3 Takeaways Podcast Transcript Lynn Thoman (https://www.3takeaways.com/) Ep 34: Getting The Odds On Your Side: Legendary Investor Howard Marks INTRO male voice: Welcome to the 3 Takeaways podcast, which features short memorable conversations with the world's best thinkers, business leaders, writers, politicians, scientists, and other news makers. Each episode ends with the three key takeaways that person has learned over their lives and their careers, and now your host and board member of schools at Harvard, Princeton, and Columbia Lynn Thoman. Lynn Thoman: Hi everyone, it's Lynn Thoman, welcome to another episode. Today, I'm excited to be here with legendary investor, Howard Marks. He is co-founder and co-chairman of Oaktree Capital Management, a global investment firm, which has about $150 billion under management, and is the largest investor in distressed securities worldwide. According to Warren Buffett, "When I see memos from Howard Marks in my email, they're the first thing I open and read. I always learn something." I'm excited to find out from Howard how we can all invest better for higher returns and less risk. Thank you, Howard, for being here today. Howard Marks: Pleasure, Lynn. LT: Howard, you have said, "Businesses are both more vulnerable and more dominant in today's world with much greater opportunities for dramatic changes in fortune, both positive and negative." Can you elaborate on that and its implications? HM: If you go back 40 or 50 years, the world felt like an unchanging place. There were new developments, there were new car models, there was sports news, but the world didn't change very much, we didn't have a feeling of transiency. Events played out in front of this stable backdrop, but the backdrop was unchanging. Well, today it changes every day, and change and technology are much more a part of life today than in the past. We used to talk about companies as being defensive, and they may not do so well in the great times, but they're very safe in the bad times, and we talk about companies with moats. Newspapers were a good example of that. But today, everything is vulnerable, almost everything can be disrupted. So that's the origin of that statement, I mean, you come up with a better mouse trap, you can get on top and maybe you can stay there until somebody else comes up with a better mouse trap, or maybe you can stay there if you evolve yours. But almost everybody is subject to being disrupted and disruptors have a lot of opportunity. LT: And what are the implications for investing? HM: The main implication is, you'd better think about that. When you're looking at a company or an industry, you'd better give a lot of consideration to its potential for being disrupted. This is something we didn't think about in the past, we didn't think about whether newspapers could be supplanted by another form of communication, but now we know that they are and they're fighting for their lives. LT: So there are no safe stodgy companies to invest in that are lower risk anymore? Page 1 HM: Well, I think that's right. Yeah, exactly. LT: Can you describe the strategies of the most successful investors you've known? HM: It's so interesting you should ask that, Lynn, because there is no common thread. I know people who do distressed debt, stocks, bonds, real estate, private equity, venture capital, macro investors, etcetera, and they're hard working, demanding of themselves. Invariably highly intelligent, often unemotional, which is an important component in the mix, curious and most of them are somewhat well-rounded. But there are many ways to skin the cat in investing, and some of them I don't care for, but I also know people who are very good at it, so I think it's the attributes of the person rather than the philosophy. HM: I'm what's called a value investor, which means that I only invest in assets where I think that they have a tangible value, an intrinsic value we call it, and that it's ascertainable, estimatable. Value investors, try to figure out the intrinsic value and then see if you can buy for less, and that's when we buy. But there are people who invest in potential new drugs, they can't quantify the value, they can only make wild seat of the pants guesses. But there are people who do drugs, technology, macro even, some of the greatest investors in history like George Soros and Stan Druckenmiller, invested primarily on macro, the movements of the economy, of currencies, of markets, not so much individual stocks. And there are people who do it many ways, but you have to have those attributes. LT: What are the most important things in investing? HM: Well, I wrote a book entitled The Most Important Thing, and it has 21 chapters, and each chapter says, "The most important thing is... " And then it's a different thing. Because there is no one most important. And I used to go to clients and I would say, "Well, the most important thing is not losing money," and then I would say, "The most important thing is buying cheap," and then I would say, "The most important thing is having upside potential." So I realized that that there is no one most important thing. Now in the book, it happens that I spend three chapters on the subject of risk, because I think risk is very important. Risk is what keeps you from losing... I mean risk control is what keeps you from losing money, and enables you to have hopefully upside, which is disproportional to the downside, so it covers a lot of bases. HM: And the other thing is this, it's not hard to make money in the market, especially in good years and the vast majority of years are good years, the stock market goes up much more regularly than it goes down. So you can be a successful investor with ease, in terms of making money. I think the real accomplishment is to have profit potential, which is disproportionate to the risk you take. That's an accomplishment, and that gives what we call in the trade, superior risk-adjusted returns, and that requires attention to risk. So the three chapters are, the most important thing is understanding risk, identifying risk, and then managing risk. And I do think that the ability to manage risk and reduce risk without proportionally reducing your return potential, I think that's a real accomplishment. LT: And are there simple things to manage and reduce risk that all investors should think about? HM: Well, the obvious one is diversification, and diversification, it's not a magic elixir, it merely says that if you don't have any big positions, you can't have any big losses. Spread it out. Now, it is possible for something system-wide to happen, which affects all your investments even if you have Page 2 them spread out in many places, but usually if something goes wrong with company A, that doesn't mean it goes wrong with company B, so you have diversification. Now, when you diversify, you have to remember, it's not having a number of things, it's having things that respond differently to a given situation. So if you have 100 stocks, but they all get their supplies from China, then you have one exposure. So it's important to bear that in mind. HM: But I always say we diversify to protect against what we don't know, we concentrate to take advantage of what we do know. So if you are a great stock picker and you have one favorite, maybe you should put all your money in it. If you invest in say 10 things or 50 things or 100 things, you're diluting whatever appropriate judgement you made about that one good one. So diversifying is a matter of sub-optimizing, you trade away downside risk for upside, and you give up some upside potential at the same time, most people think that's the cheapest form of risk control available, but it also has a negative impact on return, and you can't ignore that. LT: You've thought a lot about market cycles, both major long-term market cycles and shorter term cycles around the long-term trends, and you've even written a terrific book titled Mastering The Market Cycle, Getting The Odds On Your Side. Can you talk about how important cycles are and where we are in the current cycle? HM: Yes, well, cycles are really important because we live our lives through something called pattern recognition, and we understand that it's colder in the winter than the summer, so we know how to dress. We don't have to put our finger out the door every morning to decide whether to put on shorts or a parka. And we understand phenomena through their repetition. Mark Twain is reputed to have said that history doesn't repeat, but it rhymes. There are concepts and themes that repeat from one iteration of history to the next, not necessarily the details. That's why he said history doesn't repeat, but the basic concepts. And so I think the cycles are a very important fact of life in the economy and in the markets. HM: If you look at it, the economy goes like this, slight fluctuations along this upward trend line at a rate of about 2% or so a year.