most people that’s not gonna end up successful, you have to live your life your way, and of course, the challenge, as I say, he has to figure out what your way is. And when I’m talking to people at Wharton or Harvard Business School, or Columbia or these great schools, most of them have enormous ability, they’re very intelligent, they wouldn’t be there if they weren’t special kids, and they can accomplish most of them, what they set out to do, especially if they invest within their skill set, but the hard part is figuring out what it is that will make you happy at a time, at a time when everybody, and I’ve seen these waves of careers, so there was a time, believe it or not, when most people wanted to be accountants because it was a profession in demand. Then there was a time when everybody wanted to be a consultant, and then in the 90s, and maybe even, I guess in the 00’s, everybody wanted to be an investment banker, and now everybody wants to be a venture capitalist and a techy. What a terrible idea is to choose your career because it’s the one everybody else is choosing. Number one, it’ll be crowded and competitive, and number two, it may not be satisfactory to you, so I always say to kids, your career you choose should play to your strengths and avoid your weaknesses. And it should be the thing that will make you the happiest. We only get one life as far as I know, and what a mistake it is to squander it on something that doesn’t play to your strength and make you happy, and something which is chosen just because it will make you the most money. Unless, that’s the thing that will make you happy, but I mean that’s my most important piece of advice, but I have lots of observations on the world. You even mentioned when we were chatting before the, what you called the 2 x 2 matrix, about the fact that the things that work the best are the things that are unconventional and correct. It’s a little hard to be unconventional, most people don’t do it naturally, and the things that are conventional are often the right thing because they’re the thing that so many people have thought about and chosen to do, so it’s hard to be unconventional, and it’s hard to be right when you’re unconventional, but when you do both, it’s the most successful. That’s one of the challenges in life, one of the illogicalities of life.
52:21
Sean: This leads me to wonder about the start of Oaktree, and I’ve had a few young people in the investing space that are wanting to soon or hopefully someday go off on their own, and you hit on self-belief earlier, I’m wondering how important was self-belief at the onset of Oaktree Capital?
Howard: Well, it wasn’t a great challenge for us, Sean. Number one, you talked about young people who wanna go off on their own, we weren’t young people at the time, I was just about to turn 49, and my partners were in the 30s and later, the youngest guy, I think I was 34 at the time. There were five of us who started Oaktree together and we had worked at TCW together. My oldest partner, Sheldon Stone, who joined me at City in 83, and my newest partner, Richard Masson who joined me at TCW in 88. By 95, when we started Oaktree, we had worked together seven to 12 years, we were not newcomers to each other or to the business, and we had been very successful already, and number one, we made enough money so that we could live with the risk if it didn’t work. And number two, we had been successful together, so we had kind of proved out our methodology and developed reputations which are important in the investment business, so deciding to go and do it on our own was not enormously risky, and as I mentioned, Bruce Karsh had joined me in 87 and Larry Keele had joined me in 86. So the five of us went out and started Oaktree, we didn’t have to figure out what we would do, because we’d already been doing it for almost a decade, and all we had to do was, well, since I write, I sat down, I codified what it is we had been doing, and that became our investment philosophy and our business principles, both of which are published on the web at Oaktreecapital.com, and which we haven’t changed, we’ve added one thing to the business principles, and we haven’t changed a word of the investment philosophy in almost 26 years, and so Oaktree is what I call a culturally driven organization, and so there’s no uncertainty within Oaktree of what we do, it’s written out, it’s there, everybody understands it… We don’t have religious arguments, I say, as I put it, we don’t have battles between the cowboys and the chickens, everybody knows what the route of success is at Oaktree. I wrote in, there was a memo around 02 called The Most Important Thing, which really set the model for the book, which came out in 11, and the book has 21 chapters, 20 in the first edition and 21in a second, ’cause I added one, but each chapter says the most important thing is, And it’s a different thing, because in investing there is no one most important thing, there are many things which are essential and you have to get right. And so that’s why I use that format. But in the memo, it talked about a good partnership, which is the most important thing, and I said in there that, that the most important thing in a partnership, the shared values and complementary skills. And I think that if you work with people who have different values than you do, it’s unlikely to be successful, because it’s gonna be riven by strife and say, the battle between the cowboys and the chickens, because when you go through a bull market, the cowboy say the chickens are holding us back, and when it turns into a bear market, the chickens say the Cowboys are getting us killed, and it’s unlikely to be successful. And then complementary skills, if your skills are duplicative and you have the same strengths, then you probably have the same weaknesses, and the weaknesses can get you into trouble and the strengths are duplicative and what ends up happening is one person eventually says, Well, I can do everything he does and more, I don’t need him, and so he says, I want you to go cut your share, I need more, and that jeopardizes the organization, so shared values and competency skills and that’s one of the things that I’m very proud that we have at Oaktree and it’s worked very well. And Bruce and I now have been partners for almost 35 years, and we’ve never had an argument and I’m very proud of that. We’ve had a lot of heated debates. But no arguments.
Sean: Is there a conversation with Bruce that when I asked that question just comes to mind? A very memorable one for you?
Howard: Well, I mean, the most memorable one, And as I said, we’ve never had an argument, and the most memorable one is not a disagreement, it’s an agreement, but the reason why we were able to so cautious heading into the global financial crisis is ’cause we were in agreement on the state of the world, and you know, I would read the newspaper and I would go into his office, I’d say, look at this, and they would report some new deal that was done, and I would say to him, Look at this piece of crap that was issued yesterday, there’s something wrong. If a security so terrible and so punitive to the buyers can be issued today and can run into excessive demand, then there’s something wrong with the market, ’cause the market is supposed to be a policeman to issuance and the presence of risk-aversion on the part of buyers polices the market, it keeps the market safe and sane, and if nutty securities can be issued which are terribly risky than unfounded, then there’s something wrong, and it was just that simply that turned us cautious in the years leading up to the global financial crisis. And when you avoid the pain of the collapse, which we did, then you have your wits about you then you can swing into action and take advantage of the bargains that are created by the carnage, if you are being hurt every day and your portfolio is breaking down and your companies are turning into basket cases, requiring remediation, you can’t become aggressive, number one, you’re too busy, and number two, you’re too scarred to be able to turn aggressive, and when the world melts down as it did in 08, after the Lehman bankers and you see everybody’s got all these problems that they’re working on, and you kind of have few if any, companies requiring remediation, then you say, Oh man, this is great, I love it, this is a buying opportunity. You can’t do that, if you’re getting beat up every day.
1:00:09
Sean: Survival is the hell of a thing. Howard, I know we’ve gotta close up here in a minute, one of the things that you do a great job of, and I feel like smart people do, is they take the logical words and they put thoughts into things that we’ve thought, but just haven’t been able to articulate. A minute ago, you mentioned codifying down your thinking. I know so many people who are fans of the memos must think, what is that process like when you’re thinking out the next memo?
Howard: First of all, the greatest thing about the memos, well people like them, I’ve been writing for just over 30 years… In the first 10 years, I never had a response. Not only that, nobody said that, that was great. Nobody ever said I got it. Literally how they only went through the clients and they were only a few hundred, and these were the days of mail and to respond, somebody would have to actually pick up the phone and call, look up my number, or put pen to paper and then write it and put the stamp on it, a mail, and put it in the mailbox, and nobody ever did that for 10 years, and I kept going because it was great for me, and first of all, it’s my creative outlet, I love to write, and number two, I have learned so much from writing, and a lot of the things that I think are there because I thought of them during the writing process many times, I write a memo, I go into the writing process, not having thought the thoughts, and thoughts emerge in the writing process, the greatest example is that I was writing a memo on risk in 06, and you know, everybody talks about quantifying risk and so forth, and I wrote down that risk cannot be quantified in advance, risk is the probability of a bad outcome, you can’t measure probabilities of uncertain events, There’s no place you can look I’d say, that at the time I said that risk is the probability of permanent loss, there’s no place you can look to measure the probability of a bad outcome and so that was very important, and I wrote that. I always thought that… And then I kept typing and I wrote And you can’t even figure out the probability of a loss after the fact, you can’t tell whether something was risky after the fact. If you invest 100 and a year later, you sell it for 200, was it risky? You can’t tell. Why? Because the outcome that happened, it was only one of the outcomes that could have happened… We’re back to Taleb and alternative histories. And so, if many things could have happened but didn’t, then you can’t say what the real range of possibilities was, you can’t say what the probability distribution governing that investment was, that is to say you can’t tell whether it was risky, so I love to write. There are two kinds of memos, there are the ones in the moment an event happens, and I think that it’s my job to explain them to my clients, and so I write, as I said, Leman Brothers went under on September 5 and Friday, I walked in the office on the 18th, sat down and wrote a memo and we published it on the 19, I think it was called No What, or something Brilliant like that. And so it doesn’t take long and I do it quickly. Then there are memos which are important in their substance, which are kind of like projects and these I accumulate information clippings, Pile them up ,when I’m ready to go. I start writing, and these can take one to three months because I feel no hurry and I wanna do a thorough job. So I write them over, sometimes quickly, sometimes over time, I don’t feel the pressure, time pressure on the ladder one, so I write a section and then I’ll stop for a week or something like that, and when I next have a thought I’ll write some more, just like with the books, they’re not written under time pressure, take a lot of time, and then you know, I love to edit them because I feel it kind of shaping and polishing like that. And then when they’re ready, there are a few people, I share them with the Oaktree and they give me comments and then they go out.
1:04:48
Sean: I love it. Two of my all-time favorite memos were Risk Revisited, and then Dare to be Great 2, I have all your memos printed out.
Howard: Well I actually think that certainly until recently, I’ve written a couple of good ones, one called You Bet about the comparison gambling point called Getting Lucky, about the importance of luck and how lucky I’d been, and now this one about value. Most people write and say that Something Of Value is the best and the response has been extremely strong, but other than that, I think that RiskRevisited Again, not Risk Revisited but Risk Revisited Again and Dare to be Great 2 are the two best.
1:05:37
Sean: Yeah, Something of Value. Me thinking a lot about my relationship with my father. With Covid, just not getting to spend much time with him, and you made me think I really wanna sit down with him some more and have some deeper conversations, so I need to thank you for that.
Howard: We need it forever, you know?
Sean: Yeah, absolutely. I know we need to wrap up here. Two final things, you’ve mentioned to Taleb, you mentioned a lot of great works throughout the years, any other books that just have really stuck with you throughout all of the years?
Howard: Well, one of my heros with John Kenneth Galbraith, he wrote a book called A Short History of Financial Euphoria, which I thought was very good. And one of the first ones that got me formally thinking about cycles, because what it was about was some of the excesses of optimism that he had seen, and some of the extreme bull markets, Peter Bernstein’s book Against the Gods, which discusses the origin of the science of probabilities, and it’s only because of the creation of the science of probabilities that we can understand and risk and transfer risk. The insurance industry couldn’t exist if there was no sense for the probabilities of bad things happening, which is what we transfer the risk of that to the insurance company, by taking out car insurance and so forth, so Against the Gods was very important. And Devil Take the Hindmost by Edward Chancellor, which talked about things like the South Sea Bubble and Tool of Bubble, and that book was the inspiration for my memo, bubble.com, the first day of 2000, which talked about the excesses of the tech bubble. First of all that, but I wrote that on the 10th anniversary of the first memo, and that’s the first one that got a response, and that’s the one…So I said that after 10 years, I became an overnight success because of bubble.com, and that’s what put me on the map because it was right quickly, remember I said If you’re right but it takes five years, it looks like you’re wrong, this one was right, right away ’cause I did it in 2000, and so… Yeah, that was terrific.
1:08:05
Sean: Howard, you know, I could do this for hours with you. Final one, if you were gonna do this with someone dead or alive, not a family member or a lost friend, anyone throughout history, and you could spend the evening having conversation with, who would it be?
Howard: Probably Ben Graham, I’ve been lucky to spend a good amount of time with Warren Buffett and Charlie Munger especially. And Seth Klarman, who’s one of the people that I think thinks best, maybe because we think the same, but I think that I’d love to spend some time with Ben Graham. That’s
1:08:40
Sean: Fantastic. Well, Howard, you know this, I value just what you’ve been able to teach so many throughout the years, it’s had such an impact on me, so I wanna thank you for that. We’re gonna have all the books, all the memos linked up anywhere else, you want listeners staying connected with you.
Howard: Well, all the memos carry an email address for responses, and I love to get responses and I get a lot, and they’re very gratifying and most people say nice things because they don’t wanna say bad things, and it’s these responses, that keep me going, and I keep them and so I’m always glad to hear on that email address. Great.
Sean: Great, well, Howard, thank you so much for joining us on What Got You There
Howard: Thanks for your questions. It’s been a lot of fun Sean.
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