Mastering The Market Cycle: Getting the odds on your side

by Howard Marks

Positioning and selection are the two main tools in portfolio management. It may be an over-simplification, but I think everything investors do falls under one or the other of these headings. Aggressiveness — the assumption of increased risk: risking more of your capital; holding lower-quality assets; making investments that are more reliant on favorable macro outcomes; and/or employing financial leverage or high-beta (market-sensitive) assets and strategies Defensiveness — the reduction of risk: investing less capital and holding cash instead; emphasizing safer assets; buying things than can do relatively well even in the absence of prosperity; and/or shunning leverage and beta The choice between aggressiveness and defensiveness is the principal dimension in which investors position portfolios in response to where they think they stand in the cycles and what that implies for future market developments. Skill — the ability to make these decisions correctly on balance (although certainly not in every case) through a repeatable intellectual process and on the basis of reasonable assumptions regarding the future. Nowadays this has come to be known by its academic name: “alpha” Luck — what happens on the many occasions when skill and reasonable assumptions prove to be of no avail — that is, when randomness has more effect on events than do rational processes, whether resulting in “lucky breaks” or “tough luck”