Investing Wisdom from Howard Marks
of Oaktree Capital
My regular listeners probably heard
one of my earlier segments where I spoke about Howard Marks, the 67-year old
billionaire who co-founded investment management firm Oaktree Capital which now
manages about $84 billion in assets and is a publicly-traded company with
ticker symbol OAK.
Oaktree focuses its investments on
high-yield bonds, distressed debt and private equity, and has delivered a
whopping 23% average annual return over the past 25 years... so Marks has
rightly earned his fame and fortune. To give you an idea of just how much a 23%
rate of return is: If you invested $10,000 25 years ago, it would be worth
$1,769,000 today.
And, like Buffett, Marks too sends
out folksy memos to Oaktree clients where he outlines his views on investing,
the markets and the economy that are insightful, direct and sharply written.
And today, I'm going to share a few insights from Marks' latest memo - morphing
his thoughts so they apply to individual financial planning. I've decided to
break this up into a two-part series - with the first half of Marks' memo
today, and the rest to follow next week.
Key Questions to Ask First
So in this latest memo, Marks first
addresses philosophical questions on what to consider in setting up your
investment portfolio. Once you have a clear idea on what your investment goals
are, based on your retirement needs, Marks says you should discuss the
following questions with your advisor:
- Is it possible to build a
retirement portfolio that can beat the market? If yes, then how, and to what extent
can we beat the market?
- What's the best way to manage
risk?
- How do we define success, and what
risks are we willing to take to achieve investment success?
Then, as you build your portfolio,
you'd want to balance it out between index investments (where you should not
expect market-beating returns), individual stocks such as dividend payers, and
perhaps some alternative investments to a smaller extent. If you're closer to
retirement, you might also want the safety of inflation-protected bonds. And for
the safety of bonds, index investments and dividend stocks, you should be
willing to accept "average" performance. But for the alternative
investment portion of your portfolio, you should expect above-average or
superior returns, as Marks calls it.
Pick Funds that Dare to be Different
For your alternative investments
where you're seeking superior returns, look for funds that are backed by a
strong track record, and where fund managers dare to be different. You see, if
you pick a mutual fund that's run by a manager who is essentially following or
mimicking what others are doing, you'll just end up paying high fees without
getting any real bang for your buck.
So for this alternative portion of
your portfolio, look for managers that are courageous enough to be different
and open to being wrong... managers who assemble a portfolio that is different
from those held by most other funds. As Marks puts it, to be a top performer,
the fund manager has to "escape the crowd" by being active in unusual
market niches, buying things others haven't found, don't like or consider too
risky to touch. A good alternative fund manager avoids what the market
considers to be a darling, or all the rage, and engages in contrarian cycle
timing, and concentrates heavily in a small number of things that he thinks
will deliver exceptional performance... everything that personifies great
investors such as Howard Marks and Warren Buffett.
As Marks puts it "the cautious
seldom err or write great poetry" in referring to fund managers that follow
the herd.
So look for fund managers who dare
to be different, have a consistent history of market-beating performance and
are transparent with their investors. That said, you also need to recalibrate
your expectations with such alternative funds because their investments often
could take longer to bear fruit... so only invest a small portion of your funds
that you're not planning on touching till you reach retirement... because if
you picked the right alternative investment fund, those superior returns could
compound very nicely over time.
Now I know that it's near impossible
for most individual investors to really evaluate alternative investment funds,
so this is where a good, qualified advisor can offer advice and help kick some
of your returns into high gear.
And as I mentioned above, Marks'
company - Oaktree Capital - is publicly traded with ticker symbol OAK, so you
can buy shares to participate in Oaktree's success; When you invest shares in
OAK, you are not buying into Marks' portfolio, but rather participating the
company's profit from its portion of the investment it takes for itself and the
fees that are generated from his clients. Oaktree shares also offer a pretty
compelling 7.7% dividend yield at current levels... but this is not a recommendation
so please do your own research should you consider buying Oaktree.
Most great investments begin in
discomfort.
Most people feel good about making
investments where the underlying premise is widely accepted, where recent
performance has been positive and where the outlook is rosy - but such
investments are high in demand and are unlikely to be available at bargain
prices.
Bargains are usually found among
things that are controversial, that people are pessimistic about, and that have
been performing badly of late - investments that generate discomfort for most
people. And this is where good alternative funds excel. For example, Oaktree
Capital focuses on distressed debt - bonds issued by companies that are on the
ropes in some way or another, bonds that are priced at pennies-to-the-dollar...
bonds that comfort-seeking investors would not even think about. This
discomfort is what causes distressed debt to be priced cheaper than it is
really worth, and it's one sector that has helped fuel Oaktree's outsize returns.
This area of investing is practically impossible for the typical investor to
get into and one has to have superior skills in order to avoid being burned
badly if things don't work out.
Marks also says; Dare to Be Wrong
Marks also reminds us that with
courageous, discomfort-generating investments, you must also be prepared for
failure as an inescapable potential consequence of trying to do really well. In
other words, be prepared to lose money on this alternative portion of your
portfolio... it's not something anyone wants, but get into alternative
investments with the understanding that non-mainstream investments could be
harder to liquidate and have greater risk, and while your fingers are crossed
for the upside, be aware that you could also lose money. That said, a good
alternative investment fund should protect you significantly on the downside
too.
So look for alternative funds that
invest judiciously, have more successes than failures, and make more on their
successes than lose on their failures.
Alas... No Magic Formula
Marks also cautions us that there is
no easy formula to produce superior risk-adjusted returns - because if there
were, everyone with a positive IQ would be rich.
Or, as good ol' Charlie Munger,
Warren Buffet's Partner bluntly puts it, "Investing is not supposed to be
easy. Anyone who finds it easy is stupid" and does not understand
investing's complex and competitive nature. Hardly the words of someone who
wants to be politically correct, but he makes a good point. Why should
successful investing be so easy that the uneducated and lazy investor achieves
superior rate of return? It just doesn't happen that way.
Superior investment results can only
come from a better-than-average ability to figure out when risk-taking will
lead to gain and when it will end in loss. And this is not easy task. So it's
good to look for fund managers that ideally have a strong background in
economics, financial math, accounting and investment analysis.
