As a DIY investor, I have struggled for resources to build my knowledge beyond the text of MBA curriculum and the material from CFA Institute. It helps that there is now a plethora of successful fund managers – most, not surprisingly, from US – who put their expertise on paper and in the process create a guide that stand the tests of time, market cycles, interest rate movements.
I spent a good part of last fortnight on “The Most Important Thing” by Howard Marks. All of 180 pages and yet packs a punch above its weight. And there are 19 “the” most important things in the book – not one.
The book and its author
Howard Marks is the co-founder of Oaktree Capital Management, a global investment management firm with an AUM of $189B as on 31/12/2023. The company specializes in alternate investments – credit, private equity, real assets in addition to listed equity. According to the Oaktree Capital website, Mr. Marks started writing these memos in 1990 and continues to do so. These memos are admired within the investment community. These memos form the core of the book “The Most Important Thing: Uncommon Sense for the Thoughtful Investor”. The validation from Warren Buffet is right on the cover.
The book is arranged in 20 neat chapters – I mixed up the order while reading, and found each chapter speaks for itself. The last one is a summary – a sort of reiteration of the critical points made elsewhere in the book.
If I had to identify a key theme – it would be the laser-sharp focus on risk. In almost every chapter, he makes a reference that gives a new perspective on risk. My favorite is the one where he says paying a high price for a security (at low margin of safety) is risky. TBH, I have never thought of risk as deeply as Mr. Marks recommends that we do. Pick up the book please.
I selected a few critical points – my opinion.
Critical points
In order to achieve superior investment results, it is important to develop second-level thinking. That goes beyond the obvious. This second-level thinking holds non-consensus view regarding value. And to achieve superior results, one has to be right.
The edge for second-level thinkers comes from superior information or analysis, or both. However, given the inability of an average person to read the market cycles and the economy and make a projection, Mr. Marks advises to keep the focus on the granular – company, sector, industry and to understand the state of the market from the behavior of the participants.
It is possible to outperform in a market that is inefficient. Market inefficiency is a matter of degree – no market is complete either efficient or inefficient. Quite helpfully, Mr. Marks gives a summary of how to identify opportunities in the market.
In order to profit from a declining market, it is critical that the investor has a view on the intrinsic value of the asset. It takes gumption to stick to that even as further price declines suggest that the investor may be wrong.
The price of an asset is driven by 3 factors:
underlying fundamentals – long term impact
psychology – short term impact
technical – short term impact
The primary risk of value investing is that it can take the markets a long time for prices to converge to “your valuation”. It is worth quoting Keynes who said “The market can remain irrational longer than you can remain solvent”. (In this context, I like the quote from Prof Ashwath Damodaran who says “you don’t have to be right about your value to make money, you just have to be less wrong than the others”)
Mr. Marks introduces a new way to look at risk. He defines risk as the possibility of losing money – beyond the traditional definition of risk as volatility. This incorporates the possibility of lower returns and losses for investments with high expected returns.
Investment risk comes primarily from too high prices which in turn come from excessive optimism and inadequate skepticism
Elevated popular opinion can lead to both lower return and high risk
Controlling risk – in form of returns that are voluntarily foregone – can seem excessive but is the best method to avoid losses.
The main risks of investing
risk of losing money
risk of missing opportunities
The key contributor to the market excesses of bubble and crash is an improper amount of risk aversion. This is amplified by the fact that investor attitudes towards risk fluctuates greatly
The biggest investing errors come from psychological factors – greed, fear, envy, suspension of disbelief, to name a few.
On Contrarianism – Mr. Marks tags superior investors as contrarians. This is not deliberate, rather an outcome of second level thinking. As the market goes through cycles, it requires a contrarian mindset to make money. However, he is clear that no strategy works all the time – not even a contrarian one.
Divergence of views
“Assets can be overpriced over a long time. Eventually though valuation has to matter.”
I am not entire sure if this is true for India. Companies like Nestle India, Avenue Supermarkets (Dmart), Trent – are available at eye popping valuation. These are high quality stocks with proven operational success stories. Are these fairly valued? Definitely not. Do markets place a premium on such stocks? You bet. These and others of their ilk have always traded at high P/Es. If you want these in your portfolio you pay the price.
"Buying at a discount from intrinsic value and having the asset’s price move towards value doesn’t require serendipity – it just requires the market participants to wake up to reality.”
Hmmm. Who’s version of reality? Even towards the end of a bull or bear rally, the trigger for “waking up” is unknown. Doesn’t happen overnight. It take a few days to reverse. Also, the “waking up to reality” would require not just for the price to move towards value, it will require the price to move towards “my value” – what are the chances of that happening? And how long does one wait for this happy occurrence?
"When the market’s functioning properly, value exerts a magnetic pull on price.”
In the short term, markets are driven by psychology and technical. So, I am not entirely sure how this magnetic pull is exerted. Secondly, valuation is not a science. The same stock will have multiple intrinsic values depending on who is running the valuation– so what exactly is implied here? Finally, how does one know when a market is functioning properly?
"The safest and most potentially profitable thing is to buy something when no one likes it. Given time, its popularity, and thus its price, can only go one way: up.”
I can make no sense of this statement – Since Mr. Marks doesn’t give the context of the asset class, I can only hope he doesn’t mean this for listed equity.
In a nutshell
I will leave you with what I think is the key point. During periods of market exuberance, an investor would do well to
take note of the carefree, incautious behavior of others
prepare psychologically for a downturn
sell assets, or at least the more risk-prone ones
reduce leverage
raise cash
generally, tilt portfolio towards increased defensiveness.
While this is solid advise for institutional investors, for the DIY investors like myself, this seems a good brief to follow.
Disclaimer
These are my opinion. The sample companies mentioned in this are randomly picked to illustrate a point and for no other purpose. Also, please speak with a SEBI-registered Investment Advisor before taking any decision on your investment needs.
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