#234 Howard Marks – Latest Thinking, Spotting Patterns, and Understanding Risk
Big Ideas
- After going through the crash of the Nifty Fifty early in his career to making money steadily and safely, Howard says he has learned two things: it’s not what you buy, it’s what you pay.
“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”
- Howard has learned throughout his years investing that being right too early is indistinguishable from being wrong.
“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.”
- Howard says that it is vital for investors to know themselves and their strengths and to be aware of your strengths and weaknesses that evolve over time.
“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.”
- While Howard is an expert investor, he has also learned many life lessons outside of investing. One of these life lessons is that decisions work best when they are unconventional and correct:
“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”
2:03 Standing Out From The Herd
When asked if there’s something he does every day, Howard says that a necessary condition of outperforming others is staying away from the herd mentality.
“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.”
4:30 Howard’s Competitive Advantage
While Howard is not investing at the individual investment level anymore, he describes his contribution at Oaktree Capital as providing more general direction and helping with the perception of the macro environment. Howard explains that Oaktree’s competitive advantage is that they have 25 different strategies adding up to 140 billion, ranging from 5 billion to 20 billion per strategy.
Even though many other people have increased their assets substantially in the past few years, Oaktree was concerned that the market was vulnerable and they did not increase their assets.
“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”
8:45 Pattern Recognition
When talking about pattern recognition, Howard references author Ray Dalio and his studying of pattern recognition throughout history. Howard describes how whether you are studying history or living through history, you begin to recognize situations that have occurred before and you can just say “oh, it’s one of those.”
“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”
Mark’s says that when you hear someone say “this time is different”, a red light should go off. However, he does reference a Sir John Templeton phrase that 20% of the time, it really is different, and the world does change, and Howard thinks it’s probably around 40% or 50% today with changing prices and rapid technology changes.
“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”
13:03 Howard’s Various Career Interests
Howard says that when he was in junior high he first wanted to be a history professor, then an architect, and in high school he became very interested in accounting.
“I loved accounting because accountings symmetrical, there are always two entries and they balance each other, and I was just attracted to logic”
Howard began his time in college at Wharton as an accounting major but soon switched to finance.
14:16 The Beginning of Howard’s Career
After graduating from graduate school at University of Chicago, Howard applied to six different jobs in six different industries.
The only job in investment management that he applied for was with City Bank which he had worked at during the summers of his time at graduate school. Howard got the job and worked there for sixteen years. During that time, Howard was working in the bank trust departments investing in what was called the ‘Nifty Fifty’, the 50 best and fastest growing companies in America.
“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”
Howard says he was lucky that he wasn’t fired since most clients lost all their money. When a new Chief Investment Officer was brought in to pull City Bank out of the slump and Howard transitioned from working as the director of research to working on a convertible bond portfolio.
“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”
Howard says that in August of ‘78 he got the phone call that changed his life. The phone call was from the head of the bond department saying that ‘some guy named Milken’ in California was working on high-yield bonds and the head of the bond department asked Howard if he could figure them out and Howard said yes.
“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.”
Going from the disaster of the Nifty Fifty investments to making money steadily and safely, Howard says he learned two things: it’s not what you buy, it’s what you pay.
“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”
22:19 Lessons from Third Thursday Group
In the early 70’s, Howard was a member of something called the Third Thursday Group, which was a group of directors of research and senior investors that met on Wall Street for lunch on the third Thursday of every month. Howard says that among the many lessons he learned from these conversations, one of the first smart things Howard remembers hearing is about the three stages to a bull market.
- When very few people, only a gifted few understand that there could be improvement.
- When most people accept that improvement is actually taking place.
- When everybody believes that things can only get better forever
Howard says that investing really comes down to what stage the market is in and what feelings people are guided by.
“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”
26:09 Being Right Too Early
Howard says that one of the greatest lessons he learned early on was that being right too early is indistinguishable from being wrong.
“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.”
Howard references lessons he learned from the following books:
Fooled By Randomness by Nassim Taleb
Lesson: “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”
Decision-Making Under Uncertainty by C. Jackson Grayson
Lesson: “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”
31:07 The Decision Howard is Most Proud Of
Howard says that one of the best decisions he ever made was starting the first distressed fund mainstream financial institution with his partner Bruce Karsh because it has been one of Oaktree’s most successful strategies since ‘88. Howard praises his partner Bruce and says that having a good partnership is very important for success.
“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.”
Howard tells the story of how Bruce and he raised a stand-by fund for investment in distressed in 2007-2008 which was the largest at the time at 11 billion dollars completely uninvested. Later, when Lehman Brothers went down, Howard got support from Bruce to invest aggressively.
“Over the remainder of 08, he invested an average of about 450 million a week for 15 weeks at 7 billion and that’s all you have to do to be successful was buy 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”
36:51 Influences on Howard’s Investing
Howard explains how his parents were adults during The Depression and they taught him to not put all his eggs in one basket and be cautionary with his spending.
“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”
Howard describes how he would not have been successful if he was investing as an optimist or dreamer.
“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 Know Thyself in Investing
Howard says that he did not know himself in the 60s or 70s and his strengths evolved from the 80’s through today.
“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.”
Howard references his favorite quote from English writer Christopher Morley, “There’s only one success to be able to live your life your way”
“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 Familial Differences in Investing
Howard explains how living with his son Andrew and his family during the pandemic has been a huge help for him to understand his biases.
“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”
Howard runs through an example of a conversation about investing that displays their differences when it comes to risk, selling, and holding investments.
“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.”
48:17 Living Life Your Way
Since Howard has written the book, The Most Important Thing Illuminated, Sean asks what Howard would include in a book on the most important thing outside of investing. Howard’s answer: living life your way.
He talks with many students and Wharton, Harvard Business School, Columbia, and other great schools and says they ask him for advice on what they should do. Howard tells them to figure out what will make them happy and not to do something just because everyone else is doing it.
“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.”
Howard says that decisions work best when they are unconventional and correct.
“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 Self Belief at Oaktree Capital
Howard says that self belief was not difficult at the beginning of Oaktree Capital because he was about to turn 49 and the youngest partner was 34, so they had all worked together prior and been successful in their careers.
“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”
Since they already had the recipe for success figured out, all that was left was to write it down. Howard’s creative outlet is writing and so he took the task of codifying what they had been doing, and that became their investment philosophy and business principle.
“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”
1:00:09 Howard’s Memos
Howard has been writing his memos for over 30 years and for the first 10 years he never heard a response from anyone.
“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”
Howard explains the two types of memos that he writes.
Type 1: Memos written in the moment an event happens and Howard explains them to clients
Type 2: Memos which are important in their substance that take 1-3 months to complete
Howard says his favorite two memos he has written are Risk Revisited Again and Dare to be Great 2.
1:05:37 Howard’s Book Recommendations
“ 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”
“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”
“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”
1:08:05 Howard’s First Choice Pick To Interview
If Howard could interview anyone dead or alive, he would choose Ben Graham.
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