Howard Marks, a fellow Chicago alum, runs Oaktree Capital and is known for his concise and colorful memos (http://www.oaktreecapital.com/memo.aspx), which have gained the status of Warren Buffett's shareholder letters in the financial perspective oeuvre.
He came to LSE to speak and I jotted down a few notes. Keep in mind that I tend to only jot notes on items personally interesting to me, which is likely a very different set from those that would be interesting to the rest of the world.
After taking a few moments to indulge in that newly-resurrected-and-made-socially-acceptable hobby of efficient-market-bashing, Marks offered some principles for investing with his usual folksy charm.
1. The average is not the norm
Or in other words, you can't ignore the outliers. Not just the Black Swans, but all the outliers. You can understand this at a surface level, but there are significant implications for how you try to model the future when the validity of averages is in question. Some might ask, what's the point of putting together a model at all if your "sensitivity" analysis is a football field wide in scope?
2. "I know" vs. "I don't know" school
Some people belong to one, some to the other. Do you always start with what you know? Do you feel like you have a good understanding of the principles that drive the world? Or are you constantly aware of the massive uncertainty that pervades the world? Are you comfortable with saying "I don't know" frequently to people you respect? The difference between these schools of thought is the difference between playing offense or defense. Marks is of the "I don't know" school. He thinks you might do well with both strategies but every once in a while, playing offense in markets will result in a blow-up. Taleb is also of this school - he never sells options, only buys them (though I wonder if this intellectual subscription is in contrast to his natural propensity).
I'm also a fully paid-up member of the "I don't know" school. The name of this blog is no coincidence. However, I wonder whether this must by necessity be a continuum rather than a binary choice. You can't operate very well in an objective reality without some "I know." The question remains then how do you know what can be known, how do you decide what you will seek to know, and what do you leave in the effectively enduring realm of uncertainty?
[Speaking of schools of thought, are you an asker or a guesser?
http://www.guardian.co.uk/lifeandstyle/2010/may/08/change-life-asker-guesser]
3. Bull and bear markets are driven by mass psychology
The 3 stages of a bull market: (1) A knowledgeable few think things will get better; (2) Most people recognize improvement is underway; (3) Everyone believes things will get better forever
The 3 stages of a bear market: (1) A knowledgeable few think the market is overpriced; (2) Most recognize that a decline is taking place; (3) Everyone believes things will get worse forever
4. Beware the twin impostors of short-term success and short-term failure
The correctness of a decision can't be judged by the outcome. You never know whether you were just lucky. It is the process and protocols that must be judged, and the only way to do so is over time.
Interestingly, I asked Marks how Oaktree judges decisions if not by outcomes, how do they grade their investment professionals. He basically said they don't, going on a tangent about how they want to promote collaboration rather than competition and therefore don't do a lot in the way of individual variable compensation. But of course they grade their individual employees, implicitly if not explicitly. For someone that seems to put significant weight on process, I'm surprised they don't have an established protocol for grading decisions, at least qualitatively.
5. Develop an appreciation for "alternative histories"
This is related to the previous point. All the other things that could have happened should be part of one's context for "now." I've always thought this. Like, perhaps in another forked universe, I am poverty-stricken, uneducated and a paraplegic, and I begged the divine fates for the life I have now, and poof! Here I have this golden life but never have a full appreciation of what could have been. In the same way, we always view what is, as inevitable. We forget that at the point of a decision - say, one of Alan Greenspan's more destructive decisions - no one knew what the right decision should be. We still don't know what the best decision would have been. We only know that there were certain effects that stemmed from one particular fork.
[By the way, while Alan Greenspan from his actions seems to be of the "I know" school, this quote from him indicates that he has a foot in both: "I say this without a great conviction because anyone who has a great conviction at this stage about what the economy is doing or what proper policy is I think is under a mild state of delusion."]
6. Three individual traits for investing success
Aggressiveness, Timing and Skill. It's very hard to have all three traits at once. If you think you do, you probably don't.
7. Invest in the most complicated investments that you can fully understand
Marks didn't say this but he did make the point that the more simple and intuitive the investment, the more likely it is that the value has already been baked into the current share price. If you believe, as I do, that you shouldn't make an investment without fully understanding it, then that means you should invest near the top of your intellectual capability.
8. The problem of commitment
The problem of commitment is quite intuitive. There are not that many large opportunities out there. They are relatively rare. If you talk to a trader, they make most of their money on a few big trades (a la John Paulson). The same, in principle, holds true for investment managers. In order to reap the benefits of a potentially large opportunity, you have to commit a sizable amount of capital. But in so doing, you take on some nontrivial amount of risk (almost by definition).
9. Good judgment is the ability to make optimal tradeoffs with available information; great judgment is knowing what information to use
Marks says: "Everyone has an opinion; it doesn't mean it's right"
This is the critical problem. Your intuition is sometimes right and sometimes wrong. Your intuition likely tells you roughly the same as everyone else's intuition, our biology being shared. When it conflicts with everyone else's intuition, your intuition tells you that you should share their intuition, making you doubt your own. But their intuition is also sometimes wrong. So what do you do? You can try to institutionalize judgment using models and formulae, but what you get in a complex system tends to be uselessly predictable. Great judgment is hard to come by.
For a concatenated PDF book of Howard Marks' memos:
http://streetcapitalist.com/2009/09/26/oaktree-capital-memos-from-our-chairman-1990-2009/
He came to LSE to speak and I jotted down a few notes. Keep in mind that I tend to only jot notes on items personally interesting to me, which is likely a very different set from those that would be interesting to the rest of the world.
After taking a few moments to indulge in that newly-resurrected-and-made-socially-acceptable hobby of efficient-market-bashing, Marks offered some principles for investing with his usual folksy charm.
1. The average is not the norm
Or in other words, you can't ignore the outliers. Not just the Black Swans, but all the outliers. You can understand this at a surface level, but there are significant implications for how you try to model the future when the validity of averages is in question. Some might ask, what's the point of putting together a model at all if your "sensitivity" analysis is a football field wide in scope?
2. "I know" vs. "I don't know" school
Some people belong to one, some to the other. Do you always start with what you know? Do you feel like you have a good understanding of the principles that drive the world? Or are you constantly aware of the massive uncertainty that pervades the world? Are you comfortable with saying "I don't know" frequently to people you respect? The difference between these schools of thought is the difference between playing offense or defense. Marks is of the "I don't know" school. He thinks you might do well with both strategies but every once in a while, playing offense in markets will result in a blow-up. Taleb is also of this school - he never sells options, only buys them (though I wonder if this intellectual subscription is in contrast to his natural propensity).
I'm also a fully paid-up member of the "I don't know" school. The name of this blog is no coincidence. However, I wonder whether this must by necessity be a continuum rather than a binary choice. You can't operate very well in an objective reality without some "I know." The question remains then how do you know what can be known, how do you decide what you will seek to know, and what do you leave in the effectively enduring realm of uncertainty?
[Speaking of schools of thought, are you an asker or a guesser?
http://www.guardian.co.uk/lifeandstyle/2010/may/08/change-life-asker-guesser]
3. Bull and bear markets are driven by mass psychology
The 3 stages of a bull market: (1) A knowledgeable few think things will get better; (2) Most people recognize improvement is underway; (3) Everyone believes things will get better forever
The 3 stages of a bear market: (1) A knowledgeable few think the market is overpriced; (2) Most recognize that a decline is taking place; (3) Everyone believes things will get worse forever
4. Beware the twin impostors of short-term success and short-term failure
The correctness of a decision can't be judged by the outcome. You never know whether you were just lucky. It is the process and protocols that must be judged, and the only way to do so is over time.
Interestingly, I asked Marks how Oaktree judges decisions if not by outcomes, how do they grade their investment professionals. He basically said they don't, going on a tangent about how they want to promote collaboration rather than competition and therefore don't do a lot in the way of individual variable compensation. But of course they grade their individual employees, implicitly if not explicitly. For someone that seems to put significant weight on process, I'm surprised they don't have an established protocol for grading decisions, at least qualitatively.
5. Develop an appreciation for "alternative histories"
This is related to the previous point. All the other things that could have happened should be part of one's context for "now." I've always thought this. Like, perhaps in another forked universe, I am poverty-stricken, uneducated and a paraplegic, and I begged the divine fates for the life I have now, and poof! Here I have this golden life but never have a full appreciation of what could have been. In the same way, we always view what is, as inevitable. We forget that at the point of a decision - say, one of Alan Greenspan's more destructive decisions - no one knew what the right decision should be. We still don't know what the best decision would have been. We only know that there were certain effects that stemmed from one particular fork.
[By the way, while Alan Greenspan from his actions seems to be of the "I know" school, this quote from him indicates that he has a foot in both: "I say this without a great conviction because anyone who has a great conviction at this stage about what the economy is doing or what proper policy is I think is under a mild state of delusion."]
6. Three individual traits for investing success
Aggressiveness, Timing and Skill. It's very hard to have all three traits at once. If you think you do, you probably don't.
7. Invest in the most complicated investments that you can fully understand
Marks didn't say this but he did make the point that the more simple and intuitive the investment, the more likely it is that the value has already been baked into the current share price. If you believe, as I do, that you shouldn't make an investment without fully understanding it, then that means you should invest near the top of your intellectual capability.
8. The problem of commitment
The problem of commitment is quite intuitive. There are not that many large opportunities out there. They are relatively rare. If you talk to a trader, they make most of their money on a few big trades (a la John Paulson). The same, in principle, holds true for investment managers. In order to reap the benefits of a potentially large opportunity, you have to commit a sizable amount of capital. But in so doing, you take on some nontrivial amount of risk (almost by definition).
9. Good judgment is the ability to make optimal tradeoffs with available information; great judgment is knowing what information to use
Marks says: "Everyone has an opinion; it doesn't mean it's right"
This is the critical problem. Your intuition is sometimes right and sometimes wrong. Your intuition likely tells you roughly the same as everyone else's intuition, our biology being shared. When it conflicts with everyone else's intuition, your intuition tells you that you should share their intuition, making you doubt your own. But their intuition is also sometimes wrong. So what do you do? You can try to institutionalize judgment using models and formulae, but what you get in a complex system tends to be uselessly predictable. Great judgment is hard to come by.
For a concatenated PDF book of Howard Marks' memos:
http://streetcapitalist.com/2009/09/26/oaktree-capital-memos-from-our-chairman-1990-2009/
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