It is that time of the quarter when we refresh ourselves of some of the ‘most important things’ in investing – when the legendary Howard Marks’ memo lands in your inbox. As timeless as they are, Marks’ way of delivering these insights make them that much more effective. In this memo, Marks touches upon some of his favourite topics of contrarianism, second order thinking, long term focus and the futility of macro.
On investment success requiring one to do something different:
“In 1978, I was asked to move to the bank’s bond department to start funds in convertible bonds and, shortly thereafter, high yield bonds. Now I was investing in securities most fiduciaries considered “uninvestable” and which practically no one knew about, cared about, or deemed desirable …and I was making money steadily and safely. I quickly recognized that my strong performance resulted in large part from precisely that fact: I was investing in securities that practically no one knew about, cared about, or deemed desirable. This brought home the key money-making lesson of the Efficient Market Hypothesis, which I had been introduced to at the University of Chicago Business School: If you seek superior investment results, you have to invest in things that others haven’t flocked to and caused to be fully valued. In other words, you have to do something different.
“This just in: You can’t take the same actions as everyone else and expect to outperform.”
You can’t hope to earn above average returns if you don’t place active bets, but if your active bets are wrong, your return will be below average.
If you hope to distinguish yourself in terms of performance, you have to depart from the pack. But, having departed, the difference will only be positive if your choice of strategies and tactics is correct and/or you’re able to execute better”
On second level thinking
“The basic idea behind second-level thinking is easily summarized: In order to outperform, your thinking has to be different and better.
Remember, your goal in investing isn’t to earn average returns; you want to do better than average. Thus, your thinking has to be better than that of others – both more powerful and at a higher level. Since other investors may be smart, well informed and highly computerized, you must find an edge they don’t have. You must think of something they haven’t thought of, see things they miss, or bring insight they don’t possess. You have to react differently and behave differently. In short, being right may be a necessary condition for investment success, but it won’t be sufficient. You have to be more right than others …which by definition means your thinking has to be different.
This all leads me back to something Charlie Munger told me around the time The Most Important Thing was published: “It’s not supposed to be easy. Anyone who finds it easy is stupid.” Anyone who thinks there’s a formula for investing that guarantees success (and that they can possess it) clearly doesn’t understand the complex, dynamic, and competitive nature of the investing process. The prize for superior investing can amount to a lot of money. In the highly competitive investment arena, it simply can’t be easy to be the one who pockets the extra dollars.
intelligent contrarianism is deep and complex. It amounts to much more than simply doing the opposite of the crowd. Nevertheless, good investment decisions made at the best opportunities – at the most overdone market extremes – invariably include an element of contrarian thinking.
Unconventional behavior is the only road to superior investment results, but it isn’t for everyone. In addition to superior skill, successful investing requires the ability to look wrong for a while and survive some mistakes.”
On the importance of long term focus and futility of macro:
“All the discussion surrounding inflation, rates, and recession falls under the same heading: the short term. And yet:
On investment success requiring one to do something different:
“In 1978, I was asked to move to the bank’s bond department to start funds in convertible bonds and, shortly thereafter, high yield bonds. Now I was investing in securities most fiduciaries considered “uninvestable” and which practically no one knew about, cared about, or deemed desirable …and I was making money steadily and safely. I quickly recognized that my strong performance resulted in large part from precisely that fact: I was investing in securities that practically no one knew about, cared about, or deemed desirable. This brought home the key money-making lesson of the Efficient Market Hypothesis, which I had been introduced to at the University of Chicago Business School: If you seek superior investment results, you have to invest in things that others haven’t flocked to and caused to be fully valued. In other words, you have to do something different.
“This just in: You can’t take the same actions as everyone else and expect to outperform.”
You can’t hope to earn above average returns if you don’t place active bets, but if your active bets are wrong, your return will be below average.
If you hope to distinguish yourself in terms of performance, you have to depart from the pack. But, having departed, the difference will only be positive if your choice of strategies and tactics is correct and/or you’re able to execute better”
On second level thinking
“The basic idea behind second-level thinking is easily summarized: In order to outperform, your thinking has to be different and better.
Remember, your goal in investing isn’t to earn average returns; you want to do better than average. Thus, your thinking has to be better than that of others – both more powerful and at a higher level. Since other investors may be smart, well informed and highly computerized, you must find an edge they don’t have. You must think of something they haven’t thought of, see things they miss, or bring insight they don’t possess. You have to react differently and behave differently. In short, being right may be a necessary condition for investment success, but it won’t be sufficient. You have to be more right than others …which by definition means your thinking has to be different.
This all leads me back to something Charlie Munger told me around the time The Most Important Thing was published: “It’s not supposed to be easy. Anyone who finds it easy is stupid.” Anyone who thinks there’s a formula for investing that guarantees success (and that they can possess it) clearly doesn’t understand the complex, dynamic, and competitive nature of the investing process. The prize for superior investing can amount to a lot of money. In the highly competitive investment arena, it simply can’t be easy to be the one who pockets the extra dollars.
intelligent contrarianism is deep and complex. It amounts to much more than simply doing the opposite of the crowd. Nevertheless, good investment decisions made at the best opportunities – at the most overdone market extremes – invariably include an element of contrarian thinking.
Unconventional behavior is the only road to superior investment results, but it isn’t for everyone. In addition to superior skill, successful investing requires the ability to look wrong for a while and survive some mistakes.”
On the importance of long term focus and futility of macro:
“All the discussion surrounding inflation, rates, and recession falls under the same heading: the short term. And yet:
- We can’t know much about the short-term future (or, I should say, we can’t dependably know more than the consensus).
- If we have an opinion about the short term, we can’t (or shouldn’t) have much confidence in it.
- If we reach a conclusion, there’s not much we can do about it – most investors can’t and won’t meaningfully revamp their portfolios based on such opinions.
- We really shouldn’t care about the short term – after all, we’re investors, not traders.
Even if we think we know what’s in store in terms of things like inflation, recessions, and interest rates, there’s absolutely no way to know how market prices comport with those expectations. This is more significant than most people realize. If you’ve developed opinions regarding the issues of the day, or have access to those of pundits you respect, take a look at any asset and ask yourself whether it’s priced rich, cheap, or fair in light of those views. That’s what matters when you’re pursuing investments that are reasonably priced.
The possibility – or even the fact – that a negative event lies ahead isn’t in itself a reason to reduce risk; investors should only do so if the event lies ahead and it isn’t appropriately reflected in asset prices. But, as Bruce says, there’s usually no way to know.
…No strategy – and no level of brilliance – will make every quarter or every year a successful one. Strategies become more or less effective as the environment changes and their popularity waxes and wanes. In fact, highly disciplined managers who hold most rigorously to a given approach will tend to report the worst performance when that approach goes out of favor. Regardless of the appropriateness of a strategy and the quality of investment decisions, every portfolio and every manager will experience good and bad quarters and years that have no lasting impact and say nothing about the manager’s ability. Often this poor performance will be due to unforeseen and unforeseeable developments.
…Thus, what does it mean that someone or something has performed poorly for a while? No one should fire managers or change strategies based on short-term results. Rather than taking capital away from underperformers, clients should consider increasing their allocations in the spirit of contrarianism (but few do). I find it incredibly simple: If you wait at a bus stop long enough, you’re guaranteed to catch a bus, but if you run from bus stop to bus stop, you may never catch a bus.
…Appropriate investment procedures contribute significantly to investment success, allowing investors to pursue profitable long-term contrarian investment positions. By reducing pressures to produce in the short run, liberated managers gain the freedom to create portfolios positioned to take advantage of opportunities created by short-term players. By encouraging managers to make potentially embarrassing out-of-favor investments, fiduciaries increase the likelihood of investment success”
The possibility – or even the fact – that a negative event lies ahead isn’t in itself a reason to reduce risk; investors should only do so if the event lies ahead and it isn’t appropriately reflected in asset prices. But, as Bruce says, there’s usually no way to know.
…No strategy – and no level of brilliance – will make every quarter or every year a successful one. Strategies become more or less effective as the environment changes and their popularity waxes and wanes. In fact, highly disciplined managers who hold most rigorously to a given approach will tend to report the worst performance when that approach goes out of favor. Regardless of the appropriateness of a strategy and the quality of investment decisions, every portfolio and every manager will experience good and bad quarters and years that have no lasting impact and say nothing about the manager’s ability. Often this poor performance will be due to unforeseen and unforeseeable developments.
…Thus, what does it mean that someone or something has performed poorly for a while? No one should fire managers or change strategies based on short-term results. Rather than taking capital away from underperformers, clients should consider increasing their allocations in the spirit of contrarianism (but few do). I find it incredibly simple: If you wait at a bus stop long enough, you’re guaranteed to catch a bus, but if you run from bus stop to bus stop, you may never catch a bus.
…Appropriate investment procedures contribute significantly to investment success, allowing investors to pursue profitable long-term contrarian investment positions. By reducing pressures to produce in the short run, liberated managers gain the freedom to create portfolios positioned to take advantage of opportunities created by short-term players. By encouraging managers to make potentially embarrassing out-of-favor investments, fiduciaries increase the likelihood of investment success”
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