HOWARD MARKS ON INVESTOR PSYCHOLOGY

This section has clippings from the book “The Most Important Thing” authored by respected Howard Marks. I feel pride to say that I am a complete follower of Howard Marks’ principles because an investment is incomplete without understanding him. It is essential to imbibe the entire book, which investors can buy from online store.

Warren Buffett:

“When I see memos from Howard Marks in my mail, they’re the first thing I open and read. I always learn something”

 

Howard Marks:

In the world of investing, most people find it terribly hard to sit by and watch while others make more money than they do.

  • How can people be unhappy making 16 percent a year and happy making 3 percent? The answer lies in the tendency to compare ourselves to others and the deleterious impact this can have on what should be a constructive, analytical process.
  • Given that we don’t know exactly which future will obtain, we have to get value on our side by having a strongly held, analytically derived opinion of it and buying for less when opportunities to do so present themselves. 
  • We have to practice defensive investing, since many of the outcomes are likely to go against us. It’s more important to ensure survival under negative outcomes than it is to guarantee maximum returns under favorable ones.
  • Where are the leading competitors from the days when I first managed high yield bonds twenty- five or thirty years ago? Almost none of them are around anymore. And astoundingly, not one of our prominent distressed debt competitors from the early days fifteen or twenty years ago remains a leader today. Where’d they go? Many disappeared because organizational flaws rendered their game plans unsustainable. And the rest are gone because they swung for the fences but struck out instead.

At Oaktree, on the other hand, we believe firmly that “if we avoid the losers, the winners will take care of themselves.” 

Personally, I like caution in money managers. I believe that in  many cases, the avoidance of losses and terrible years is more easily achieved than repeated greatness, and thus risk control is more likely to create a solid foundation for a superior long- term track record. Investing scared, requiring good value and a substantial margin for error, and being conscious of what you don’t know and can’t control are hallmarks of the best investors I know. 

“Dare to Be Great,” September 7, 2006

  • For example, consider this conundrum: Many people seem unwilling to do enough of anything (e.g., buy a stock, commit to an asset class or invest with a manager) such that it could significantly harm their results if it doesn’t work. But in order for something to be able to materially help your return if it succeeds, you have to do enough so that it could materially hurt you if it fails. 

Defensive investing sounds very erudite, but I can simplify it: Invest scared! Worry about the possibility of loss. Worry that there’s something you don’t know. Worry that you can make high-quality decisions but still be hit by bad luck or surprise events. Investing scared will prevent hubris; will keep your guard up and your mental adrenaline flowing; will make you insist on adequate margin of safety; and will increase the chances that your portfolio is prepared for things going wrong. And if nothing does go wrong, surely the winners will take care of themselves.

“The Most Important Thing,” July 1, 2003

  • Everyone knows assets have prospective returns and risks, and they’re possible to guess at. But few people understand asset correlation: how one asset will react to a change in another, or that two assets will react similarly to a change in a third. Understanding and anticipating the power of correlation— and thus the limitations of diversification— is a principal aspect of risk control and portfolio management, but it’s very hard to accomplish. The failure to correctly anticipate co- movement within a portfolio is a critical source of investment error.

In heady times, capital is devoted to innovative investments, many of which fail the test of time. Bullish investors focus on what might work, not what might go wrong. Eagerness takes over from prudence, causing people to accept new investment products they don’t understand. Later, they wonder what they could have been thinking.

  • The global crisis provided a great opportunity to learn, since it entailed so many grave errors and offered up the lessons enumerated in my December 2007 memo. Pitfalls were everywhere: investors were unworried, even ebullient in the years leading up. People believed that risk had been banished, and thus they need worry only about missing opportunity and failing to keep up, not about losing money. Risky, untested investment innovations were adopted on the basis of shaky assumptions. Undue weight was accorded opaque models and “black boxes,” financial engineers and “quants,” and performance records compiled during salutary periods.
  • Finally, it’s important to bear in mind that in addition to times when the errors are of commission (e.g., buying) and times when they are of omission (failing to buy), there are times when there’s no glaring error. When investor psychology is at equilibrium and fear and greed are balanced, asset prices are likely to be fair relative to value. In that case there may be no compelling action, and it’s important to know that, too. When there’s nothing particularly clever to do, the potential pitfall lies in insisting on being clever.

The superior investor never forgets that the goal is to find good buys, not good assets.

  • Most trends— both bullish and bearish— eventually become overdone, profiting those who recognize them early but penalizing the last to join. That’s the reasoning behind my number one investment adage: “What the wise man does in the beginning, the fool does in the end.” The ability to resist excesses is rare, but it’s an important attribute of the most successful investors.
  • Most investors think diversification consists of holding many different things; few understand that diversification is effective only if portfolio holdings can be counted on to respond differently to a given development in the environment.
  • Risk control lies at the core of defensive investing. Rather than just trying to do the right thing, the defensive investor places a heavy emphasis on not doing the wrong thing. Because ensuring the ability to survive under adverse circumstances is incompatible with maximizing returns in good times, investors must decide what balance to strike between the two. The defensive investor chooses to emphasize the former.

Risk control and margin for error should be present in your portfolio at all times.  

 

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