MALE SPEAKER: Hello, everyone. Welcome to today's talk. We have a very, very
special guest today. And I couldn't be more pleased. In thinking about an
introduction for him, I quickly realized
there's nothing that's going to beat his own words. So I'm going to share a couple
of snippets from his writings over the years. And as I do so, think about
what would be your guess when he wrote them. So here's one. The bottom line is that many
of the investors setting the prices in today's markets
don't care about valuation. I get no sense, at all, that
the analysts and portfolio managers backing
the large cap growth stocks and internet
high flyers can imagine prices at which they would be
mere holds or, heaven forbid, sells. When do you think
this was written? AUDIENCE: [INAUDIBLE]. MALE SPEAKER: This was '99. So yeah, there's something
to say about the timeliness of what our guest writes. And here's one more. This is from the last 10 years. In the end, buyers took out
the biggest mortgage possible given their incomes and
prevailing interest rates. Such mortgages would land them
in the houses of their dreams and would leave
them there as long as conditions did
not deteriorate, which they invariably do. Anyway you slice it,
standards for mortgage loans have dropped in recent years
and risk has increased. Logic based? Perhaps. Cycle induced and exacerbated? I'd say so. Certainly, mortgage
lending was made riskier. We'll see in a few
years whether that was intelligent risk taking or
excessive competitive order. When was this? AUDIENCE: [INAUDIBLE]. MALE SPEAKER: This was 2007. And we are a few
years from there. And we've seen what happened. So I'm sure all of you want
to know what's on our guests mind today. And we are so fortunate that
he's here with us in person. So without any further
ado, ladies and gentlemen, please join me in welcoming
the one and only Howard Marks. [APPLAUSE] HOWARD MARKS: Well
that's quite an induction and [INAUDIBLE] puts a
lot of pressure on me that I have to be right. So it's hard. But I'm really
excited to be here. I want to thank [INAUDIBLE]
for setting up this event. And he's worked
very hard to make it go well for you and for me. And I hope it'll be
fun for all of us. And because I get the
impression here at Google that fun is important. Right? AUDIENCE: Absolutely. HOWARD MARKS: So there aren't
too many things in life that are worth doing
if they can't be fun. As you know, I
wrote a book in 2011 called the most important thing. And the reason it has that title
is because I would find myself in my client's office. And I would say the most
important thing in investing is controlling risk. And then five minutes later,
I would say the most important thing is to buy at a low price. And five minutes later, I would
say the most important thing is to act as a contrarian. So back in 2003,
I believe, I wrote a memo called The
Most Important Thing. I listed 19 things. Each of which was the
most important thing. And then I used that. I couldn't think of a
better format for my book. So I used the same
format in 2011. Interestingly, some of
the things are different. That goes to show you that one's
thinking should still be alive and should still evolve. And I know that [INAUDIBLE]
and some of the other fellows went to see Charlie Munger
speak in Los Angeles this week at age 91. And I'm sure he's still
evolving and getting younger. So I'm going to
try to do the same. Now I should tell you, and I
don't know if you know this, but I write memos
to the clients. And I'll refer to a lot of
memos in this session, probably. And they're all available on
oaktreecapital.com website. And the price is right. They're all free. And I've been sending
them out now 25 years. I started in 1990. And I got a letter
from a guy named Warren Buffet in 2009 or '10. And he said, if
you'll write a book, I'll give you a
quote for the jacket. So I had been planning
on writing a book when I retired from work. But Buffet's promise caused me
to accelerate my time frame. And what the book is is--
who here has read it? OK, about half. So what the book is,
it's a recitation of my investment philosophy. And as it says in the forward
to the philosophy, which I took the forward-- I
don't know about you, I never read the forwards books. But I took the forward
to mine very seriously. And what it says
in there-- it's not designed to tell you
how to make money. And it's not designed to tell
you how easy investment is or to try to make it easy. And in fact, my highest
gold is probably to make it clear how hard it is. Investing is very
difficult because it's, kind of, counter intuitive. And it, kind of, turns back
on itself all the time. And there are no
formulas that work. So what I tried
to do in the book is teach people how to think. Now the thoughts they should
hold change from time to time. But how to think, I think,
is valid in the long term. And it's my invest philosophy. And I wasn't born with
an investment philosophy. You'll hear from
a lot of people, if you're interested in
investing, he'll say, well, I started reading prospectuses
at age eight, and I didn't. Or you know, at 13, I
invested my bar mitzvah money, which I didn't do. But in fact, when I was getting
out of graduate school-- age 23 in 1969 so I know you
can all do the math-- I didn't know what
I wanted to do. I had studied finance at Wharton
and accounting at Chicago. And I knew I wanted to
do something in finance. But I wasn't very specific. So I interviewed in five
or six different fields. Large consulting firms,
small consulting firm, accounting firm,
corporate treasury, investment management,
investment banking, six, so I ended up in the
investment business. Why? Because I had a
summer job in '68 at city in the investment
research department and I liked it. I had fun, right. That's a good reason. So I went there. And by the way,
interestingly, there was nothing magical about
working in the investment business at that time. It paid the same
as all the rest. All six jobs that I was
offered had the same pay. Between 12.5 and 14
a year, not a month. And there were no famous
investors at the time. Investing was not
a household word. There were no
investment TV shows. So I just did it
because I liked it. I liked the people. And I thought that the investing
was intellectually interesting. So I didn't have a philosophy
then when I started. And I had some things I
had learned in school. But I think that your
philosophy-- your philosophy-- as opposed to somebody
if you studied Descartes or Locke
or somebody like that, you learn his philosophy. You might learn a philosophy
by studying a religion. But that's not your philosophy. Your philosophy will
come from the combination of what you have been
taught by your teachers and parents and your experiences
and what your experiences tell you about the things
you were taught and how they have
to be modified. So I developed my philosophy. It might seem like I started
writing the memos a long time ago-- 25 years-- but I
had been working already over two decades, at that time. So I think that the integration
of real life into philosophy is essential. Now I prepared a few
slides for today. And basically, the
slides are here to illustrate where
philosophy came from. Talk to you about some of
the foundations and roots. So I call it origins
and inspirations. And I hope you'll
find it interesting. So first of all, not in
order chronologically but, hopefully, in order to try
to make something intelligible. Fooled by Randomness, by
Nassim Nicholas Taleb. Now who here has read that? All right, more people
than have read my book. And I think it's very important. I think it's an excellent
book with very, very important ideas. Now don't tell
Nassim I said this, but I tell all the people I
speak to that it is either the most important badly written
book or the worst written very important book that
you'll ever read. I think it's not very clear. And I think it's
not-- well, maybe there's no attempt
to make it clear. But I think a lot of the ideas
are very important and even profound, in my opinion. So among other things,
and the basic theme is that in investing
there's a lot of randomness. And if you look at
investing as a field without randomness where
everything is determinative, you'll get confused
because you will not draw the proper inferences
from what you see. For example, just a brief
example, you see somebody and they report a great
return for the year. The scientist who thinks that
the investment world runs like the world of physics
might think, well, great return, that means
the guy's a great investor. But in truth, it might be
somebody who took a crazy shot and got lucky. Why? Because there's a lot of
randomness in the world. When I went to Wharton
in 1963, the first book I remember learning was
called Decision Making Under Uncertainty, by
C. Jackson Greyson who became, as I recall,
America's first energy czar. And I learned a couple
important things from that book. Number one, that you
can't tell from an outcome whether a decision
was good or bad. It's very important. Most people don't
understand this. Totally counter intuitive. But the truth is,
in the real world where there's randomness
at work-- I mean, if you build a bridge
and it falls down, then you must assume
that the engineer made a mistake that it
was a bad decision to build the bridge that way. But in the real world of
where there's randomness, good decisions fail
to work all the time. Bad decisions work all the time. The investment business is
full of people who are, quote, right for the wrong reason. Made a bad decision, it didn't
work out the way they thought, but they got lucky. And they were bailed
out by events. So this is very important. And this is the basic theme
of "Fooled By Randomness," Taleb's first book. Since then, he has written
the black swan, which became more famous, but I
don't think is as good a book. And he's written a book
called anti fragile. And that one didn't get famous. But I think that this book is
something everybody should read it if you have an interest
in numbers, investing, and how the world works. So as I say, the book is all
about the role played by luck. And basically, even if you
know what's most likely, many other things
can happen instead. This is very, very important. We talked earlier at
lunch about what's the most important
lesson you can draw. Well, of course, I'll never
say most important to anything. But one very important
lesson for you to learn is that you should not act as
if the things that should happen are the things that will happen. Again, in the world of
the physical sciences, you could probably
bet that that's true. And the electrical
engineer knows that if he turns on a
light switch over here, the light will go on there
every time because it's subject to physics. Not in the world of investing. So for every
possible phenomenon, There is a range of
things that can happen. There may be one where
it's possible to discern which one is the most likely. And if we draw a
probability distribution, that may be the highest
point on the distribution. The most likely single
outcome but that doesn't mean it's
going to happen. And the reason we don't have
many probability distributions that look like this
but rather that look like this is because a
range of things can happen. And it's very, very
important to notice that, number one, there are
lots of things that can happen. So you have to allow for them. And number two, the thing
that is most likely to happen is far from sure to happen. So that's very key. There's a professor at
the London Business School who put it so simply. He said risk means more things
can happen than will happen. And again, this is
profound in my opinion. In the economic world,
people generally make decisions
based on something called expected value, which
is to say that you multiply every possible outcome. First of all, of
course, you don't think in terms of a single outcome. You think in terms of
a range of outcomes. So you take every-- if
you could iterate over so many-- you take
every possible outcome, you multiply it by the
likelihood that it'll happen, you sum the results,
and then you get something called
the expected value from that course of action. And you choose your
course of action based on the highest
expected value. And that sounds like a
totally rational thing. But what if the course of
action that you're considering has some outcomes that you
absolutely can't withstand? Then you may not do it. You may not do the highest
expected value course of action because it has some you
can't live with, you know. Who here is willing
to be the skydiver who was right 98% of the time? You know, for example. So you may elect to do bike
riding on the Google campus rather than skydiving, even
though skydiving is more exhilarating 98% of the time. Anyway, so the point is as I
lived my life from learning about [INAUDIBLE]
learning about Taleb, from learning from
my own experience, I realized that should
does not equal will. Lots of things that should
happen fail to happen. And even if they
don't fail to happen, they fail to happen on schedule. So the thing that the economist
or the financier thinks should happen this year
may happen in three years. And you got to live three
years to see it happen. One of my favorite
sayings is never forget the six foot tall
man who drowned crossing the stream that was
five feet deep on average. We can't live by the averages. We can't say, well, I'm
happy to survive on average. We got to survive
on the bad days. And if you're a
decision maker, you have to survive long
enough for the correctness of your decision
to become evidence. And you can't count on
it happening right away. I always remind
people overpriced is not the same as
going down tomorrow. And if you bear that
simple truth in mind, I think it helps. So Taleb and the role of
lock luck, very important. Then John Kenneth Galbraith. John Kenneth Galbraith,
for those of you who are not familiar
with ancient history, was an American economist. Died around '05, I think, maybe
a little after and at the age of about 98 and he was
one of my favorites. He was a little
on the left side. He was somewhere between free
enterprise and socialism. But he was what we call
a liberal in the days when it was OK to say that word. But he was very, very smart. And he was not famous
as an economist. But he played a lot of
roles in government. And he was a diplomat. But he wrote some
very good books. And one of them is
called A Short History Of Financial Euphoria. And I like thin books. And his is thin. Especially the ones he wrote
in the last decade or two of his life were very thin. So I enjoyed those. But the short
history is very good, and I'll recommend that to you. And one of the things
he says is we have two classes of forecasters. The ones who don't know and
the ones who don't know they don't know. Now I don't believe in
forecasts, macro forecasts. People who forecast
interest rates, performance of economies, and
performance of stock markets. And I don't think
that my efforts to be a superior investor
and most other people's are aided by macro forecasts. So am I saying that the
forecaster is never right? No, I'm not saying that. The forecasters are often right. Last year, GDP grew 2%. Many forecasters forecast that
GDP will grow this year at 2%. That's called extrapolation. And usually, in economics,
extrapolation works. Usually, the future looks
like the recent past. So usually, the people who
forecast a continuation of the current are right. The only problem is they
don't make any money. Because let's take the
economy-- most people forecast two something
for this year. A growth rate of
two something is cooked into the prices
of securities today. If the growth rate turns
out to be two something, everybody who forecasted
that would be right. But security prices
will not change much because that two
something growth was anticipated and
discounted a year or two ago. So all those people who are
right won't make any money. So that's correct. So extrapolation
works all the time. Forecasts that
are extrapolations work all the time, but
they don't make any money. Logically, am I saying that
forecasts never make any money? No. The forecasts that make
money are the forecasts of radical change. If everybody's predicting
2.4% growth for this year and if I predict minus 2 and
it turns out to be minus 2 or I predict six and
it turns out to be six, I'll make a lot of money. So forecasts which are not
extrapolations-- forecasts which are radically different
from the recent past-- are potentially very
valuable if they're correct. Of course, they do not have
any value if they're incorrect. And if they're
incorrect, they'll cost you a lot of money. If everybody else thinks
it's going to be 2.4 and you predict six and
it turns out at 2.4, you're probably going to have
taken the wrong investments and lost a lot of money. So deviant forecasts,
which turn out to be right, are potentially very
valuable but it's very hard to make them. It's very hard to
make them correctly. It's very hard to make the
correctly consistently. And somebody at lunch
mentioned an early memo I wrote called the value of forecasts. And in one, there was
the value of forecast and then there was the value of
forecasts two, I think, right. And in one of those, I
reviewed the history, the recent history, of the
Wall Street Journal poll. Every six months, the
Wall Street Journal publishes the results
of a poll of economists on GDP growths, CPI, the
value of $1, price of oil, whatever it might be,
a bunch of phenomena. They do it consistently. And they ask ask, like, 30
people consistently over time. So it shows,
basically, that most of the time when
people get it right it's because they predicted
extrapolation and nothing changed. Once in awhile, something
changes radically. And invariably,
somebody predicted it. But the problem is, if
you look at that person's other forecasts
over the years, you see that that person always
made radical forecasts and never was right
any other time. So of course, if you're
getting your information from a forecaster, the
fact that he was right once doesn't tell you anything. The views of that
forecaster would not be of any value to you unless
he was right consistently. And nobody's right consistently
in making deviant forecasts. So the bottom line for
me is their forecasting is not valuable. And that's something that
my experience has told me. So we don't know
what's going to happen and randomness will play a
big role in what happens. And randomness is, by
definition, unpredictable. Number three, The Losers
Game, by Charlie Ellis. This is very interesting. Anybody here know the
name of the company TRW? A few people. TRW used to be a
big conglomerate. And now it's known
primarily for credit scores. And there was a
guy named Si Ramo. He was the R. It was Thompson,
Ramo, Wooldridge. And he was the R in
TRW and very smart. And Si Ramo wrote a book. And it was about
winning at tennis. Who here plays tennis? OK, this is good because as
I go around the world now, very few people
play tennis anymore. But what Ramo said is that there
are two kinds of winning tennis players. If you look at Pete Sampras,
or Nadal, or Djokovic, how do they win? The winning champion
tennis player wins by hitting winning shots. Hits shots that the
opponent can't return. They're either so well placed,
or so strategic, or so fast and hard that the opponent
can't return them. And if Nadal hits a shot, which
is not a potential winner, then his opponent can
probably put it away because it doesn't have
enough difficulty on the ball. So the championship tennis
player wins by hitting winners. You play tennis, right? How do you win? Do you win? AUDIENCE: Sometimes. HOWARD MARKS: How do you win? AUDIENCE: If I win, it's
by not hitting it out. HOWARD MARKS: That's right. The amateur tennis
player like him and me, we win not by hitting winners
but by avoiding hitting losers. And we believe that if we can
just push it back 20 times and just get it over
the net 20 times, our opponent can only do it 19. We believe that we'll
out-steady him, outlast him, and eventually he'll hit it
into the net or off the court. We'll win the point. But we'll win the point
without having hit a winner. So there are obviously
two styles of tennis. So the same is
true for investing. So Charlie Ellis wrote an
article called The Losers Game. And he said he thought that
investing-- so championship tennis is a winners game. It's won by winners. He thought amateur
tennis is a losers game. It's won by the people
who avoid being losers. Charlie thinks or thought that
investing is a losers game. So the best way to
win at investing is by not hitting losers. Now I believe also that
it's a losers game. Not as much as Charlie believes
and not for the same reason. Charlie believes that
investing is a losers game because the market is
efficient and securities are priced right. I believe there
are inefficiencies. I just think it's hard
to consistently take advantage of them. And you have to be
an exceptional person to take advantage of them
on a consistent basis. And the reason that the
pro can go for winners is because he is
so well schooled and practiced and steady
and talented that he knows that if he does
this with his foot and this with this hip and
this with his elbow and this with his wrist that the
ball will go where he wants. He doesn't worry about
miscues, wind, sun in his eyes, or distraction. He's so well schooled. In fact, in scoring
tennis matches, they keep track of something
called unforced errors. And the reason they
keep track of them is because there are so few. The pro doesn't make a
lot of unforced errors. We make unforced
errors all the time. So in order to survive,
we have to avoid them. So the point is, if you're
going to be an investor, you have to decide am I good
enough to go for winners, or should I emphasize
the avoidance of losers in my approach? So I say here that the
difficulty of getting it right is what makes
defensive investing so important because
it's just for us in investing, especially
because there's randomness, if we do the right thing
with our foot and hip and arm and elbow, we're not going
to get a winner every time. And then the fourth origin that
I wanted to talk about today was my meeting with Mike
Milken in November 1978. So in '78, I got a call
from my boss at Citibank. And he said, there's some guy
in California named Mike Milken, and he deals with something
called high yield bonds. Can you figure out
what that means because one of our clients had
asked for a high yield bond portfolio. And in that day,
nobody knew about it. It was unknown. So I met with Mike
in November of 1978. He came to see me
at Citi in New York. He was looking for clients. He was just starting off in
the high yield bond industry. And there was a great meeting. And he explained to me
that if you buy AAA bonds, there's only one way to go. AAA bonds are bonds that
everybody thinks a great. There companies are
making a lot of money. They have prudent
balance sheets. The outlook is good. Everything's perfect. So if everything's perfect,
that means it can't get better. And if it can't get better, that
means it can only get worse. It doesn't have to get worse. But if there is a change, it's
going to be for the worse. And if you've bought a
bond on the assumption that it's perfect and it gets
worse, then you lose money. So that's important. On the other hand, he said,
if you buy single-B bonds and they survive, there's
only one way for them to go, which is upgrade. Now that's not exactly
true because they can default and go bankrupt. But the ones that survive
will go up, will be upgraded, and the surprises are
likely to be on the upside. So this is very important. Again, this is about trying to
hit winners and avoid losers. And if you're buying bonds that
most people don't think much of, it's hard to
have a big loser because such low expectations
are incorporated. Now let me digress for
a minute because this is really important. How do you make
money as an investor? The people who don't
know think the way you do it is by buying good
assets, a good building, stock in a good company,
or something like that. That is not the
secret for success. The secret for
success in investing is buying things for
less than they're worth. So if you buy a high quality
asset-- and I say in the book, there's a guy on the radio. When I lived in LA, I listened
to NPR on the way work. And there was a guy
and I heard him say it. He said, well, if you go into a
store and you like the product, buy the stock. He couldn't be more
wrong because what determines the success of an
investor is not what he buys but what he pays for it. And if you buy a high quality
asset but you overpay for it, you're in big trouble. You can buy a very
low quality asset. But if you pay less
than it's worth, chances are you're
going to make money. So the book says-- chapter three
says-- the most important thing is value. Figuring out what the
value of an asset is. But chapter four says
the most important thing is the relationship
between price and value. So let's assume that you're
able to figure out the value. If you pay more than
that, you're in trouble. If you get it for less,
the wind is at your back. So it was very, very important
then to be in an area where the surprises were
likely to be on the upside. And if you buy the bonds of B
rated companies which there are such low expectations,
maybe it's easy for there to be
a favorable surprise. Now how can I prove to you
that the expectations were low? The answer is that if you
look in the Moody's guide to bonds in those years, what
was the definition of a B rated bond? Quote, fails to possess
the characteristics of a desirable investment. In other words, it's
a bad investment. Now, I drove here from
the airport in my car. And if I take you
outside to look at my car and I offer it to you
for sale because I don't need that car anymore. When I'm done here,
I'm not coming back. If I say to you,
would you like to buy my car, what is the one
question you must ask me before saying yes or no? Price. You get an A. You get
an A. So in other words, it's a good buy at
a certain price. It's a bad buy at another price. Moody is now saying
that B rated bonds are a bad by without
any reference to price. So in other words,
there's no price at which a company that
has some credit risk is worth investing in. And by the way, before I turned
to high yield bonds and '78, I was part of the
banks machinery to buy the stocks of
America's best companies. And I explained to
[INAUDIBLE] if you bought the bonds of Hewlett
Packard, Perkin Elmer, Texas Instruments, Merk Lilly Xerox,
IBM, Kodak, Polaroid, AIG, Coca Cola, and Procter & Gamble, and
if you bought them all in '68 and you held them until '73,
you lost 90% of your money. Why? Because they were overpriced. The average stock
since the postwar has traded at 16 times
its next year's earnings. These were trading
at 80 and 90 times. Why? Because they were so good. Everybody says these
are great companies. Nothing can go wrong. So it doesn't matter
what price you pay. And if you pay 80 or
90 times, that's fine. So here we are,
in my experience-- again, experience
as a teacher-- you invest in the best
companies in America, you lose a lot of money. Then you go to the high
yield bond business, you invest in the worst
companies in America, you make most money. So it's an instructive lesson
if you have your eyes open and you learn from
experience, which I did. But the key words
were and they survive. Right? This little trap
there because you have to catch those three words. If you buy single-B
bonds that don't survive, then you're in big trouble. But obviously,
it's tautologically true that if a company about
which the expectations are low survive, it'll
probably, at minimum, it'll pay off at maturity. And maybe in the meantime
it'll be upgraded or taken over if they survive. So what that convinced
me when I was starting the high-yield bond business
and this conversation came at a great point in time
is that my analyst should spend all their time
trying to weed out the ones that don't survive. Not finding the ones that
will have favorable events but just excluding the ones
that have unfavorably events. And that's what we did. Now I'll tell you an
interesting story. Around '05 or '06, the bible
of investing is a book called Security Analysis written
by Graham and Dodd. And they wrote the
first edition 1934. But Ben Graham was
Warren Buffett's teacher at Columbia and, in many ways,
the father of value investing. And he and David Dodd
wrote this book in '34. And they updated it in '40
and then several times after. And the '40 edition is
considered to be a great edition. So in '05 McGraw Hill,
which owned the book, said they want to
update the book. And they turned it over
to Seth Klarman who's a great debt investor
in Boston at Baupost and a professor-- I can't
remember his name right now. What? AUDIENCE: [INAUDIBLE] Greenwald. HOWARD MARKS: [INAUDIBLE]. That's right. Bruce Greenwald at Columbia. So you should be up here. I'll sit down. And they turned it
over to Seth and Bruce to bring out this revision. And they, in turn, asked
people to revise the sections. And they asked me to
revise a section on debt. So that meant I had to go and
read the 1940 edition in order to update it. And I came across
something fascinating. And it was and it verified
what I had always thought. It said that bond investing
is a negative art. What does that mean? What it means is, I
don't know how many of you know how bonds work, but
a bond is a promise to pay. You give me $100, and
I promise to give you 5% interest every year, and
then give your money back in 20 years. Fixed income it's called because
all the events are fixed. The contract is fixed. The return is fixed,
assuming the promise is kept. So all 5% bonds that
pay will pay 5%. None will pay six. None will pay four. All the ones that
pay will pay 5%. What does that mean? It means of the
ones that pay, it doesn't matter
which ones you buy. I'm going to like this one. I like that one a lot. That pays five. And I like that one. That pays five. It doesn't make any difference. You're not going to
be a hero by choosing among the bonds that pay. The only thing that
matters is to exclude the ones that don't pay. So if there are 100
bonds, 90 will pay. They'll all pay the same thing. It doesn't matter which
of the 90 you choose. The only thing that
matters is excluding the 10 that don't pay. Negative art. The greatness of
your performance comes not from what you buy
but from what you exclude. So I thought that
was very useful. I should have that up here, too. But anyway, Milken
was my fourth input. So Taleb says that
the future consists of a range of possibilities
with the outcome significantly influenced by randomness. And Galbraith says the
forecasting is futile. And Ellis says that if the
game isn't controllable, it's better to work to avoid
losers than to try for winners. And Milken says that holding
survivors and avoiding defaults is the key in bond investing. So if you put them
all together, that's how you get the philosophy
that's in the book. These were my origins. So when we started Oak Tree
April 10 of 1995 almost exactly 20 years ago, we wrote
down our investment philosophy. And here it is. We published it. We were a bunch of guys who
had been working together for most of the previous 10
years at a different employer. And we left there as a group. And we started Oak Tree. So for a philosophy, I believe
in writing things down. And like learning
at the [INAUDIBLE] says today right
them down, right. So we wrote down our philosophy. We published it. We never changed a word since. And the clients like
knowing what our roadmap is. So these were the six tenets
of the investment philosophy. So the first one says that
the most important thing is risk control. And we tell the clients we
think that for excellence in investing, the most
important thing is not making a lot of money. It's not beating the market. It's not being in
the top quartile. The most important thing
is controlling risk. That's our job. That's what we'll do for you. And the clients
come to us who want to invest in our asset classes
with the risks under control. There are other people
who put less emphasis on controlling risk. And they have better
results in the good times and worst results
in the bad times. Our clients want
what we give them. Number two, we have an
emphasis on consistency. So we say we don't try for the
moon at the danger of crashing, you know. The first memo that
I wrote in 1990-- I'm sure you remember
that, [INAUDIBLE]-- talked about a guy who was head
of an asset manager that had a terrible year. And he said, well,
it's very simple. If you want to be in the top
five percent of money managers, you have to be willing
to be in the bottom. I have no interest in
being in the bottom 5%. And I don't care about
being in the top 5%. I want to be above the
middle on a consistent basis over the long term. And there's a funny bit of math. This will confound
the-- what did you call yourself-- data scientists? This will confound the data
scientists in the room. So in that first memo, I
contrasted the comments from that money manager with a
comment from one of my clients who told me right about
the same time there was the juxtaposition
that caused me to write that first memo. He told me that for
the previous 14 years, his pension fund had never
been above the 27th percentile or below the 47th percentile. So it was solidly in
the second quartile every year for 14 years. So let's see. 27. 47. The average of
that is 37, right? What percentile do
you think that fund was in for the whole 14 years? AUDIENCE: [INAUDIBLE]. HOWARD MARKS: Four. Four. And if you think about it,
it's really almost mysterious. Why the fourth? Not the 37th. And the answer is that
when people blow up, they really blow up. So we said we want consistency. We want to be a little bit
above the middle all the time. Maybe we'll pop up to
the top in the years when the markets are
terrible and our risk control is rewarded. But we think that over
a long period of time we'll be very
respectable that way. And our clients
will have an absence of bad experiences,
which I think, for them, is very important. So then macro-forecasting is
not critical to investing. We do not make our decisions
based on macro-forecasts, as I explained to you. We all have opinions. We-- our official dictum is that
it is OK to have an opinion. You just shouldn't
act as if it's right. And I think this
is very important. You know, Mark Twain
said, "it's not what you don't know that
gets you into trouble. It's what you know for
certain that just ain't true." So we try to avoid
holding strongly to those macro opinions. And finally, we don't do a
lot of market timing, which is very, very hard to do. We do long term investing
in assets that we think are underpriced. So that's the Oak
Tree philosophy. You could see how the origins
and inspirations that I went through fit into that. And in fact, it's all distilled
in our model, which says that if we avoid the
losers, the winners take care of themselves. And if we can make a large
number of investors and just weed out the
problems, then we'll have-- just think of
the bell shaped curve. We'll have a lot to do
OK and an occasional one, which is exceptional if
we can weed these out. So a lot of money managers
go into the clients and say we will get
you in the top quartile into the great right hand tail. I think it's hard to do
on a consistent basis. And if you aim for the right
hand tail and you miss, you end up in the
left hand tail. What we say is we'll just
lop off the left hand tail. And if we can do
that successfully, and we pretty much have,
then what will you have? OK, good, very good, great,
terrific, but no terrible, the average will be very good. And that's basically
what we've had. So lastly, I'll just leave you
with what I consider my three greatest adages. Not mine but the
ones I've encountered over my career and that
have been the most helpful. And they're all
used in the book. First of all, what the wise man
does in the beginning, the fool does in the end. In every trend in investing,
it eventually becomes overdone. If you find an asset which is
cheap and buy it, that's great. If everybody else figures
it out that it's cheap, then it will go up. Then people see
that it's rising. And more people jump on the band
wagon and it goes up, up, up. And the last person
to buy it is a fool. And the first person to
buy it is a wise man. It's the same asset. Just at different prices. And as people say,
first the innovator, then the imitator,
then the idiot. So that's another way
to look at this adage. Number two, never forget
the six foot tall man who drowned crossing
the stream that was five feet deep on average. Kind of like that skydiver
who's right 98% of the time. It's not sufficient,
depending on how you want to live your life,
to survive on average. We have to survive
on the bad days. So we have to be able to survive
the low spots in the stream. Your portfolio has to be set
up to survive on the bad days so you won't be shaken
out of your investments. And then finally, being
too far ahead of your time is indistinguishable
from being wrong. And yet, that's
a great challenge because, as I said
before, the things that are supposed to happen
will not necessarily happen. And they absolutely
will not happen on time. So you have to be able
to live until the wisdom of your decisions is
proved, if at all. So all of these
things, I think, say something about modesty
and humility of belief rather than cock sureness, which
I think is the greatest risk. So with that, [INAUDIBLE],
I'll stop talking. And we have a little time left. And I'd love to
take your questions. That's what I'm here for. MALE SPEAKER: Thank you, Howard. This was fascinating. So we are open for questions. Please raise your hand, and
I'll bring the mic to you. AUDIENCE: The thing you said
about what the wise man does in the beginning the
fool does in the end, you can come up
from a single stock. You can think about your
whole philosophy that way. So you've been focusing
here on avoiding losers. And maybe humans are, kind of,
generally focused on trying to find winners. Maybe that's what
we'll always do wrong. But if everybody in the world
is trying to avoid losers, maybe the wise investor
now shoots for the winners, do you know what I mean? Sort of self-balancing. HOWARD MARKS: Sure. Well, number one, I
don't think that we have to worry about
everybody becoming to prudent or to wise because we're
talking about human nature. Charlie Munger--
the boys went to see Charlie Munger this week. One of the great
quotes that Charlie gave me was from the
philosopher Demosthenes, who said for that which a man
wishes that he will believe. What do most people
want more anything else? They want to get rich. Very few people think that
the secret to their happiness comes from prudence and caution. Most people think it comes from
that stroke of genius, which will put them on easy street. But you're absolutely right. And there are times
when most people behave in a prudent
and cautious manner. When is it? It's in a crash when security
prices are down here. Right? That's the time to turn
aggressive and buy. So Buffett says
the less prudence with which others
conduct their affairs the greater the
prudence with which we must conduct our own affairs. And there are times when
we should turn aggressive. And that's when everything's
being given away. AUDIENCE: So you said hat
you did not make any macro forecasts, right? But actually the macros can
affect companies in other ways. Like if you have an
interest rate of, like, 30%. I mean, 99% of
the companies will be gone or something like that. So how do you even
make an investment? HOWARD MARKS: OK. So now I know I'm not coming
back to Google anymore because the people are too
intelligent because this is one of the great traps. I say that we don't invest on
the basis of macro forecast. But you have to have an
economic framework in mind when you predict the fortunes
of individual companies. And what I would
say is what we try to do is it's one thing
to say that oil is at 50 and we're going to
invest in this company because it will do
fine if oil's at 50, survive if it goes to 30,
and thrive if it goes to 70. But it's another thing
to say oil is 50, I think it's going
110, I'm going to invest in this
company, which is going to be great if it goes to 110
but bankrupt if it stays at 50. So the question is, how
radical are your forecasts? And we try to
anticipate a future that looks pretty much like the
norm and make allowance for the thing that things
other than the norm can happen. And I can't really be much
more concrete than that. By the way, all this
stuff is judgment. You know, there are no rules. There are no algorithms. There are no formulas
that always work. None of this is any good unless
the person making the decision has superior judgment. And the first
chapter of the book says the most important thing
is second level thinking. Most people think
on the first level. To be a superior investor, you
must think on the second level. You have to think different
from everybody else. But in being different,
you have to be better. So the first level
thinker is naive. He says, this is a great
company, let's buy the stock. The second level thinker
says it's a great company, but it's not as great as
everybody thinks it is. We better sell the stock. That's the difference
between being an average person and a
person with superior insight. By the way, most people
are not above average. Yes, sir. AUDIENCE: Do you think
diversified index funds adequately protect the
amateur investor from losers? HOWARD MARKS: Well this
is a great question. The role of the index fund. A lot of people say, I'm going
to take a low risk approach. I'm going to invest
in an index fund. And they are confused. What an index fund does is
it guarantees you performance in line with the index. So the point is because
of the operation of what's called the efficient
market, not many people can beat the market. It's true. Most mutual funds do
not beat the market. Most mutual fund investors
would be better off just to be in an index fund. And in fact, most active
investment schemes impose fees that
they don't earn. And that is one of
the major reasons that most active investment
schemes perform below average. So the index fund, which is
called passive investing, yes it reduce,
eliminates, the likelihood that you fail to keep
up with the index. It also, of course,
eliminates the possibility that you outperformed the index. So you trade away the two sides
of the probability distribution for surety that you
get index results. But it doesn't eliminate
the risk of the investment. It eliminates the risk of
deviating from the index. What you have to keep in mind
is that the index fund investor loses money every time
the index goes down. Why? Because there's no value
added to keep it above. And by the way, index
investing is a fine thing for the average amateur
investor because the average amateur
investor, number one, can't beat the market
and, number two, can't find anybody
or hire anybody who can beat the market. But the only thing
is he shouldn't think that it's a risk-less trade. You eliminate what we
call benchmark risk. But you retain the risk
of the underlying asset. AUDIENCE: So you've
been through one or two of these business
cycles, I guess. HOWARD MARKS: Yes. AUDIENCE: And with
availability of information and with a number of
books being written about this subject about
value, and proper investing, and how many managers
don't beat the market, do you think the
average investor is doing anything different
than they were 20 years ago? HOWARD MARKS:
Well, look, I think there's a minor movement
toward indexation. It's not groundswell. There's still lots of money in
actively managed mutual funds where there's 2% a year of fees
and costs or one and a half. But I think there's more
in indexation every year. And that's probably appropriate. But I'll just turn i around. I'll leave you with a question. Why can't people
beat the market? Because the market's
pretty efficient. And market prices
most things right. And most people can't
find and identify and act on the times when the
market prices things wrong. That's why most people
can't beat the market. That's what I learned at
University of Chicago. And I think it's pretty true. So the reason for the
inability to beat the market is the markets efficiency. The markets efficiency comes
from the concerted efforts of thousands of
investors who are trying to find the bargains. What happens when
they stop trying? So when the interest
in active investment declines because
people give up on it and turn to passive investing
and all the analysts quick studying the
companies, then prices resume their deviation
from intrinsic value. Then it becomes possible
to beat the market again. So it's really paradoxical and,
I would say, counter-intuitive. But I don't think we
are close to that day. But in theory, there comes a
day when so little attention is being paid to
active investing that active investing
starts working again. Yes, sir. AUDIENCE: Thanks, Howard,
for coming for the talk. To talk about the difference
in value and the price, the other dimension is time. So how do you estimate the time
taking to [INAUDIBLE] to close? HOWARD MARKS: You never do. You never know. See, what he's saying-- again,
it's a very good question. And what we want
to do is we want to find things where the
intrinsic value is here and the price is here. So his question is, how
do we estimate the time that it's going to take
for the gap to close? And the answer is
there's no way to say. On occasion, there are
what we call catalysts. And one catalyst would be the
pending maturity of a bond. If a bond is going
to mature in 2012 and it's selling at 60
because most people think it's going to go
bankrupt but we think it's going to pay
off at maturity, then the existence
of the maturity date is going to force the
convergence of price to value. Another catalyst today is
all these activist investors. They find the company. It's selling. They think the
interesting value is here. It's selling here because
the management is sub par and they're not doing
the right strategy. So they go in. They foment trouble. They try to get a board seat. They try to force the
management to do the right thing to course, to cause, the price
to converge with the value. So there are a few
catalyst in the world. But generally speaking,
you buy a stock. You hope-- you would
think it's worth here. The price is here. You hope it'll convert. But there's no way
to estimate the time. And that's the reason why being
too far ahead of your time is [INAUDIBLE] from
being wrong because it can take a long time. AUDIENCE: Would you always
look for presence of catalyst when you find a gap? HOWARD MARKS: There
aren't enough. I mean, it happens. Most of what we do is in
the fixed income world. And there are more catalysts
in the fixed income world than in the equity world. You find a stock. How many stocks you think
the activist investors go after a year? 10? 20? 50? 100? No more. There are thousands of stocks. So most stocks are never
going to get catalyzed. AUDIENCE: Curious
if you could tell us what it was like when you
were out raising money for Oak Tree in the early days. I would imagine that today
some clients are skeptical. But I would imagine
that it was-- was it a lot different
for you back then? HOWARD MARKS: Well by the
time we started Oak Tree, it wasn't that hard because
we had a reputation. But when I started raising
money for our strategies-- 1978 junk bonds-- 90% of
investment organizations like Google had a
rule, a concrete rule, against any bond investing below
A or below investment grade, which is BBB. And of course, Moody said
it's an imprudent investment. So that was very,
very hard to overcome. But what you have to do is
you have to find a few people. You see, you have to
find a few people. You have to go say to
them you should do this because nobody else is. Because nobody else is doing
it, it's languishing cheap. You make no money
doing the things that everybody wants to do. You make money by
doing the things that nobody wants to do who
then turn out to have value. And if you say that message to
100 investors in the beginning, maybe 10 jump on board. After it works for a
while, then the rest come on, like the screen says. But hopefully, not too extreme. But the point is it was
very hard in the beginning. And in certain
foreign countries, it was even harder because in
certain foreign countries where the thinking is a little more
narrow than American thinking I always thought that if I
go into somebody's office and I say you should do
this because nobody else is they'd call the man in the
white coat to take me away. They don't understand. You know, I think that
Americans semi intuitively understand the value
of contrarianism and of being a maverick. But in many countries,
they just don't get it. So that's an
example, high yield. But then we started Oak
Tree in-- oh, no, no. That was at Citi. In '85, I switched from Citi to
Trust Company of the West, TCW. And in '88, we brought out
the first distress debt fund. Now we're not
investing in companies that have a risk of default. We're investing in bonds
that are either in default or sure to be. And people would say,
well, how can you possibly make money
investing in the bonds of bankrupt companies? And we had to explain to them
that if a creditor of a company doesn't get paid the interest
in principle as promised, they have a claim against
the value of the company. And they exert that claim in
a process called bankruptcy. And in bankruptcy,
to oversimplify and over generalize, the
old owners are wiped out. And the old creditors
become the new owners. And if you bought an ownership
stake through the debt for--what-- for less than it's
worth, then you make money. And we've made about 23% a
year for 28 years investing in distressed debt before
fees without any leverage. So that's pretty astronomical. Why? Because from time to
time in distress debt you get to buy things for
less than they're worth. And in fact because
other people are fleeing from the bankruptcy,
maybe you get them to buy them for a lot
less than they're worth. So it's very challenging. But you can't
convince everybody. But if you can
explain the merits and tell the story clearly,
and concisely, and persuasively then you get some clients. And then, if you
get good results, then you get more clients. AUDIENCE: Thank you,
Howard, for your talk. One question. Buffet, in '99, said that if he
was running very small amounts of money he would be able
to find lots of bargains and beat the market
by 50% and he would use the word guaranteed. I presume he meant
that there are a lot of inefficiencies in the
small capitalization stocks. One thing that kind of surprises
me is if someone, an analyst, willing to work
hard on his own, not in an institution, the word
of distress debt investing is kind of shut out, even
for the value investor. [INAUDIBLE] with a lot
of technicalities and it seems like the big institution
has a lot of advantage there. Are there such inefficiencies
that are kind of shut out to the institutions but the
small investor willing to work hard can find inefficiencies
in the debt world? HOWARD MARKS: Well I think
that the small guy can even be active in distressed debt. He can't get enough bonds to
get a seat at the creditors committee table or have a voice. But he can still
find superior values. You know, so what I was saying
in answer to your question is that if you get some accounts
and you have good performance, you'll get more accounts. So that goes a little
further because what I really say is that if you
have good performance, you'll get more money. And eventually, if you let
that process become unchecked, if you get more money,
you'll have bad performance. And this is one of the
conundrums in our business. So you have to halt that. But the truth of the matter
is that the little guy has an advantage as long as
he's willing to stay small. Many people are not because in
the short run, the more money you manage when you get
fees, it's a great lure to take on more money. But you have to
stop it at a point before it starts running
your performance. Now, for the data
scientists among us, I always like to point out that
if I worked at Firestone Tires and I developed a new
tire, and I wanted to know how far it would
go, I would put it on a car and run it until
it blew up, right. That's called
destructive testing. But as an investor with clients
and a fiduciary responsibility, I don't have the luxury of
doing destructive testing. So I can't add more. People always say
to me, well, what's the limit on how much
money you can invest well? And I can't find out by
running into the wall. I have to stop this
side of the wall. One of the
interesting lessons is that if you stop
this side of the wall then you never find out
where the wall really is. But that's what we have to do. So you have to stop. And I believe that
the person who has a big brain, and a little
money, and a lot of time, and exceptional insight
can find great bargains. But that's a pretty
daunting list. And I don't think that Buffett's
guarantee necessarily extents to everybody in this room. AUDIENCE: Do you see any
unhealthy trends in valuation in the market today the
same way [INAUDIBLE] was valued in the past? HOWARD MARKS: Yes, I do
because the menu extends. What we call the
capital market line extends from what's
called the risk free rate. The risk free rate is the
rate, generally speaking, on the 30 day treasury bill. And of course, if you can
get 3% on the risk free rate, then in order to tie up your
money for five years in a five year treasury you want four. And to get it 10
years, you want five. And if you can get 10 years on
a government security of 5%, then in order to go into a
corporate security, which has some credit risk,
you would demand six. And to go into a high
yield bond, you demand 12 and so forth. So there's a kind of a process
called equilibration, which makes things line up in terms
of relative risk and return but always pegged from
the risk free rate. Today, the risk
free rate is zero. So everything that I just
named, this capital market line, has had a parallel
downward shift. So before the
crisis, [INAUDIBLE] mentioned about the fact
that I turned bearish. All my money was in
was in treasuries. All the money that I had outside
of Oak Tree was in treasuries. And I was getting 6 1/2% for
one, two, three, four, five, six year maturities. I was getting income and safety. Today, you have a choice. Income or safety because
the things today that are highly safe pay no income. You know, and if
you go to Fidelity-- conduct an experiment. Go to Fidelity or Vanguard
or a big mutual fund firm and go online and look at
their menu of offerings and what is the current net
yield after fees and expenses. And you'll see that for
money market and short term treasuries, and maybe
intermediate treasury, the yield is zero. So just think. The guy is watching the
Super Bowl in his undershirt. He gets a statement
from Fidelity. He opens it up, and it says the
yield on your fund is now zero. He grabs the phone. He calls the 800 number. He says get me out of that
fund that yields zero, and put me in the
one that yields six. And he becomes a high
yield bond investor. He has no idea why. He doesn't know what
a high yield bond is. He doesn't understand
what the dangers are. He doesn't understand how to
pick a high yield bond manager. But he's seduced by
that 6% versus zero. And all around the
investment world today, people are
chasing return. They don't like the
low returns that are available on safe instruments. They're going for the gusto. They're going for
riskier instruments. And they're doing it mindlessly. And I promised you I'd
mention some memos. I forgot to do that. But if you go back, I wrote one
in March of '07 called The Race To The Bottom. And I talked about
the fact that when people are, number one,
eager to invest and, number two, not sufficiently risk
conscious they do risky things. And when people do
risky things, the market becomes a risky place. And that's why Buffett
says, the less prudence with which others
conduct their affairs, the greater the
prudence with which we must conduct our own affairs. And that is going on
now to some extent because people can't get a good
return from safe instruments. They're going into the risky
ones, and they're bidding. You know, so there's
a race to the bottom. It's like an auction. Now if you want to buy a
painting at Sotheby's, there's an auction, and the
painting goes to the person who pays the highest price. But in the investment world,
it's a reverse auction. Well sometimes you
pay highest price, but sometimes you
bid in lowest return. So there's a bond that's going
to be issued by a company. I say I demand 7% interest. And this fellow says,
no, I'll take six. And that guy says,
I'll take five. I say I want protective
covenants to make sure that the company can't do
things that ruins its own credit worthiness. He says I'll do it
with less covenants. And that guy says, I'll
do it with no covenants. What happens? The bond is issued at
5% with no covenants. And that's the
race to the bottom. And anybody who
participates in that bond probably could be
making a mistake. And that's going on now. Not to the same terrible extent
that it was in '06 and '07. But you got to be careful today. Oak Tree's model for
the last 3 and 1/2 years has been move forward
but with caution. Caution has to be a
very important component of everybody's actions today. Well thank you very
much for being with me. And I hope you enjoyed it. And when I think of more
stuff, I'll come back. MALE SPEAKER: Thank you so much. [APPLAUSE]
