Memorandum of Understanding with Howard Marks

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WEBSITE EXCLUSIVE: This week on the Insight Bridge, Greg sits down with Howard Marks, renowned investment professional, celebrated author, co-founder and co-chairman of Oaktree Capital, and seemingly perpetual investment committee member for an exclusive interview.

In this episode, Howard shares the history of his famous memos, his perspective on the markets, and advice for committee members and aspiring investors. Howard explains why the penalty for taking action is often greater than for doing nothing, why investment committees should take a step back, and how aspiring professionals should first and foremost seek happiness—whatever that looks like—to find fulfillment and success in their careers. With decades of investment experience and a lifetime of wisdom on the behavior of the markets, Howard shares his unique perspective and champions the importance of artistry in investment. You won’t want to miss this exciting episode!

Chapters

00:00:33 – Episode Overview

00:01:10 – Welcome and Introduction

00:02:58 – How Howard Got His Start in Investing

00:04:26 – The History of Howard’s Famous Memos

00:10:25 – Advice for Incoming Investment Committee Members

00:16:02 – The Difference Between Managing Money and the Business of Managing Money

00:19:47 – Running a Business in a World Full of Uncertainties

00:24:05 – Howard’s Thoughts on the Current Market

00:36:32 – Words of Wisdom for Aspiring Investment Professionals

SPEAKERS

Howard Marks, CFA

Co-Chairman

Since the formation of Oaktree in 1995, Mr. Marks has been responsible for ensuring the firm’s adherence to its core investment philosophy; communicating closely with clients concerning products and strategies; and contributing his experience to big-picture decisions relating to investments and corporate direction. From 1985 until 1995, Mr. Marks led the groups at The TCW Group, Inc. that were responsible for investments in distressed debt, high yield bonds, and convertible securities. He was also Chief Investment Officer for Domestic Fixed Income at TCW. Previously, Mr. Marks was with Citicorp Investment Management for 16 years, where from 1978 to 1985 he was Vice President and senior portfolio manager in charge of convertible and high yield securities. Between 1969 and 1978, he was an equity research analyst and, subsequently, Citicorp's Director of Research. Mr. Marks holds a B.S.Ec. degree cum laude from the Wharton School of the University of Pennsylvania with a major in finance and an M.B.A. in accounting and marketing from the Booth School of Business of the University of Chicago, where he received the George Hay Brown Prize. He is a CFA® charterholder. Mr. Marks is a Trustee and Chairman of the Investment Committee at the Metropolitan Museum of Art. He is a member of the Investment Committee of the Royal Drawing School and is Professor of Practice at King’s Business School (both in London). He serves on the Shanghai International Financial Advisory Council and the Advisory Board of Duke Kunshan University. He is an Emeritus Trustee of the University of Pennsylvania, where from 2000 to 2010 he chaired the Investment Board.

Host

Greg Dowling

Chief Investment Officer, Head of Research, FEG

Greg Dowling is Chief Investment Officer and Head of Research at FEG. Greg joined FEG in 2004 and focuses on managing the day-to-day activities of the Research department. Greg chairs the Firm’s Investment Policy Committee, which approves all manager recommendations and provides oversight on strategic asset allocations and capital market assumptions. He also is a member of the firm’s Leadership Team and Risk Committee.

Transcript

Greg Dowling (00:02):

Welcome to the FEG Insight Bridge. This is Greg Dowling, head of research and CIO at FEG, an institutional investment consultant and OCIO firm serving nonprofits across the U.S. This show spans global markets and institutional investments through conversations with some of the world's leading investment, economic, and philanthropic minds to provide insights on how institutional investors can survive and even thrive in the world of markets and finance.

Greg Dowling (00:32):

Today on the Insight Bridge, we are honored to have Howard Marks as our guest. Howard is the co-founder of Oaktree Capital Management, but he may be best known for his memos. According to Warren Buffett: "When I see memos from Howard Marks in the mail, they're the first thing I open and read. I always learn something."

Greg Dowling (00:51):

The magic is the clarity in which he distills complex concepts. On today's podcast, we will learn how these memos got started and what his favorites are. He will also share some advice for incoming investment committee chairs and thoughts on current market conditions. It should be a classic. Howard, welcome to the FEG Insight Bridge.

Howard Marks (01:12):

Thank you, Greg. It's great to be with you.

Greg Dowling (01:13):

So for those that don't know you, could you introduce yourself and Oaktree?

Howard Marks (01:18):

Well, Oaktree is a 26-year-old global alternative investments manager with primary DNA in credit. We started in Los Angeles and we now have offices in New York, London, and Hong Kong, and smaller offices elsewhere. We have $150-odd billion under management. I think those are the important demographics.

Greg Dowling (01:41):

If people don't know who Howard Marks is, who is Howard Marks?

Howard Marks (01:44):

Howard Marks is a co-founder. We had 5 founders of Oaktree in '95. I'm now co-chairman with my partner Bruce Karsh. I joined the investment management business in 1969 at Citibank, and I spent 26 years at Citibank and Trust Company of the West and then 26 years here. So exactly half my career trying to figure out where I'm going to spend the next half.

Greg Dowling (02:04):

[laughs]

Howard Marks (02:04):

As you know, Greg, I lead the firm. I'm not an active investor anymore, but I try to provide leadership to the firm, help out on strategic and corporate decisions, write memos to the clients--I'm now in my fourth decade of doing that--and have written a couple of books based on the philosophy expressed in the memos.

Greg Dowling (02:25):

I'll give you a plug. The Most Important Thing is one of my favorite books on investing. It is wonderful.

Howard Marks (02:31):

Thank you very much. Well, I always planned to write a book when I retired, whenever that was going to be. Warren Buffett wrote me in '09 and he said, "If you'll write a book, I'll give you a blurb for the jacket," and that was enough to get me going. I enjoyed writing it and having it out has been very rewarding.

Greg Dowling (02:49):

I feel like--and probably many do because they read your memos and feel like they know you a bit. You've been in global Wall Street for a very long time. I really don't know how you got interested in investing. I know you were born in New York, you grew up in New York, you moved to L.A. But between then, how did you get into the industry? Was there an event that happened in your childhood?

Howard Marks (03:11):

Certainly not in my childhood. There are a lot of people in our business who say, "I've been investing since I was nine. I invested my bar mitzvah money." But I didn't have any such influences. And in fact, I went to Wharton undergraduate expecting to be an accountant--which is what my dad was, and I took accounting in high school and loved it--and switched to finance, but not with a particular profession in mind.

Howard Marks (03:34):

In the summer before years of graduate school at the University of Chicago, I got a job at Citibank in the operations area. Between years of grad school they asked me back, and I said, "I'll do anything except do that again," and they put me in the investment research department. When I was getting out of the University of Chicago, I really still didn't know what I wanted to do. I applied for six jobs in six different fields and in the end went to Citibank because I had had a good summer, enjoyed the work, and liked the people. And so I kind of ended up here in a haphazard way, certainly not a childhood obsession.

Greg Dowling (04:10):

A little serendipity.

Howard Marks (04:11):

Exactly. I'm a big believer in serendipity and in luck.

Greg Dowling (04:14):

You've had a bit of skill along the way, but certainly luck helps. You'd mentioned your memos--and in fact, you actually have a podcast now called The Memo. You've been doing it for 40 years. Do you remember what made you write that first memo and what the topic was?

Howard Marks (04:31):

Remember I said fourth decade, so that means I've been doing it for more than 30 years. I wrote the first one in 1990 and I certainly didn't have a grand plan. I never said, "Oh, I'm going to write memos to the clients annually, quarterly, with any regularity." I didn't know if it would be good for business, but I had some events that happened, two events happened. We talk about serendipity. I'm always interested in the juxtaposition of things. Two events happened that I thought together taught a very important lesson about investing.

Howard Marks (05:00):

And so I said, "Well, that's interesting. I'll write a memo." And I did. Then I think I wrote one the next year, maybe not anything in the year after that, and two after that. It was sporadic at the beginning, until it became more regular. And by the way, I'll mention, Greg, that in the first 10 years, not only did nobody ever say they got it and they enjoyed it, nobody ever said they read it.

Greg Dowling (05:22):

[laughs]

Howard Marks (05:22):

Nobody ever acknowledged receiving it. What started it is a little bit mysterious. What kept me going is totally mysterious. If you do something for 10 years and nobody says, "I got it," what keeps you going? But I did.

Greg Dowling (05:35):

[laughs]

Howard Marks (05:35):

I think the answer is that I wrote for my own enjoyment and because interesting things popped into my mind.

Greg Dowling (05:41):

Did your writing style change over time? When I read your memos--and I think a lot of people feel this way--there's this clarity, there's this...almost this folksiness. You mentioned Warren Buffett. When he writes or talks, he has a similar way of doing it. Very complex, but you kind of boil it down to be like, "Wow, he said that in such a way that it makes complete sense and is understandable." Did that develop over time or did you always have this ability to write?

Howard Marks (06:06):

I think I always had it. That was developed in college. I had one professor in particular who was really demanding on writing. And in those days, in the '60s, if he said, "Change this and change that," you had to retype the whole paper, none of this word processor stuff. That really sharpens your focus and makes you try to do your best on the first draft. I write for clarity; that is my number one goal. I feel the best when people write me back and say, "You made something complex simple." And I think that writing in an everyday voice helps in that regard. I don't try to be sophisticated or show off what I know through complex statements. I try to make it clear, I think that'll improve the reception. And so my rule is I try to write the same as I speak. If you think about it, why wouldn't you?

Greg Dowling (06:55):

That's right. How long does it take you to write a memo?

Howard Marks (06:58):

If it's a big topic and there's no rush, it can take two months. I write a little, I put it down. I get some more ideas, I pick it up. The last memo I wrote, I wrote a bunch of it in October and then I think I just put it down, I wasn't moved to work on it anymore. And then I picked it up and... I think we put it out the day before Thanksgiving, I wanted to give people something to read. That one took about 6 weeks. On the other hand, I could do it in 6 hours. On September--I think it was the 18th--of '08, we walked into the office on a Monday and we learned that Lehman Brothers had gone bankrupt, and I got a memo out that day because then there was urgency.

Greg Dowling (07:34):

Is there one in particular that you remember as being your favorite memo?

Howard Marks (07:39):

There are a couple. It's hard to choose, it's kind of like choosing between your children. I wrote one on risk in '06 and revisited it in '14, and then put out one called "Risk Revisited Again" in 2016, and that was everything I know about risk. And I think it eventually became quite good the third time around. Same year, I think I wrote one called "Dare to Be Great II," which says that if you want to be an outstanding money manager, you have to dare to be different from others. Clearly if you do the same things as everybody else, you can't distinguish yourself. You have to dare to be different, which opens you up to the possibility you have to dare to be wrong. You have to dare to look wrong.

Howard Marks (08:20):

I think that was so important in understanding the essence of investing. Then finally, in February of '07, I wrote one called "The Race to The Bottom," which talks about what happens in a carefree investment environment when there's too much money in the hands of would-be investors and they're too eager to put it to work. So those are all important.

Howard Marks (08:42):

And then of course, on the first day of 2000, I put one out called "Bubble.com" talking about how I viewed the tech sector. I'll always have a fondness for that because that's the one that got me out of purgatory. After I wrote that, it had a huge response and it was correct soon. Those are very important ingredients. Being correct is not enough, you have to be correct soon or else, as they say in our business, "Being too far ahead of your time is indistinguishable from being wrong." That's the one that created an interest in the memos, and as I wrote in the introduction to my first book, that's the one that made me an overnight success after 10 years.

Greg Dowling (09:15):

Probably my favorite would be "Dare to Be Great." I just think there's so many lessons there about managing money that are really important.

Howard Marks (09:23):

Well, the point is it was a little different 50 years ago. Warren Buffett talks about buying dollars for 50 cents, and you could do that. And when you buy a dollar for 50 cents, you have an extremely high probability of being successful. But you can't do that anymore because markets have become more efficient. It is true that if you want to have great outcome, you have to deviate from the herd. And when you deviate from the herd, it's not written down any place that you are right and everybody else is wrong. You may be wrong.

Howard Marks (09:51):

So you have to dare to be wrong. And even if you're right, as I indicated before about the "Bubble.com" memo, even if you're right, you may not be proved right for a few years, in which case you look wrong, and you have to be willing to live with that. You have to have the intestinal fortitude, the financial fortitude, the understanding with your clients, that permits the very patient approach.

Greg Dowling (10:13):

That is well said. Now you have had the honor of serving on a lot of different investment committees over the years.

Howard Marks (10:20):

Yes.

Greg Dowling (10:20):

And that is largely our client base and probably most of our listeners right now. What advice would you give to an incoming committee member right now?

Howard Marks (10:30):

Well, you've come to the right place, because I happen to have a presentation I give on request called "Advice to Investing Institutions," and that's what it's about. What I would say is: number one, you have to have a creed. You have to specify what you believe in. Do you think economic forecasting works? Do you think that active management works? Do you think that markets are efficient? Do you believe in growth? Do you believe in value? Do you believe in being open-minded, etc.? And also, do you want to have a great outcome at the risk of possibly looking bad, or do you want to hug the benchmarks and eliminate the possibility of looking bad and the possibility of looking great? Investing is a business where it's very easy to be average and it's very hard to be above average. Which do you want to do?

Howard Marks (11:14):

Everybody might say, "Well, I want to try to be above average." But remember, you bear the risk of being below average, those two are inseparable. So number one, a creed and a clear statement of what you're trying to accomplish and an understanding of how you think it should be accomplished. Then I think it's really important to create a supportive environment for the staff. What that means is taking a really long-term approach. Everybody says, "Oh, I'm a long-term investor." And then you look at the agenda for the meeting and you see that the first thing is a half-hour discussion of the last quarter's performance. And if you spend a half hour asking people, "Well, why did you do this? And how did you do that? And why were you up this or down that? And why are you behind the index? Why isn't your return as good as so and so's return or the peer group," then you can't possibly foster a long-term approach.

Howard Marks (12:02):

But if it's true in our business, which of course it is, that we sometimes know what's going to happen but we never know when, and that you have to do things and you can't do anything without bearing the risk of looking wrong for a while, clearly only a long-term result matters. The short term doesn't matter. And if you put undue influence on the short-term, then people will not do things in the interest of a good long term which bear risk in the short term, which is essentially everything active. So I think these things are important and the committee should be supportive. Now obviously not supportive unreasonably; if somebody makes a big mistake for bad reasons, you have to bring it to them.

Howard Marks (12:46):

And by the way, I say a mistake for bad reasons. The first book I remember reading when I got to Wharton in 1963 was called Decision Making Under Uncertainty and it was with regard to the oil business. The thing that stood out the most from reading that, which was kind of eye-opening, was that the mark of a good decision is not a good outcome. This is really counterintuitive, superficially. If you think about it for a minute, of course it's right. Given the fact that there are unpredictable and random events that happen in life, every good decision is not going to work, and some bad decisions are going to work. Some good ones are going to fail. You can't possibly say, "You made money, that was a good decision; you lost money, that was a bad decision." You can have a very good, well thought-out decision that takes into account all of the available information, really well-considered, and it fails anyway.

Howard Marks (13:37):

The committee, the board, can't be a jerk about it. They can't just castigate people for everything that didn't work. That would be as silly as bowing down to every decision that does work, because some decisions work for the wrong reason. You make an investment, you think A, B, and C will happen--none of them happen, but D happens and you make money. For example, in March of 2020, who thought that the market would be up 20 for the year? So you have to be understanding of people who didn't think so, and so forth. That's important.

Howard Marks (14:08):

I think that the board... When I chair committees, I try to get them out of the arena of vetting managers. I think that the real essence of the board's performance should be advise and consent, the old Allen Drury book. They should give their advice, they should essentially give their consent to the things that the staff wants to do which make sense, and then get out of the way. They can give the benefit of their experience, and one of the things I try to do when I am the chair is try to get the committee members--presumably more experienced than the staff--to share their wisdom on whether this is the time to be more aggressive than usual or more defensive than usual, but then leave them alone.

Howard Marks (14:47):

And if we, generally speaking, approve a portfolio structure which has asset classes with ranges, for example, the staff should be free to change the allocation within the range. We approve a strategy, let's say venture capital. The staff should be free to pick the managers. I guess what I'm saying is that the committee should not be involved at the micro level, which some people might call meddling or kibitzing.

Howard Marks (15:15):

If you have a CIO and you feel that you have to superimpose your wisdom on hers or his, then you shouldn't have that CIO, in my opinion. You should have a CIO that you are willing to rely on. Because if you tell the CIO what to do, among other things, or meddle or undercut, then when the year is over or the five years are over and you say, "Well, your performance wasn't great, you're in the doghouse," they'll say, "You didn't let me perform. You didn't let me run the show. You told me what to do. You demoralized me, you sapped my confidence, and you didn't follow my advice." So I'm a great one for decentralizing and delegating. You still hold the person responsible, but you don't meddle.

Greg Dowling (15:58):

Those are some really great thoughts on governance, and governance is so important in those types of situations. I wanted to also hear your thoughts and advice on the difference between managing money and the business of managing money, because you've worked in the business and on the business. How are they different?

Howard Marks (16:18):

Managing money, in my opinion, is an art form. You have to assemble a lot of data, absorb it all, figure out the proper conclusions, and take a strategic approach to the world. You have to balance the desire to make money with the desire to avoid losses. You have to plan for the long term, but you have to be able to survive in the short term, and so forth. There's no formula that can be written out for managing money. I don't think that most money management can be turned over to a computer, and certainly if you turn it over to a computer... Every generalization I make, there are exceptions. I would say that you can't turn it over to a computer, but look at Renaissance, for example, and how fabulously they've done. I discussed this in a memo from about six years ago called "Investing Without People."

Howard Marks (17:08):

But the truth is, for the most part, great money management comes from people who see things better than others. Maybe they're smarter, maybe they know more about business, but also there's an intuitive sense. There's a balancing of the interests. I'm not someone who believes that you can foresee the future or predict the future, the macro future--the economy and the markets and interest rates and things like that. Of course, inflation is the topic of the day.

Howard Marks (17:32):

I don't believe that those things can be foreseen, I don't believe that the future is yet determined. There'll be a lot of things between now and then which will influence it. So how can you know what's going to happen? I think of these decisions, especially with regard to the shape of the future, as reaching into a bowl which contains a bunch of balls in a lottery. You may have 90 white ones and 10 black ones.

Howard Marks (17:57):

So you may say, "I'm going to get a white one," and then you reach your hand in the bowl and you get a black one, because improbable things happen all the time and things that are highly likely fail to happen all the time. If you continue with that lottery concept, which I think is highly applicable, what a great investor is, in my opinion, is someone who has a highly superior sense for the balls in the bowl. Companies publish all of their financial information. They don't publish the odds of making money in their stock and nobody else does either. Well, people trust opinions, but you know what opinions are worth.

Howard Marks (18:33):

The point is that the superior investor has a better sense for the balls in the bowl so that she has a sense for the probability of gain and the magnitude, and a sense for the probability of loss and the magnitude, and can figure out whether the probability of gain justifies assuming the probability of loss.

Howard Marks (18:55):

Now, nobody knows these things for sure. They're only probabilistic statements. But I think that superior investors, based on their analysis, can develop a superior appreciation for the probabilities. I've been quoting a statement lately from a former chairman of General Electric who said, essentially, "There is no getting away from the fact that everything we know is in regard to the past and all of our important decisions are with regard to the future."

Howard Marks (19:25):

So you delude yourself dangerously if you think you know what the future holds. 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." And this is very, very important, in my opinion. The superior investor doesn't know it either, but her judgements are, on balance, superior.

Greg Dowling (19:47):

If you are investing and it is an uncertain world full of different probabilities--I think of the Knightian uncertainty principle, University of Chicago, kind of the "known knowns" and "known unknowns" and all that kind of stuff--how do you then run a business that is running a bunch of different strategies in this probabilistic world?

Howard Marks (20:07):

Greg, I think that in business there are two kinds of companies. Well, of course there's a range, it's not just two kinds, but there's two polarities. At one pole you have artisans and at one pole you have factories. I'm much more comfortable being at the artisanal end of the structure. A lot of our peer firms who went public... Well, we went public in '12, but semi-public in '07. A bunch of firms in our area went public starting in '07. You couldn't do it before '07, but in '07 it became popular because of the condition of the market. A lot of them have grown assets much more than we have because we always start with, "The most important thing is doing a great job." And if you get to the factories, most of them don't talk that much about performance. They do a competent job of delivering competent performance, but they don't dare to be great.

Howard Marks (20:56):

In many cases, they have too much money to be great. If you run trillions of dollars, is it really reasonable to think that you could have eye-popping returns? I don't think so. The first decision, in my opinion, is whether you want to be an artisan or a factory. If you want to be an artisan, you put investment performance first, it is the necessary condition. If you are a factory, you might say, "The markets do fine on average, we'll give them average performance and we can confidently do that with huge amounts of money." That's an important choice. And then most of the other decisions follow from that. For example, one of the great decisions is how much money to take.

Howard Marks (21:34):

If you are in the alternative asset classes like we are, and we insist on outstanding performance, then clearly you can't take too much money. You can't take an unlimited amount of money if the good ideas are not infinitely scalable. But if you are in the so-called "beta" asset classes, the mainstream asset classes of stocks and bonds--first of all, you're limited by the efficient market hypothesis which says you can't beat the market, secondly, the facts are, very few people do consistently better than others for long periods of time with huge amounts of money.

Howard Marks (22:05):

Then you say, "Well, we can take all the money we can get." Then the most important thing becomes, number one, marketing; number two, having a control system to make sure that your performance is not very different from the average; and cost control, protecting your profit margins, and so forth. And a lot of advertising and marketing.

Howard Marks (22:24):

These are the keys. I'm not saying one is right or wrong. We know which one is right for us, and I know which one is right for me. At this point in time, I work for nothing. I don't get a paycheck, I don't get a bonus at the end of the year, I don't participate in the profits for many of the funds. My only interest is that I own part of the equity in the company. And, of course, in the long run, I want to make that worth the most, so I work very hard. A lot of the biggest managerial decisions that we have to make involve short term versus long. Everybody wants to do better, everybody wants to presumably make more money and raise the profile of their firm--and maybe themselves--but do you want to maximize in the short run or the long?

Howard Marks (23:03):

Goldman Sachs has a concept they call "long-term greedy," which I think is a good concept. And that's my concept. I want to be known as having started a great firm and I want to have that firm become very valuable in the long run. In my opinion, to do that, sometimes you have to make sacrifices in the short run. For example, you put a limit on your assets under management or the size of individual funds. And you don't say, "We're going to take all we can get," because there's a point where more size has a negative effect on your performance. Usually you can expect that that's a reasonable thing to see happen. So you turn down money and you limit your revenues, and consequently your profits. But if you're an artisan, that's the right thing to do.

Greg Dowling (23:47):

I love it. All right. So you're that great craft beer that's hard to find and can't be mass-produced.

Howard Marks (23:53):

I hope there's something to that, Greg.

Greg Dowling (23:55):

All right. Well, you know what? I would be remiss if I didn't ask you a little bit about the current markets. You have written a lot on cycles.

Howard Marks (24:05):

Yeah.

Greg Dowling (24:05):

So maybe your first thought of cycles and where we could possibly be in that cycle.

Howard Marks (24:11):

Well, first of all, you have to bear in mind that the events of 2020 were not cyclical events. A cycle is kind of a naturally occurring thing that we see in the economy and the markets and in other fields of endeavor. Basically what happens being human is that there's a central trend--and in the economy and in corporate profits it's an uptrend, which is the good news. People's optimism rises, and as their optimism rises, they value securities higher. And they get more and more and more and more optimistic, and they feel better and better. and they buy them at higher and higher prices until a limit is reached. A limit of excessive optimism. And then there's some disappointment, or for some reason things don't go as well as people had hoped and things turn down. And even if the underlying long-term trend is still positive, people stop feeling as good about it.

Howard Marks (25:00):

They start to feel a little worse about it, and then it declines, and then they get sad and they sell and that makes it go down more, and then they get depressed and then we reach an excess on the bottom. And then, of course, that has to correct, because you can't stay at this excessively depressed level forever. So when I think about cycles, I think about--not ups and downs, but excesses and corrections, excesses and corrections. Excess in one direction corrected in the other direction, reaching an excess in that direction and then correcting in the opposite direction.

Howard Marks (25:29):

So this naturally occurring organic process of cyclicality. That's obviously not what happened in 2020. We had an exogenous event, COVID. You might think of a meteor hitting the earth, for example. And then we had an exogenous event which was the man-made recession. We closed down the economy. It's never been done before. We closed the economy. And of course we had the worst quarter in history in the second quarter for GDP, down 34% on an annualized basis.

Howard Marks (25:58):

So the worst quarter since they started keeping statistics in the 40s. Those were not cyclical, so get away from that. However, we had the beginnings of up cycles. The Fed and the treasury were highly activist in injecting liquidity and taking other measures--cutting interest rates, buying bonds--and all the markets turned up for a variety of reasons, ranging from mechanical to financial to technical to psychological, and all of the above. People concluded that the economy would turn up. And by the way, in the third quarter we had the best quarter in history, up 33% on an annualized basis. Then eventually the positive trend asserted itself. So here we are, in answer to your question, a year and a half or a year and three quarters later at the end of 2021.

Howard Marks (26:42):

So cyclically, asset prices are high in historical terms based on historical valuations. Part of that is induced by the Fed. They've cut interest rates so low that people have no alternative but to invest in risk assets to try to get a suitable rate of return. The other thing is that the interest rates play a very direct role in setting valuations. If you think about it for a minute, we have the lowest interest rates in history, so on that basis, we should have the highest valuations in history. In some areas we do and in some areas we don't quite, but the point is--and I said in my memo in July, thinking about macro--that I think that asset valuations are reasonable relative to interest rates and relative to other assets. Now that's not very reassuring because the reasonableness of the asset prices then is based on the level of interest rates, which most people conclude are going to go up--although people have concluded that for a year, year and a half, and it hasn't happened.

Howard Marks (27:39):

Whether valuations are reasonable relative to interest rates or not, they're still damn low. Prospective returns are just about the lowest we've ever seen. Back in '05, '06, '07, I was very worried about the markets so I put all my money other than what was at Oaktree in 1-, 2-, 3-, 4-, 5-, 6-year treasuries. It's what we call a "laddered portfolio." It's the dumbest form of investing known to man. But I made 6% with total safety and total liquidity, and I was ecstatic. If you do that today, you get 1%. So it's hard to be ecstatic. And the lowness of that prospective return tends to push people out the risk curve and they do riskier things to try to get an acceptable return. The question is, how do you get a good return in a low return world? There are no easy answers.

Howard Marks (28:25):

There are a variety of things you can try, but they all have shortcomings. So anyway, I'll try to get back to your question. Asset prices are high. The market cycle is advanced. Some people have tried to call it a bubble, which to me is an irrational level of asset prices--and as I said, for the most part I don't think you can say we're there--but people have been blowing the whistle on this market for over a year and it keeps going up. Asset prices are high. I think because the economic outlook is good--I mean, it's one of the reasons.

Howard Marks (28:55):

Usually, high asset prices occur roughly simultaneously with an advanced stage of the economic recovery. Clearly this economic recovery is just over a year old, and based on the norms, has years to go. So yes, asset prices are high, but the economic outlook is good. That's usually not the case. In other words, the cycles--to get back to your questions--are asynchronous, and that presents a great problem. Of course, it's always a great problem, you never know what to do for sure.

Howard Marks (29:25):

I think given the offsetting features of, on the one hand, high prices, on the other hand, good economic outlook, on the third hand, worry about inflation--I would say that people should be in their normal position with regard to offense versus defense. To me, that's the most important question in your portfolio. Every investor should have a sense for their normal risk tolerance, their normal risk position, and they should normally be there. On rare occasions, they might be so convinced that the market's dangerous and reduce, or so convinced that the market is attractive and become more aggressive, but not very often.

Howard Marks (30:02):

When I was writing my second book, which is called Mastering The Market Cycle, I said to my son who's a professional investor, "I think that over the course of my career my market calls have been about right." He said, "Yeah, dad, that's because you did it 5 times in 50 years."

Greg Dowling (30:17):

[laughs]

Howard Marks (30:17):

I found five occasions in my career when the argument was compelling and the probability of being right was extremely high. Those five essentially worked. I might have missed one or two, so there might have been seven and I only got five, I don't know. But the point is, if you try to do it 50 times or 500 times, and if you try to do it when the markets are not at extremes of high and low, then the arguments become weaker and the probability of being right declines.

Howard Marks (30:46):

And when the market is in the middle range, what I call the "zone of fairness," it's very hard to accurately predict its direction. Remember what I said earlier: we sometimes know what's going to happen, but we never know when. So if you conclude that the market is 5% to 10% overvalued, for example, I don't think you do anything, because markets and individual securities are often overvalued and become more so and more so and more so. Then eventually they get into a bubble where it's unsustainable. But at 5% over intrinsic value or 10% overvalued, the probability of having a decline soon is low and the cost of exiting too soon is high.

Howard Marks (31:30):

Now let me spend a minute on that. The cost of exiting the market is high because of what I said a few minutes ago: the economy, companies, and markets have a positive underlying trend. Based on history so far--and we have no reason to think that the future will be different--if you invested for the long term, you made money. All you had to do was get in and then disconnect your phone. No matter when you got in, you made a lot of money. I joined the business in '69, and if you put a dollar in the S&P when I joined, as I recall, it wasn't worth a dollar again until 1987. But if you put that dollar in in '69 and left it in for the last 52 years, it's probably worth... I don't know, what's it worth, Greg, $20, 30, $40? You know?

Greg Dowling (32:15):

Yeah.

Howard Marks (32:16):

You got fabulously rich. All you had to do was get on board and don't screw it up by jumping in and out.

Greg Dowling (32:24):

I like that. Strategic inaction.

Howard Marks (32:26):

Exactly. They used to say, "Don't just sit there, do something." I would say, "Don't just do something, sit there."

Greg Dowling (32:31):

I love that. Market timing is very difficult and to paraphrase--I don't know if you said it or you wrote it, but I remember reading or hearing that you said, "You should only do something when things are very black and white, but most times the world is gray and shades of gray." And you're saying right now that we're in this pattern of shades of gray because things are a little bit weird, right, COVID?

Howard Marks (32:54):

Yeah. Look, I'm worried. I'm worried about the elevated level of prices. I'm worried about the likelihood that inflation will stay--not at six, but at four or three. I'm worried about the likelihood that interest rates will go up and take valuations down. I'm worried about China. I'm worried about Ukraine. I'm worried about Omicron. There's a ton of things to worry about. And so it's easy to say, "I'm worried. I'm getting out." But you should worry about getting out and having it be a mistake. Eight or 9 times out of 10, the market goes up each year. So 80%, 90% of the time it's a mistake to reduce. It's not always a mistake. If you get out because you're worried, not only do you have to be right and see the market decline, but then you have to make another good decision to get back in.

Howard Marks (33:39):

I can tell you from observation, on the rare occasions when people get out and the markets collapse, what they do is they pat themselves on the back, they say, "That was a great decision," and they sit there and they watch it go back up. Last year, 2020, a few smart people cut their exposure in February or the beginning of March. And they felt great on March 23. The S&P went from 3,300 on February 19 to 2200 on March 23. That's 32 days, a 1/3 decline. But I don't know anybody who got back in. And certainly individuals or--what can I say--less sophisticated investment committees should not try market timing. The best can rarely do it. It's especially not recommended given the high probability of market gains, on average. Now you can't live your life by the averages. But look, the market has gone up about 9%+ a year for the last 90 years. University of Chicago work showed that.

Howard Marks (34:43):

So let's be conservative and let's say the normal expectation for the next 90 years is 7%. That's quite low, but reasonable. At 7%, your money doubles every 10 years. If you're 25 years old and you're going to have investments for 60 years, if you put in $100 today, it becomes worth--2, 4, 8, 16 32 64--$100 becomes $6,400. Now that assumes you leave it in, it compounds at 7, you pay no taxes. But boy, that's a hell of a machine to get in the way of and to tamper with. For most people, the default solution should be to get in and stay in. And by the way, get in doesn't mean put all your money on red or on number 22. It means figure out what the appropriate normal risk posture for you and your organization is. Get there and stay there.

Howard Marks (35:36):

Now that has certain benefits, because let's say... We used to say for institutions the normal posture is 60/40 stocks versus bonds. This is an old-fashioned notion, obviously there's no alternative investments or anything like that, but 60/40. You say, "That's our normal position we're going to do that." And then the stock market goes on a great tear and you find that you're now at 75/25. Guess what? You go back to 60/40 and that automatically results in profit-taking and trimming your exposure. If the market collapses and stocks get down to 45% of your portfolio, sell some of your bonds. Your bonds probably went up, they do well in recessions. Sell some of your bonds and take it back to 60% stocks. So normal risk posture with automatic stabilization is a great tool and it doesn't require a lot of brilliance. That's the good news.

Greg Dowling (36:27):

We've covered a lot of ground here. I did want to ask you one final question. If your grandchild came to you and said, "Hey, I'm thinking of getting into the industry," what advice would you tell them?

Howard Marks (36:40):

First of all, there's no advice that's good for everybody, because everybody is different. And whenever anybody asks me for personal advice and career advice, I go back to Christopher Morley, an English writer, who said, "There's only one success. To be able to live your life your own way." And for many people, including me early on, the hard part is figuring out what your way is. What will make you happy in your life and how can you set the groundwork? Having said that, okay, I think that investing is a great area. It is creative. It's not just the green eyeshade type. I wanted to be an accountant, that's the green eyeshades. Even they have to make decisions between methods sometimes, but investing is not green eyeshade because so much of it involves the future and making judgements about the future.

Howard Marks (37:22):

It is very creative. Superior investing comes from seeing things other people don't see, and clearly that can't be easy, because if everybody could see it that way, they would. I think that investing requires some superior insight. Some intuition, if you will, educated intuition. But I find it great. It has evolved enormously in my time in the markets. It still changes every year, or every month. The things you did yesterday that were successful may not work tomorrow. I find that exciting, stimulating. But is that a good thing for your grandchild? Depends on your grandchild's personality.

Howard Marks (37:57):

If your grandchild is going to be frustrated... The greatest batter in the history of baseball got a hit 40% of the time. And the greatest investor may be right 60% or 65% of the time. If your grandchild's going to be frustrated at being wrong 40% or 35% of the time, then they shouldn't be an investor.

Howard Marks (38:14):

There's an interesting book called Fooled by Randomness. Nassim Nicholas Taleb talks about the role of randomness in investing and talks about some of these concepts like the fact that you can be right for the wrong reason or wrong for the right reason or whatever. But he constantly contrasts investing with dentistry. He says, "If you go to dental school and you learn how to fill a cavity and you fill it that way every time, you're successful every time. So the dentist can bat 1000, the great investor can bat 600, which one will make you happy?" Most of the investors I know would probably be bored stiff being dentists. And a lot of dentists would be terrified being investors. So you have to figure that out. I keep coming back to the word "creative," Greg. I'm lucky because I found some inefficient markets and I went in when nobody else was there. By definition, that can be terrifying, but that's how you accomplish great things.

Howard Marks (39:01):

My favorite fortune cookie said that, "The cautious seldom err or write great poetry." And I think that says it all. What is your goal in life? Some people want to avoid error, some people want to write great poetry, and the right advice clearly is not appropriate for both of them. What do you want to accomplish in life? What will make you happy? The bottom line for me on career advice, what I tell people is: "Find something that'll make you happy, because you only get one life and you spend more time working than any other waking activity. It should make you happy." Most of the people that are going to hear this podcast have the ability to do the things that will make them happy if they can figure it out. So do something that'll make you happy, do something that plays to your strengths, do something that avoids your weaknesses. And I think if you can do those three things, you're on the road.

Greg Dowling (39:50):

That is well said, and thank you for sharing the wisdom that you have collected over many, many years, and that you even found in fortune cookies.

Howard Marks (40:00):

Thank you.

Greg Dowling (40:01):

Thanks, Howard.

Howard Marks (40:02):

Pleasure to be here, Greg.

Greg Dowling (40:04):

If you are interested in more information on FEG, check out our website at www.feg.com and don't forget to subscribe to our communications so you don't miss the next episode. Please keep in mind that this information is intended to be general education that needs to be framed within the unique risk and return objectives of each client; therefore, nobody should consider these to be FEG recommendations. This podcast was prepared by FEG. neither the information nor any opinion expressed in this podcast constitutes an offer or an invitation to make an offer to buy or sell any securities. The views and opinions expressed by guest speakers are solely their own and do not necessarily represent the views or opinions of their firm or of FEG.

 

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This was prepared by FEG (also known as Fund Evaluation Group, LLC), a federally registered investment adviser under the Investment Advisers Act of 1940, as amended, providing non-discretionary and discretionary investment advice to its clients on an individual basis. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Fund Evaluation Group, LLC, Form ADV Part 2A & 2B can be obtained by written request directly to: Fund Evaluation Group, LLC, 201 East Fifth Street, Suite 1600, Cincinnati, OH 45202, Attention: Compliance Department. Neither the information nor any opinion expressed constitutes an offer, or an invitation to make an offer, to buy or sell any securities. The information herein was obtained from various sources. FEG does not guarantee the accuracy or completeness of such information provided by third parties. The information is given as of the date indicated and believed to be reliable. FEG assumes no obligation to update this information, or to advise on further developments relating to it. Past performance is not an indicator or guarantee of future results. Diversification or Asset Allocation does not assure or guarantee better performance and cannot eliminate the risk of investment loss. The views or opinions expressed by guest speakers are solely their own and do not represent the views or opinions of Fund Evaluation Group, LLC.

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