Lessons on Investing : Howard Marks Memos

Howard Marks co-founded Oaktree Capital Management, which oversees $160 billion in assets, but few investors are aware of him. Even more surprisingly, he is one of the few investors that Warren Buffett looks up to.

Marks is a value investor with a talent for picking out cheap and troubled assets. His expertise in deep value investing enabled him to see value when others saw none in unique circumstances. Marks, a powerful investor who focused on distressed debt, high-yield debt, and private equity, revolutionised investment techniques for the rest of the world to adopt.

His approach of examining the financial information of businesses that are still mostly neglected and undervalued in order to determine their potential growth has so far helped his investors generate returns of about 19%. Investors acclaim him more for his comprehensive understanding of the global economy and the successful investing techniques he reveals in his memos.

Here are a few lessons that he has shared over the years:

On market cyclicality 

According to Howard Marks, market cycles have the power to control a variety of facets of investing, from stock market crashes to investor sentiment. In his book “Mastering The Market Cycle”, he introduced 2 important rules about market cycles:

Rule 1: Most occurrences will follow cycles.

Rule 2: When other investors disregard the first rule, the best investment possibilities appear.

The finest example of this is the common tendency of investors to overvalue equities during good times and undervalue the same stocks during difficult times. Investors consequently experience alternating bouts of high and low periods. Successful investors understand that these are transitory periods that present unparalleled opportunities for building long-term wealth.

On Forecasting

Most investors act as if they can see the future. Either they think they can, or they must, or they try to. As per Howard Marks, they can’t.

Investors would be sensible to acknowledge that they are unable to predict the future and to limit their actions to those that are under their control. It is more effective to base our decisions on what is occurring right now rather than what we believe might occur in the future.

The decision of whether to be aggressive or defensive is the most crucial one that any investor can make in the intermediate term. Not if they are bonds or stocks. Not if the market is developed or emerging. But whether it’s appropriate to be aggressive or defensive depends on the situation. 

Mr. Marks suggests that investors should concentrate exclusively on the things that are within their control because it is difficult to know what the future holds. While it is impossible to predict whether a fresh wave of COVID will occur in the near or medium term, one may decide right now whether to invest aggressively or conservatively based on their convictions.

On Herd Mentality

Making financial decisions based on herd mentality is one of the greatest mistakes a trader can make. Howard Marks contends that in order to stand out from the crowd and receive higher returns on their investments, investors must make contrarian decisions. 

Some steps to do that include:

  • Selecting stocks that experts don’t follow
  • Examining undervalued, unpopular, or controversial stocks
  • Taking into account potential problematic investments
  • Choose investments that concentrate on particular circumstances.
  • Investing in struggling industries.

He says, “Investing is a popularity contest, and the most dangerous thing is to buy something at the peak of its popularity. At that point, all favourable facts and opinions are already factored into its price, and no new buyers are left to emerge. “

On Fear of Missing Out

Given the tiny returns available on safe, boring investments these days, the fear of losing money appears to have diminished, while the fear of missing out on possibilities is at an all-time high. As a result, a brand-new risk called FOMO risk, or the risk associated with excessive fear of missing out, has emerged.

Missed opportunities are a serious concern since those who don’t can invest too conservatively. But when that anxiety goes too far, FOMO can push an investor to make decisions he shouldn’t make and frequently doesn’t comprehend, just because others are doing it. If he doesn’t join the crowd, he might be left behind and forced to deal with envy.

On Level Of Risk Undertaking

Contrary to popular opinion, Mr. Marks does not connect risk with an investment’s volatility. According to Howard Marks, risk is the likelihood that an investor may ultimately lose all of their initial investment. Therefore, he thinks that concentrating on preventing losses is the best way to lower risk. Not taking any risks might be one method to prevent losses, but that could produce noticeably lower returns.

Controlling and managing the level of risk is the most effective way to move forward. Mr. Marks offers the following suggestions for reducing investment risk:

  • Investment diversification across various asset classes
  • Periodic portfolio rebalancing
  • Recognizing and preserving one’s risk tolerance
  • The long-term nature of investing
  • Tie investments to particular objectives.

On Patience

After Lehman Brothers’ collapse, there have occasionally been a few prospects with extraordinary profits and modest risks (2008). 

And when the opportunities seem to be few and risky, it’s crucial to be patient first. Regardless of the state of the market, you shouldn’t maintain calm rationality throughout. When things are bad, you should become aggressive, and when they’re good, you should be defensive. It’s a mistake to strive to be clever when there isn’t anything worthwhile to do.

On Interpreting Information

Thanks to the contemporary information age, it is now simpler than ever to obtain a wide range of information, including corporate financials, analyst reports, news, etc. But since everyone has access to the same information, the ease with which it is available also presents a problem. For this reason, Howard Marks advises investors to try to grasp the facts they now have better. 

  • Understanding the business model in detail
  • Gaining knowledge of the company’s intangible assets
  • Gaining more insight into shifting consumer trends
  • Improving understanding of the company’s internal talent pool
  • Superior knowledge of the effects that technological disruptions might have

On Investor Behaviour

A bull market goes through three stages:

Only a handful of exceptional individuals see that things are improving in the first stage; the majority believe that improvement is occurring in the second stage; and everyone believes that things can only get better in the third stage.

The level of optimism in the pricing affects how appealing a stock’s price is. Therefore, the first stage is a wonderful opportunity to invest because there is no optimism. The third stage is characterised by optimism, and this is an excellent time to put off purchases. However, it goes without saying that most purchases occur in the third stage and very few do so in the first. In consonance with this, Warren Buffett has rightly said, “First the innovator, then the imitator, then the idiot.” 

On Process

As per Marks, you need a philosophy and a method that you adhere to no matter what happens in the market in order to be a successful investor. You cannot be an investor if you lack the bravery of your convictions, patience, and tenacity because you will continuously be pressured to buy at the peak and sell at the bottom in accordance with the consensus. 

However, it’s crucial to understand that no strategy will enable you to profit from every opportunity in every setting. You must be prepared to choose only the activities that align with your approach rather than take part in everything that occurs.

On Luck

Howard Marks acknowledged the significance of luck in one of his letters and the possibility that even the finest investors could occasionally fail to succeed if luck was not on their side. Every now and then, you might triumph in the face of overwhelming odds just by being lucky. While such victories could give you the impression that you have foresight, an experienced investor would understand that the outcome was merely sheer luck. 

He has also emphasised that success as an investor requires a certain amount of chance and that it is virtually impossible to be correct every time. But according to Mr. Marks, there are steps investors may take to increase their “luck” in the market. These include looking for investment possibilities in sectors that have a solid foundation but are not currently popular. Another choice might be to look for investment opportunities in unusual scenarios that arise from one-time occurrences like post-bankruptcy reorganisations, CEO changes, spin-offs, etc.

The techniques of successful men can be observed, understood, and then imitated as a means of success. And Howard Marks investment knowledge is one of the best places to begin.

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