The Most Important Thing: Uncommon Sense for the Thoughtful Investor (Columbia Business School Publishing)

by Howard Marks

Only if your behavior is unconventional is your performance likely to be unconventional, and only if your judgments are superior is your performance likely to be above average.

Abstention on the part of those who won’t venture in creates opportunities for those who will.

But pragmatic value investors feel just the opposite: They believe high return and low risk can be achieved simultaneously by buying things for less than they’re worth.

Skillful investors can get a sense for the risk present in a given situation. They make that judgment primarily based on (a) the stability and dependability of value and (b) the relationship between price and value.

Investing consists of exactly one thing: dealing with the future.

Investment risk comes primarily from too-high prices, and too-high prices often come from excessive optimism and inadequate skepticism and risk aversion.

People vastly overestimate their ability to recognize risk and underestimate what it takes to avoid it; thus, they accept risk unknowingly and in so doing contribute to its creation.

This paradox exists because most investors think quality, as opposed to price, is the determinant of whether something’s risky.

Risk control is the best route to loss avoidance. Risk avoidance, on the other hand, is likely to lead to return avoidance as well.

However, there are two concepts we can hold to with confidence: • Rule number one: most things will prove to be cyclical. • Rule number two: some of the greatest opportunities for gain and loss come when other people forget rule number one.

You must do things not just because they’re the opposite of what the crowd is doing, but because you know why the crowd is wrong.

Large amounts of money aren’t made by buying what everybody likes. They’re made by buying what everybody underestimates....

short, there are two primary elements in superior investing: • seeing some quality that others don’t see or appreciate (and that isn’t reflected in the price), and • having it turn out to be true (or at least accepted by the market).

The error is clear. The herd applies optimism at the top and pessimism at the bottom. Thus, to benefit, we must be skeptical of the optimism that thrives at the top, and skeptical of the pessimism that prevails at the bottom.

It’s our job as contrarians to catch falling knives, hopefully with care and skill.

Our goal is to find underpriced assets. Where should we look for them? A good place to start is among things that are: • little known and not fully understood; • fundamentally questionable on the surface; • controversial, unseemly or scary; • deemed inappropriate for “respectable” portfolios; • unappreciated, unpopular and unloved; • trailing a record of poor returns; and • recently the subject of disinvestment, not accumulation.

Oaktree has always been explicit about our belief that missing a profitable opportunity is of less significance than investing in a loser.

I consider it far more reasonable to try to (a) stay alert for occasions when a market has reached an extreme, (b) adjust our behavior in response and, (c) most important, refuse to fall into line with the herd behavior that renders so many investors dead wrong at tops and bottoms.

His views on market efficiency and the high cost of trading led him to conclude that the pursuit of winners in the mainstream stock markets is unlikely to pay off for the investor. Instead, you should try to avoid hitting losers. I found this view of investing absolutely compelling.

Clearly, if we can keep up in good times and outperform in bad times, we’ll have above-average results over full cycles with below-average volatility, and our clients will enjoy outperformance when others are suffering.

As an aside, it’s worth noting that the assumption that something can’t happen has the potential to make it happen, since people who believe it can’t happen will engage in risky behavior and thus alter the environment.

Thus, it’s our goal to do as well as the market when it does well and better than the market when it does poorly.