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My notes from Howard Marks' presentation on 2-Mar-17:
• Definition of "great" companies is dubious. Very difficult to identify great companies over a very long period
• Investing is not a matter of buying good things, but buying things well (buying assets which are out of favour)
• Forecasting is not possible as the future is not knowable. Try to know the knowable. Focus on specific sectors, industries, companies
• The main decision to make at any point in time - whether to play defensive or offensive. You cannot play both at the same time.
• Low purchase price is more important than anything else (including quality of company)
• Have to think differently (variant perception) and better - need to have some knowledge different from everyone else
• Most investors behave pro-cyclically
• You need to have a philosophy and process that you can stick to even in most trying of times
• Most corrosive of emotions is to sit up and watch others make money
• Plan to survive the "worst day" in the market without having to sell. The challenge is we don't know what the "worst day" will look like, but can get an idea from the past.
• Hubris, ego, over-confidence are enemies of an investor
• Your approach needs to be consistent with your personality
• Turn cycles to your advantage
• Look at E/P and compare with interest rates to get a sense of overall market valuations
Overall, it was a great presentation with some very good Q&A. Thanks to Prof Bakshi for inviting me and hosting such a fabulous and memorable event.
Finding bargains
• Investment is the discipline of relative selection
• Our goal isn't to find good assets, but good buys. Thus, it's not what you buy; it's what you pay for it.
• The necessary condition for the existence of bargains is that perception has to be considerably worse than reality.
Ultimately, we are all looking to make money from stocks. So, even though HUL is a great business, it is unlikely to make to really wealthy. A good business is not always a good stock and vice versa.
Patient Opportunism
• Sometimes we maximize contribution by being discerning and relatively inactive. Patient opportunism - waiting for bargains - is often your best strategy.
Patience and being emotionally able to sit tight on a position or with cash is critical, although one of the toughest things to do. This is where the right investing temperament is required. As Jesse Livermore said famously and is also oft repeated by Charlie Munger, "Throughout all my years of investing I've found that the big money was never made in the buying or the selling. The big money was made in the waiting."
Having a sense of where we stand
• Most people strive to adjust their portfolios based in what they think lies ahead. At the same time, however, most people would admit forward visibility just isn't that great. That's why I make the case for responding to the current realities and their implications, as opposed to expecting the future to be made clear.
Move beyond "hope trades" to discerning what is going on in the markets today and calibrate your actions based on that.
Investing defensively
• If we avoid the losers, the winners will take care of themselves.
• Investing scared, requiring good value and a substantial margin for error, and being conscious of what you don't knowand can't control are hallmarks of the best investors I know.
• Worry about the possibility of loss. Worry that there's something you don't know. Worry that you can make high quality decisions but still be hit by bad luck or surprise events. Investing scared will prevent hubris; will keep your guard up and your mental adrenaline flowing; will make you insist on adequate margin of safety; and will increase the chances that your portfolio is prepared for things going wrong. And if nothing goes wrong, surely the winners will take care of themselves.
Avoiding Pitfalls
• The success of your investment actions shouldn't be highly dependent on normal outcomes prevailing; instead , you must allow for outliers.
• Loss of confidence and resolve can cause investors to sell at the bottom, converting downward fluctuations into permanent losses and preventing them from participating fully in the subsequent recovery.
Shit happens. Be prepared, atleast mentally to deal with it. Don't put all your eggs in one basket no matter how good and insulated the basket is!!
Reasonable Expectations
• Investment expectations must be reasonable. Anything else will get you into trouble, usually through the acceptance of greater risk that is perceived.
Don't try to overreach. Having an unreal and unjustified return expectation is the beginning to investment mistakes. Don't pick a return (like 25% or 30% or 40%) out of thin air and hope to make that every year. It will necessarily make you do things which will eventually lead you to losses.
This concludes the learning and musings from Howard marks' The Most Important Thing Illuminated.
You can read the previous posts in order:
Part 1
Part 2
Part 3
Part 4
Part 5
Part 6
Being attentive to cycles
• Just about everything is cyclical. Cycles always prevail eventually. Nothing goes in one direction forever.
Awareness of the pendulum
• There are a few things of which we can be sure, and this is one: extreme market behaviour will reverse. Those who believe that the pendulum will move in one direction forever - or reside at an extreme forever - will eventually lose huge sums. Those who understand the pendulum's behaviour can benefit enormously.
This is one of my core beliefs. In sports, we call this by "law of averages" or "rub of the green". Mean reversion works, but in some cases, you may need to have a suitable long term time frame to judge its impact.
Combating negative influences
• Many people will reach similar cognitive conclusions from their analysis, but what they do with those conclusions varies all over the lot because psychology influences them differently. The biggest investing errors come not from factors that are informational or analytical, but from those that are psychological.
• From time to time greed drives investors to throw in their lot with the crowd in pursuit of profit, and eventually they pay the price. We must constantly be on the lookout for things that can't work in real life. In short, the process of investing requires a strong dose of disbelief. Inadequate skepticism contributes to investment losses.
Again, something very very core to my belief system. Temperament is what differentiates the good investor from the bad. And the ability to say "No" to things or stories that don't make sense regardless of who is saying it.
Contrarianism
• You must do things not just because they are the opposite of what the crowd is doing, but because you know why the crowd is wrong.
• Establishing and maintaining an unconventional investment profile requires acceptance of uncomfortable idiosyncratic portfolios, which frequently appear imprudent in the eyes of conventional wisdom.
• Only a skeptic can separate the things that sound good and are from the things that sound good and aren't. The best investors I know exemplify this trait. Skepticism and pessimism aren't synonymous. Skepticism calls for pessimism when optimism is excessive. But it also calls for optimism when pessimism is excessive.
Taking a view that is different from the majority is a psychologically difficult thing to do. But the best results are obtained by people who are able to stand apart from the crowd.
Howard Marks has written extensively on risk and its management.
The riskiest things: the most dangerous investment conditions generally stem from psychology that's too positive. For this reason, fundamentals don't have to deteriorate in order for losses to occur; a downgrading of investor opinion will suffice. High prices often collapse of their own weight.
The greatest risk doesn't come from high quality or high volatility. It comes from paying prices that are too high. This isn't a theoretical risk; it's very real.
Most investors think quality, as opposed to price, is the determinant of whether something's risky. But high quality assets can be risky, and low quality assets can be safe.
Risk is inherent in the price you pay for stocks. The higher price you pay, the higher risk there is. Irrespective of the quality of the business.
The possibility of a variety of outcomes means we mustn't think of the future in terms of a single result but rather as a range of possibilities.
No one knows the future, so deterministic projections make little sense. It is better to think in terms of a range of outcomes that covers the most likely future scenarios.
Invariably things can get worse than people expect. Maybe "worst case" means "the worst we've seen in the past". But that doesn't mean things can't be worse in the future.
Careful risk controllers know they don't know the future. They know it can include some negative outcomes, not how bad they might be, or exactly what their probabilities are.
Case in point, 2008, was much worse that what most investors had expected.
I'm very happy with the phrase "perversity of risk". When investors feel risk is high, their actions serve to reduce risk. But when investors believe risk is low, they create dangerous conditions. The market is dynamic rather than static, and it behaves in ways that are counter-intuitive.
My core investment assumption is that the market is a complex adaptive system and is auto-correcting in nature. we cannot determine outcomes from a linear thought process.
The road to long-term investment success runs through risk control more than through aggressiveness. Over a full career, most investors' results will be determined more by how many losers they have, and how bad they are, than by the greatness of their winners.
If you minimize your losers, the winners will take of itself!
There are two essential ingredients for profit in a declining market: you have to have a view on intrinsic value, and you have to hold that belief strongly enough to be able to hang in and buy as price decline suggests you are wrong. Oh yes, there's a third:you have to be right.
This will only come from experience of being right about your view.
For a value investor, price has to be the starting point. It has been demonstrated time and time again that no asset is so good that it can't become a bad investment if bought at too high a price. And there are a few assets so bad that they can't be a good investment when bought cheap enough.
There's no such thing as a good or bad idea regardless of price!
This is a critical point that people miss in their quest for "quality" stocks!! **Quality is not irrespective of price.**
Investing is a popularity content, and most dangerous thing is to buy something at the peak of popularity. At that point, all favourable facts and opinions are already factored into its price, and no new buyers are left to emerge.
There is no easy way of identifying when the peak of popularity is reached. But one should have a general sense of when prices have gone up way beyond their worth. And then the trick is to have the emotional fortitude of getting out of the position.
The safest and potentially mist profitable thing to do is to buy something when no one likes it. Given time, it's popularity, and thus it's price, can only go one way: up.
This requires a certain mindset of contrarianism and ability to sit through extended period of non-performance of stock price. This may specially be difficult when other stocks are running up consistently.
Since other investors may be smart,
well-informed and highly computerized, you must find and edge they don't
have. You must think of something they haven't thought of, see things
they missed bring insight they don't possess. You have to react
differently and behave differently.
Out of the main four edges that an investor can have, namely i)
information, ii) analytical, iii) knowledge and iv) time, here Marks is
talking about the analytical or insights edge. With the same set of
information, can you have better or different insights which will result in a differentiated result for your portfolio.
To achieve superior investment results, you have to nonconsensus views regarding value, and they have to be accurate.
For your performance to diverge from the the norm, your expectations -
and thus your portfolio - have to diverge from the norm, and you have
to be more right than the consensus. Different and better: that's a
pretty good description of second-level thinking.
I think this is the simplest yet most overlooked part. You cannot get
superior results by doing what everyone around you is doing. Some
investors I know of surround themselves only with people who have very
similar viewpoints about life and markets. To me, they are living in an echo chamber.
To really have a nonconsensus view, you have to actively look for
disconfirming evidence. That is, an idea which is exactly opposite to
the one you hold.
As Charlie Munger has said, " It's bad to have an opinion that you
are proud of if you can't state the arguments for the other side better
than your opponents."
Over the years, I have come to the conclusion that the most critical
aspect in investing is to be able to build the right temperament. To me
this is the secret sauce that separates the men from the boys and enable
some to consistently outperform others, and their benchmarks.
Temperament is something that needs to be learnt through experience.
We can augment it by taking a leaf out of the book of the masters. Over
the last 15 years, I have tried to read as much as possible about
experiences of great investors and fund managers, to try to understand
how to improve my temperament.
Let me start a series of posts on this topic over the next few days, with the writings of a great investor who I
have followed for the last decade. Not only is he a great investor but
he is a fantastic communicator and has that rare gift of making complex
subjects appear simple. He also is extremely generous in sharing his
knowledge and experience with the general public. He is Howard Marks.
You can read his book "The Most Important Thing Illuminated"
His memos are available at https://www.oaktreecapital.com/insights/howard-marks-memos
Here are some excerpts from his book and some commentary where it is necessary:
To me, risk is the most interesting, challenging and essential aspect of investing.
The real test of investing is not getting returns but ensuring the
downside is always protected. As Buffett has said famously, "Rule No.1:
Never lose money. Rule No.2: Never forget rule No.1."
You must be aware of what's taking place in the world and
of what results those events lead to. Only in this way can you put the
lessons to work when similar circumstances materialize again. Failing to
do this - more than anything else - is what dooms most investors to
being victimized repeatedly by cycles of boom and bust.
History, of markets and in general, is essential to know. You need to understand the causality of consequences of events.
Those who do not know history are condemned to repeat it. Which
basically means you need to have some mechanism of capturing your past
mistakes for posterity and are able to ensure that they are not repeated
again.
ACTIONABLE - A checklist of past mistakes and the reason those occurred is a good starting point.
