Notes on Risks from Howard Marks (Oaktree Capital)

In Marks' latest memo, Marks discusses the need for discipline, patience, and selectivity.

Many of you wonder why markets have risen so quickly, wonder why you're missing out, and are less observant on the risks attached to plowing in capital in the stock market.

Marks reminds investors that true risk managements involves forecasting the unknowable. The market fallout in Greece two weeks ago was an example. More are likely to come. Therefore, a sufficient margin of safety for the valuation of companies is warranted.

Below is a highlight from the memo.

A few important things about investing:

• Investors generally overestimate their ability to see the future, and the worst of them act as if they know exactly what lies ahead.
• It’s important to worry about what’s coming next. The fact that we don’t know what it is shouldn’t permit us to think there’s nothing to worry about.
• Low asset prices allow us to invest aggressively, without much consideration given to worrisome fundamentals and the possibility of negative surprises. But as prices rise, so should our degree of concern over these things.

The bottom line is this: the fact that we don’t know where trouble will come from
shouldn’t allow us to feel comfortable in times when prices are full. The higher
prices are relative to intrinsic value, the more we should allow for the unknown.

Full Memo is here. 

Let's Talk "Zebras"

The only thing more comforting for an individual investor "missing" the March 2009 -Present rally is not having a professional career dependent on justifying why one "missed" the great returns in the market this year (my high-lights in bold). How difficult it is now for investors to pick great investments: when stock prices go up, risks goes up, not down.

Zebras!?
“Zebras have the same problem as institutional portfolio managers. First, both seek profits. For portfolio managers, above average performance; for zebras, fresh grass. Secondly, both dislike risk. Portfolio managers can get fired; zebras can get eaten by lions. Third, both move in herds. They look alike, think alike and stick close together.

If you are a zebra, and live in a herd, the key decision you have to make is where to stand in relation to the rest of the herd. When you think that conditions are safe, the outside of the herd is the best, for there the grass is fresh, while the middle see only grass which is half-eaten or trampled down. The aggressive zebras, on the outside of the herd, eat much better. On the other hand – or other hoof – there comes a time when lions approach. The outside zebras end up as lion lunch, and the skinny zebras in the middle of the pack may eat less well but they are
still alive.”

. . . Acorn Fund’s founder, and portfolio manager, Ralph Wanger

H/T Marketfolly. The full article by Jeffrey Saut is here.

Continuing on the topic of investment psychology, Ken Norquay describes risk management in a different way in his most recent entry. Here is an excerpt:

The investment industry’s pat answer does not address the basic truth that there is risk in investing in the stock market and we need to know how to handle that risk.

...


When I first entered the investment business in 1975, mutual funds guru John Templeton got it right. He used to say: “We shop the world for undervalued stocks. We hold them for three or four years and sell them when that value is recognized.” He wanted us to buy and hold Templeton Growth Fund in full knowledge that he would buy and sell stocks for us within the fund. Modern mutual funds do not talk about selling at all. They want us to buy and hold their mutual funds, and they want to buy and hold stocks within that fund. And they really do hold: how many mutual funds off loaded their stocks before the 2008 melt down? Mutual funds management has changed dramatically since 1975.