Wednesday, April 11, 2018

The most important thing:- origins and inspirations Howard Marks

Gyan on Treadmill dated 11-Apr-2018

In the world of Investing, Howard Marks stands up there with Buffett. He heads Oaktree and his funds have given phenomenal returns over the years. In the talk that he gave at Google, he talks about his book 'The most important thing'

The title of this presentation is 'The most important thing: origins and inspirations'.

Marks started off by explaining why he named his book 'The most important thing'. As he sat in his client's office, he used to hear himself say 'the most important thing is controlling risk', then in another client's office it will be 'the most important thing is buy at a low price' and at another occasion it is 'the most important thing is being contrarian' etc.

Over a period of time, he found that he had identified almost 19 different 'things' at different times as 'the most important thing'. So when he wrote the book, he titled it that.

Why did he write the book in 2011? Originally he was planning to write a book after retirement, but Warrren Buffett promised him that if he ever wrote a book, he will give a quote for the jacket. That was a motive enough to work on his book sooner. As per Mr.Marks, the book is not designed to tell the reader how to make money or how to do investing. 

Mr.Marks did not plan to end up as an investor. After graduation he applied for 6 jobs and ended up joining an investment firm. He developed his investment and life philosophy over more than 2 decades and which is embodied in his memos to the customers. 

He titled this speech 'Origins and Inspirations'. These are the sources from which he got his ideas and inspirations to write this book. In this presentation, he explains some of these. 

The first reference to the book 'Fooled by randomness' by Nassim Nicholas Taleb. The key point is that in investing, there is a lot of randomness. You can't tell from an outcome whether the decision was good or bad. This is due to randomness. In the world of randomness, good decisions may not work out and bad decision may work out quite well. The book is about the role of luck. Even if you know what is most likely outcome, many other outcomes are possible. You should not act as if the things that 'should' happen are the things that 'will' happen. Even when what should happen actually happens, it may not happen within the given timeframe. 'Never forget the 6 foot tall man who drowned while crossing the 5 foot deep pool on an average'.
Second reference to a quote by John Kenneth Galbraith. The quote is 'we have two classes of forecasters. Those who don't know and those who don't know that they don't know.' Here Mr.Marks talks about the quality of forecasts. Most of the forecasters are just extrapolaters. The problem is that such forecasters do not make money, since that forecast is already factored in the price. The forecasts that make money are the ones that predict radical change. The problem with that approach is that if you look at the previous forecasts of the same forecaster, they are not right consistently. Which means that this correct forecast is just a fluke.

The third reference is to a quote from a book called 'Winning the Loser's Game', written by Charles Ellis. This book refers to another book called 'Extraordinary tennis for the ordinary player'. In this book, the author Simon Remo talks about two different strategies for winning in Tennis. The professional tennis players win by 'winning' more points. They his harder, constantly find the angles and win aggressively. On the other hand, amateur players win by 'not losing', by making lesser mistakes than the opponent. Their objective is to simply return the ball on to the opponents court. 

Charles Ellis, says that investing in stock market is like the 'loser's game'. In stock market, you win by making 'fewer mistakes'. Paradoxically, you lose in stock market by 'playing to win'. That is the reason why defensive investing is so important. 

The fourth reference is to the meeting Mr.Marks had with Michael ('Mike') Milken the famous junk bonds specialist. Milken single-handedly created a market for junk bonds (bonds rated AA- and below). Mr.Marks met Milken in November 78. As per Mr.Milken, there is only one way to go for AAA bonds. They are already valued high, and they can go only down. Whereas, a B rated bond, and if they survive, they can only go up. 

Making money in stock market is not by buying fairly priced stocks of good companies. The way to make money is by paying for an asset at a price lower than its intrinsic value. This reminded me of my purchase of Amara Raja Batteries, a fairly priced stock as any. I purchased it about two years ago at about 800 rupees, and the stock is still trading at the same price today. It is not that the stock is bad, it is just that it is a good stock but fairly priced and captures all the potential upsides. 

The key here is 'if they survive'. If they survive, the junk bonds tend to get re-rated upwards and you make money. So the only task for the analyst at Mr.Mark's firm is to analyse the 'survivability' of the bonds. If they survive, the bonds will make money. Bond trading is a 'Negative Art'. The performance of bond portfolio comes not from what you buy, but from what you exclude.

Based on the above inputs and many more, Oaktree Capital  came up with their philosophy. These are as follows.
  • Primacy of risk control
  • Emphasis on consistency
  • Importance of market efficiency
  • Benefits of specialization
  • Macro-forecasting not critical to investing
  • Disavowal of market timing.
The idea is not to become best at all times, The idea is to be consistently above the middle. 

Marks ends his presentation with three investment adages. 

One, what wise man does in the beginning, the fool does in the end. First the innovator, then the imitator and then the idiot. 

Two, never forget the 6 foot tall man who drowned while crossing a stream that is 5 foot deep on the average.

Three, being too far ahead of your time is being indistinguishable from being wrong. 

The session was followed by a QA session. Some great questions were asked. one of them being on the efficacy of index investing. Marks says that while index investing is good, still you run a risk that your portfolio value will fall along with the index. On the other hand, if you choose a portfolio focused on risk mitigation, you get the upside of the index without the risk of downside.

Another question was that how and when the price reach the value since the value investor is betting on the difference between the two. While he do not have the exact answer to this question (remember that the same question was asked to Mr.Benjamin Graham during the Senate Committee hearing), there are one or two catalysts that push the move towards value. One of them is that the bond is close to maturity. As the bond matures, it moves towards its face value. Another catalyst is the activist investors who force the company to change its processes so that the price will match with value. 

Great stuff guys....

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