#53 Howard Marks: Luck, Risk and Avoiding Losers
Guest Howard Marks, co-chairman of Oaktree Capital Management, discusses risk assessment, market cycles, and contrarian investing. He emphasizes overcoming emotional biases, the importance of second-level thinking, and the role of economic reality in policy, while also sharing insights on parenting and personal development.
Deep Dive Analysis
17 Topic Outline
Oaktree Capital's Response to the 2008 Financial Crisis
Overcoming Emotional Biases in Investment Decisions
The Nature of Markets and Investor Psychology
Learning from Experience and Cultivating a Supportive Culture
Distinguishing Between Bad Decisions and Bad Outcomes
Understanding Economic Cycles and Human Excesses
The Federal Reserve's Role in Economic Stability
Government's Role in Redistribution and Taxation
Economic Reality Versus Political Reality
Globalization, Specialization, and Trade Deficits
The Inherent Unfairness and Importance of Luck
Universal Basic Income and the Future of Work
Impact of Automation and Technology on Jobs
Defining and Managing Investment Risk and Uncertainty
Second-Level Thinking for Superior Investment Performance
The Three Mighty Dares for Exceptional Investing
Parenting: Teaching Kids About Money and Life Lessons
8 Key Concepts
Cycles (Economic/Market)
Cycles are fluctuations in economic or market conditions that occur because people commit excesses, usually out of enthusiasm, which then require painful corrections. These corrections often overshoot to the downside, creating a continuous pattern of expansion and contraction.
Market (Investment)
An investment market is not a physical building or a stock certificate, but rather a collective of individuals who act on their views of value through transactions. These individuals are influenced by emotions, which can lead to irrational buying at highs and selling at lows.
Bad Decisions vs. Bad Outcomes
It's crucial to distinguish between a bad decision and a bad outcome because the quality of a decision cannot be judged solely by its result. In an uncertain world, improbable things happen, and probable things fail to happen, meaning a good decision can still lead to an unfavorable outcome due to luck or chance.
Economic Reality
Economic reality refers to the fundamental constraints and principles governing economic activity, such as the inability to get something for nothing or defy supply and demand. It dictates that choices involve trade-offs and that actions have consequences, often in contrast to political rhetoric.
Political Reality
Political reality describes the tendency of politicians to make promises that do not align with economic realities, often suggesting benefits without acknowledging costs or sacrifices. This approach aims to appeal to voters by implying that all desires can be met without trade-offs.
Globalization
Globalization is the process of increasing worldwide interdependence and integration, primarily driven by the benefits of specialization. It maximizes global economic output by allowing countries to focus on what they do best, but it can create winners and losers at the individual level within nations.
Risk (Investment)
In investing, risk is defined as the probability of bad outcomes, encompassing both the probability of losing money and the probability of missing out on potential gains. It exists because the future is uncertain and represents a range of possibilities, some of which may not even be known.
Second-Level Thinking
Second-level thinking is a superior approach to investing that involves thinking differently and better than the crowd. Since average thinking leads to average results, it requires identifying mistakes others are making, understanding why their views are wrong, and holding a divergent, yet correct, point of view.
12 Questions Answered
Oaktree Capital chose to invest heavily during the crisis, believing that if the financial system did not melt down, it would be the best possible environment for investment. They deployed $10 billion over 15 weeks in late 2008.
Investor emotions, such as fear and greed, tend to drive people to buy more as prices rise and sell more as prices fall, making it very difficult to take contrarian actions against prevailing sentiment.
By having mutually supportive partners, recognizing the difference between bad decisions and bad outcomes, and avoiding criticism for mistakes, an organization can become less mistake-averse and more focused on risk control.
Economic cycles are fundamentally caused by human excesses, where enthusiasm leads to overshooting in economic activity, which then necessitates painful corrections that often overshoot to the downside.
The Federal Reserve and other central banks are primarily charged with controlling inflation and, more recently, supporting employment, which can be conflicting goals requiring skillful management.
Government policies like tax cuts can stimulate the economy, but overstimulating a healthy economy can lead to excesses that eventually require correction, potentially through higher interest rates, increasing the risk of recession.
A trade deficit means a country buys more goods from another than it sells, often because those goods are cheaper or better, which benefits consumers with lower prices but can lead to job losses in domestic industries.
Technology and automation significantly displace jobs by increasing productivity, meaning more output with fewer workers, posing a challenge for finding new labor-intensive industries to employ those displaced.
Probability describes the likelihood of various future events, while outcome is what actually happens; even if the probability distribution is known, the specific outcome of a single event remains uncertain.
Second-level thinking involves diverging from the crowd's consensus, analyzing why others might be wrong, and holding a different, superior point of view. It is crucial because thinking like everyone else only leads to average results.
To achieve superior performance, an investor must dare to be different, dare to be wrong, and dare to look wrong, as taking necessary risks and engaging in idiosyncratic behavior often appears incorrect in the short term.
Parents should talk openly about money, keep it in its proper place, instill a sense of its finiteness, allow children to manage their own finances (e.g., paying bills), and let them make non-lethal choices to learn from mistakes.
32 Actionable Insights
1. Counter Emotional Investing
Recognize that emotions often lead investors to buy at market tops and sell at market bottoms. Act contrarian to these emotional impulses to avoid making common mistakes.
2. Practice Second-Level Thinking
To achieve above-average results, cultivate thinking that diverges from the crowd and is also correct. This involves understanding what others think, why they think it, and identifying where their consensus might be wrong.
3. Dare to Be Different
To achieve superior performance, be willing to diverge from the pack, be wrong, and appear wrong in the short term. This enables the idiosyncratic behavior and risk-taking necessary for success.
4. Evaluate Decisions, Not Outcomes
Understand that a good decision can lead to a bad outcome due to uncertainty and luck, and vice versa. Avoid criticizing people solely based on bad outcomes, especially in the short run, to encourage good decision-making.
5. Prioritize Risk Control
Make risk control a primary focus in your strategy, as securing against worst outcomes allows potential winners to emerge naturally. This mindset helps manage downside even in aspirational strategies.
6. Assess Probability Distributions for Risk
Manage risk by forming a clear view of the probability distribution of future events, identifying most likely, least likely, and intermediate outcomes. Base your decisions on this understanding.
7. Avoid Unsurvivable Risks
When making decisions based on expected value, always consider if any potential outcomes are unsurvivable. Adjust your choices to align with your personal risk tolerance, even if it means foregoing the highest expected return.
8. Invest During Crises
During a financial crisis, if you believe the system won’t melt down, you must invest because it’s the best environment for returns. Not investing would be an abdication of responsibility, and preparing for total meltdown is often disastrous under normal circumstances.
9. Develop Variant Perception
Cultivate the ability to see things others miss and identify mistakes in conventional thinking. This variant perception is crucial for developing unique, correct insights that lead to superior outcomes.
10. Question Market Expectations
Don’t just focus on whether an event or company is good; critically analyze if market expectations for it are already too high. If positive outcomes are already priced in, even favorable events may not lead to profitable investments.
11. Cultivate Blame-Free Environment
Create an organizational culture where mistakes are not second-guessed or blamed. This prevents people from becoming mistake-averse and encourages the risk-taking necessary for success.
12. Hire Unemotional, Mellow Individuals
When hiring, prioritize candidates who are not overly emotional, egotistical, or prone to hubris. These traits contribute to a more stable and effective organizational culture, especially in high-stakes environments.
13. Prioritize Hiring Desired Traits
Acknowledge the specific personality traits you value in employees and make hiring for those traits a high priority. This increases your chances of building the desired team and culture.
14. Continuously Refine Thinking
Actively engage in refining and reflecting on your thoughts and understanding to continuously improve your intelligence and perspective over time.
15. Read Broadly to Get Smarter
Read widely across various subjects not just for specific professional goals, but to continuously challenge your thinking, expand your knowledge, and become generally smarter.
16. Acknowledge Luck in Success
Recognize that luck plays a significant, often unfair, role in success. Embracing this perspective can foster a positive attitude and a sense of gratitude, rather than self-deprecation.
17. Cultivate a Thankful Heart
Acknowledge and appreciate your good fortune, as a thankful heart is considered the parent of all other virtues. This perspective can foster a positive attitude and encourage sharing your success with others.
18. Live Without Regret
Strive to lead a life that you will be happy with when reflecting on it later. Self-perception at the end of life is crucial, and regret over how one lived is a tragedy.
19. Practice the Golden Rule
Apply the Golden Rule in your interactions, treating others as you wish to be treated. This is fundamental to being a good person, earning respect, and being liked for the right reasons.
20. Prioritize Respect and Care
Cultivate a family and personal ethos of respecting and caring for others, focusing on team efforts and collective success rather than individual advancement at the expense of others.
21. Understand Economic Reality
Recognize that economic realities, such as global tax rates and supply/demand dynamics, define the true playing field and rules. Attempts to contravene them through policy often lead to unintended negative consequences.
22. Question Political Promises
Be skeptical of political promises that suggest you can have everything without sacrifice or cost. These often disregard fundamental economic realities and the necessity of choices.
23. Understand Tariff Impact
Recognize that tariffs are ultimately paid by consumers through higher prices, not by the foreign country. This understanding is crucial for evaluating the true economic impact of trade policies.
24. Foster Honest Discussions
Engage in thoughtful, honest, and objective discussions, avoiding partisan fighting. This helps collectively arrive at decisions that maximize welfare for the most people.
25. Support Bipartisan Solutions
Support efforts that foster bipartisanship and open communication between opposing political sides to find reasonable solutions. This prevents polarization from hindering problem-solving.
26. Talk Money with Children
Engage children in open discussions about money and responsible financial decisions from an early age. This helps them develop good attitudes towards money and understand its real-world implications.
27. Teach Money’s Finiteness
Instill in children the understanding that money is finite, regardless of wealth, and that wasting it can lead to trouble. This encourages good financial decision-making and responsible spending habits.
28. Don’t Insulate Kids from Bills
Allow children to experience the reality of bills and financial obligations, rather than insulating them. This helps them understand where money comes from and develop responsible habits.
29. Resist Peer Pressure in Parenting
Avoid letting the possessions or experiences of other children dictate what your own children should have. Saying ’no’ and establishing family values builds character and teaches important lessons about choices.
30. Empower Kids with Choices
Allow children to make non-lethal choices to foster their decision-making skills and build trust. This experience is crucial for their development and confidence.
31. Allow Kids to Make Mistakes
Do not insulate children from making mistakes, as early mistakes (non-lethal) provide valuable learning experiences, improve decision-making processes, and teach resilience for future challenges.
32. Keep Money in Perspective
Teach children to keep money in its proper place, not as the ultimate measure of a person’s worth or merit. This fosters healthy attitudes towards wealth and poverty.
9 Key Quotes
In the real world, things fluctuate between pretty good and not so hot. But in the investment world, investors go from, you know, perfect to no chance of survival in their psychology.
Howard Marks
Physics would be much harder if electrons had feelings.
Richard Feynman (quoted by Howard Marks)
Improbable things happen all the time and probable things fail to happen all the time because the world is an uncertain place.
Bruce Newberg (quoted by Howard Marks)
Doctors do not give adrenaline to healthy patients. They give it to people who are having heart attacks.
Howard Marks
Governments don't make anything. All they do is redistribute.
Howard Marks
The thankful heart is not only the greatest of all the virtues, but it is the parent of all the other virtues.
Cicero (quoted by Howard Marks)
Risk means more things can happen than will happen.
L. Roy Dimson (quoted by Howard Marks)
Everything that's important in investing is counterintuitive, and everything that's obvious is wrong.
Howard Marks
The future is not ours to know, but it helps to know that being wrong is inevitable and normal, not some terrible tragedy, not some awful failing in reasoning, not even bad luck in most instances.
Howard Marks
2 Protocols
Oaktree's Crisis Investment Approach (2008 Financial Crisis)
Howard Marks- Acknowledge that the meltdown of the financial system is not knowable or subject to intellectualization.
- Recognize that any actions taken to prepare for a meltdown would be disastrous under normal circumstances.
- Conclude that if the financial system does not melt down, a crisis presents the best possible environment for investing.
- Commit to investing, accepting that the pace might feel too fast or too slow at times.
- Invest consistently over a period of weeks (e.g., $650 million a week for 15 weeks).
Parenting Approach to Financial Literacy and Character Development
Howard Marks- Talk openly and responsibly about money with children, not insulating them from financial discussions.
- Keep money in its proper place, avoiding the notion that wealth equates to merit.
- Instill a feeling of finiteness regarding money, teaching that it should not be wasted and requires good decisions.
- Allow children to manage their own finances (e.g., paying credit card bills) to understand accountability.
- Avoid letting what peers have dictate what your children should have; prioritize character over material possessions.
- Emphasize respect for others, caring for others, and working as part of a team for collective success.
- Teach the importance of kindness, the golden rule, and being liked and respected for good reasons.
- Allow children to make non-lethal choices to develop decision-making skills and learn that mistakes are normal and survivable.