Howard Marks memo: "I Beg to Differ"

bee

a couple of insights for Howard Marks...

In 1978, I was asked to move to the bank's bond department to start funds in convertible bonds and, shortly thereafter, high yield bonds. Now I was investing in securities most fiduciaries considered "uninvestable" and which practically no one knew about, cared about, or deemed desirable... and I was making money steadily and safely. I quickly recognized that my strong performance resulted in large part from precisely that fact: I was investing in securities that practically no one knew about, cared about, or deemed desirable. This brought home the key money-making lesson of the Efficient Market Hypothesis, which I had been introduced to at the University of Chicago Business School: If you seek superior investment results, you have to invest in things that others haven't flocked to and caused to be fully valued. In other words, you have to do something different.

and,

the total dollars earned by all investors collectively are fixed in amount, all active bets, taken together, constitute a zero-sum game (or negative-sum after commissions and other costs). The investor who is right earns an above-average return, and by definition, the one who's wrong earns a below-average return.

I Beg to Differ
https://seekingalpha.com/article/4526834-latest-memo-from-howard-marks-i-beg-to-differ

hank

I listen to Marks several times a week. He’s so “right” and I find it so difficult to follow his advice. I held DKNG and ARKK at various points this year at well below what they closed at yesterday. Yes, I made a few $$ on those spec plays. But the incredible volatility of up 9% one day and down 9% the next scared me off. Took the small gains and ran. Had I clung to those longer I’d have been better off. Both closed yesterday at their recent high. DKNG was down to $10.66 at one point a month or two ago. Near $16 yesterday as I recall - or about 50% above its 3 month low. Bloomberg reports that TSLA jumped 50% last month! Who among us has the nerve to ride those broncos?

Oversimplifying Marks, the markets are a large casino. Outsmarting the “herd” is his mentality. He must drink better whisky than I do.

Thanks @bee for posting one of my favorite investors / writers. Sorry if I stole any of your thunder.

LewisBraham

Because Marks barely mentions costs or management fees, much of what he says here seems wrong to me. The “average investor” in an almost zero cost index fund that captures the entire market beats most money managers after fees. That fee is a hurdle the active manager has to overcome every single year. The higher the hurdle is—hint Marks is first a hedge fund manager with significant fees—the more difficult that hurdle is to overcome. To overcome it, in most cases managers have to take calculated risks, to be different or contrarian as Marks describes. What he neglects to mention is the greater the fee is, the more risk, the more contrarian, the manager must be and that can lead to terrible underperformance. Meanwhile, a low fee active manager can take smaller active bets, be less of a contrarian than Marks and still win. The hurdle is smaller. I’ve seen a few low active share funds with modest or cheap fees that have also outperformed by trying to hit singles or doubles instead of home runs. Such funds because they are less contrarian but still active can also have much more consistent performance than the big contrarians with super concentrated portfolios.

There are a number of other errors I think in here regarding quant investing and a failure to acknowledge that when Marks started investing there were just a handful of professional investors looking over high yield bonds and other contrarian plays. Now there are thousands. To find the true contrarian play, you will probably have to take extraordinary risk and instead of “second level thinking,” a passive aggressive way of the manager hinting “hey l’m a genius so pay my high fee,” most investors are better off seeking low fee active managers and index funds.

Sven

Concur with LB. The days of Peter Lynch no longer exist. Today out-performing the broader stock index consistently is very challenging. For me the ability to capture the market return by using low cost index funds is good enough. Among smaller cap space, there are more opportunities in active management where they able to do better periodically , at the expense of assuming greater risk.

yogibearbull

I like Howard Marks’ long and thought-provoking pieces. The firm Oaktree Capital (AUM $159 billion) that he cofounded is big and successful in distressed credit areas. Gundlach's DoubleLine may not have happened without Marks. But the firm hasn’t done well in one area – general funds. It offers several private-equity funds, 1 FI interval-fund and 1 tiny EM equity fund. So, all we are left with is reading Marks’ great essays.
https://www.oaktreecapital.com/
https://www.businessinsider.com/marks-made-900-million-billion-investing-in-gundlach-2016-2

Oldtimers may remember VG Convertible Fund VCVSX that was closed in 2019 (AUM was still around $1 billion but that wasn’t not big enough for VG) due to outflows, lagging performance and manager turnover (Oaktree was the fund manager). Knowing about Marks and Oaktree, I followed VCVSX but never got into it as it wasn’t a great fund.

https://www.morningstar.com/articles/906914/why-vanguard-killed-a-good-fund
https://citywireusa.com/professional-buyer/news/not-worth-the-hassle-vanguard-to-liquidate-almost-1bn-fund/a1188088
https://www.mutualfundobserver.com/discuss/discussion/46677/vanguard-convertible-securities-fund-to-liquidate/p1
https://www.prnewswire.com/news-releases/vanguard-to-liquidate-convertible-securities-fund-300772427.html

hank

Scanned @bee’s linked article. Typical Marks. To me the take away is that market valuations follow a herd mentality. At any given time part of the price of a security rests on investor sentiment. Now, none of us has the research capabilities and analytic tools at Mark’s disposal. So it’s difficult trying to replicate his process or even come close.

Still, I think the herd mentality concept has legs - more so today than ever. Go back 8-12 months and read the threads posted on this forum. Certainly some anticipated the approaching storm and were taking steps to lighten up on risk. But the overwhelming number of posts remained quite bullish. People were eagerly buying. I nearly got into a spitting match with one fellow who insisted “buying the dip” was always a reliable investment approach, even with the DJI near 37,000 and the NASDAQ 20% higher than now,

So if (a big if) one can identify severely undervalued assets and if one can remain calm and allow time to do its work, than one can be more successful than investing in broadly diversified funds. It’s difficult to see how an extra 1 or 2% in fees would cancel out the benefits of a 2X or 3X appreciation in value over a few years time. BTW - Not long ago passive investing - mostly the S&P 500 was near conventional wisdom here and elsewhere. Doubters were faced with fiercely intense posts trying to prove its validity. Now many (including some D&C funds) are actually shorting that index. One problem some of my sources identify is the huge amount of passive investing coming from retirement plan contributions at the individual level. Much of that has been going into funds linked to the S&P index for decades.

LewisBraham

Consider the JAVA ETF, run by the same manager, Clare Hart, as the VGIIX mutual fund. VGIIX is a five-star fund, even though it has a low active share in part because its expense ratio is a modest 0.69% but also because Hart takes small calculated risks. She is not a major contrarian, making big bets, but contrarian enough to get the job done. The JAVA ETF has an even lower 0.44% expense ratio and holds 153 stocks. According to Morningstar, VGIIX has an active share of only 63.5%, not very contrarian at all, but enough to win without any extreme swings that are significantly different from its benchmark the Russell 1000 Value. Of course, the Russell 1000 Value is contrarian by design and an ETF tracking that can be had for even less.

Crash

Sounds like folks are talking past each other here. Agree with @hank. Sounds like @LewisBraham is saying: "Ya, but..." And his point is valid, too.

FD1000

Concur with LB.
More, I read many of Marks articles over the years and they are long. Lots of fluff with contradicting reasons of what to do and what not. The end result is hardly any specifics of what to do and when.

Crash

FD1000 said:

Concur with LB.
More, I read many of Marks articles over the years and they are long. Lots of fluff with contradicting reasons of what to do and what not. The end result is hardly any specifics of what to do and when.

......Sounds like a very common reaction from years ago on this Board re: The Zurich Axioms: complaints about the Axioms containing contradictory observations and advice, making them virtually useless. I think the response here from @FD1000 illustrates perfectly the fact that we are all put together differently. We confront the world from different perspectives, operating with very different assumptions, fundamentally. Our various approaches to making sense of things will be different. My own reply is simple: investing is not a cut-and-dried process, like following a recipe. If that's the way one invests, I assert that it must be a method arrived at after much PRIOR investigation and analysis. Because not only the Markets, but the entire world, is a jumble of contradictory signals and noise and extraneous incidentals. Each of us must sort it all out for ourselves. I am very much in touch with the line of thought which says that investing is always some combination of both Science and Art. Very little in this life is all-or-nothing, either/or, or black or white. It's complicated. Anything which is important enough to matter is complicated.

hank

Crash said:

Sounds like folks are talking past each other here …

Well, yes and no. I won’t disagree with LB. Made some excellent points. I’m into Marks’ thinking more on a philosophical level than his performance as an actual practitioner. I’m convinced that valuations at any given time are significantly elevated or depressed owing to public perception. If I can gain an edge by understanding that basic market dynamic (be it in preserving capital, reducing risk or making money) so be it. Marks is like a broken record ISTM. His is not a complex philosophy - though one most difficult to execute for some of the reasons Lewis points out. Not interested in owning his or any high fee hedge fund. He is one of dozens of successful investors today. Learn what you can from them all.

@FD1000 - Is there any professional fund manager (hedge fund, mutual fund, ETF) to your knowledge who is / or has ever been a more successful investor than you? If so, who might that be?

FD1000

Hi Crash, I agree with you, BUT, the beauty of investing is the fact it can be extremely easy. Suppose someone decides to invest $1000 monthly in a target fund(made of indexes) for 40 years in Roth 401K, makes 8% annually, and never touch this money until retirement. She retires with about 3.2 million, not bad. At age 65, she takes SS and another 2-3% from her Roth for living expenses...DONE.
Of course, she can do better and invest more.

I believe the above can beat most investors, and even pros. KISS and effective, no science or art needed. I also think many people who participate in investing forums make things too complicated, including my own (system). Financial advisers make it complicated to confuse their clients.

Crash

"...no science or art needed...."

But, but, but..... LIFE is an Art. Enough said.

Crash

"...Not interested in owning his or any high fee hedge fund. He is one of dozens of successful investors today. Learn what you can from them all."

Indeed!

hank

Tacking on … Another thing I learn from listening to Marks (via audiobook) is perseverance - sticking to your guns. Once you’ve thought something through carefully and made a decision don’t second guess yourself and settle for half a loaf as long as the reasons you bought something are still valid. Too many of us, self included, are overly influenced by short term trends. Maybe patience is a better term here.

Good discussion. Hope everyone prospers - no matter where they derive their compass setting or inspiration …

Crash

Yes, indeed. Good discussion. I couldn't have made your point any better than you stated it, hank. But I have learned not to stay MARRIED to selections which are not serving their purpose any longer. Most obviously: losers. I don't need to wallow at the bottom of the well while the water is being drawn out past me, under my own nose. And it doesn't have to be all-or-nothing, either. I don't have to divest 100% from a fund because I'm dissatisfied with it. Patience.

hank

@Crash. Yes, sometimes a parachute comes in handy.

Shostakovich

@LewisBraham: good points. With the continuing advance of machine learning and especially AI, I wonder if active investing is truly doomed.

hank

Shostakovich said:

“With the continuing advance of machine learning and especially AI, I wonder if active investing is truly doomed.”

Say it ain’t so, Joe!

- Libraries begin removing from their circulation shelves the works of Graham, Lynch, Bogle, Tobias, Marks, Munger and Buffett. These formerly revered authors are now relegated to an archival section hidden from view in some musty corner.

- David Giroux turns over fund operation to AI and takes leave from TRP. Takes a job working at a fast food joint.

- Across the nation prominent investment companies like D&C, Blackstone, PIMCO and Berkshire lay off thousands of analysts and research staff. Signs begin popping up on the doors of their former offices : “You have been replaced by a computer”

What could possibly go wrong here?

Anna

Well, off the top of the skull, as machine learning takes over there is a chance that all portfolios converge to a few over bought models based on broad descriptions of personal preference for risk, geology, politics, geopolitical, technical, social, etc. (Note the correlations that would/might create bias, even in models that strive to eliminate it.)

It just seems to me that when algorithms are in the driver's seat, the route converges to a few choices with limited endpoints. What may be the case, however, is the probably of uncertainty as a result of freeing people's time to amuse themselves with robotic wars, irrational gambling and exuberance, religiosity and anarchy, and whatever packetizes humanity into groups with group portfolios all alike. Perhaps correlations become solved when humanity becomes a manageable variable but WHAT, pray-tell shape will the machines decide to mold the portfolios and will organization, with feed-back, produce better or just boring similar models. Will the robots drive commercial success or vice versa?

Crash

Crash

@Anna, that is truly inspired !!!

LewisBraham

Given the fact that money managers have long invested in and celebrated companies that increased their profit margins by replacing human workers with machines, should we feel sorry for the same managers who are now being replaced? Or should we see it as poetic justice? I have long called the index fund a profit extraction machine.

Also, it is not simply the machines’ doing that is causing the problems here. I would say I learned about 20 years ago that the typical non-hedge fund manager charged institutional retirement plans about 0.40% to run private institutional accounts. The institutions had negotiating leverage regarding fees, yet managers could still be profitable at 0.40%. Yet they still charge routinely double that today for retail investors. Much as these same managers often complain about unionized labor having wages that are too high and say that’s why jobs are being outsourced overseas, retail investors are sick of paying 0.80% or more for what should really cost 0.40%. So they’re outsourcing the overpaid managers’ jobs to machines. Again, poetic justice.

If managers want to beat the machines in a highly competitive somewhat efficient market, they either need to charge less so the hurdle to win is lower or take large risks and charge the same exorbitant fees they always have and hope for the best. Either way, it’s still other people’s money they’re putting at risk.

carew388

+1

Crash

+1. ditto.

hank

Yes, a thoughtful opine by LB. I’m under the impression fees have been falling for individual investors, however, for years. (Doesn’t negate Lewis’ point.) I recall at work in the early 70s the original 2 options in our 403-B were either to invest in an expensive annuity or buy from a sole rep (advisor) selling Templeton products. He promised a great deal at a group discount having a “low” 4.17% front load. (Actually they began charging me a 7% load until I did the math and called them on it.) But in general, the front load was much more prevalent during the earlier days.

I’m for low fees if it doesn’t impact the provider’s quality of research and management - or service. Brings up a related question: Is the notable deterioration in TRP’s customer service (and some others as well) at least partially a consequence of progressive fee cutting over the past 3 or 4 decades? I suspect not since their AUM has also multiplied by several factors. Yet, one is left with only a shred of the service we’d come to expect from years past.

Yes, I understand LB’s point that there has been one fee structure for the monied class and a different one for individuals. I’m not grieving for the providers either. Like Twain, however, rumors of their death may prove premature.

LewisBraham

My understanding is that fees have fallen for individual investors primarily because individual investors are actively selecting low-fee index and other low fee quasi-active factor funds, not because in most cases active managers are voluntarily lowering their fees. Most of the data I’ve seen from industry trade groups like the ICI is asset-weighted fee data, revealing where investors are putting their money. By asset weighting, large low fee funds like Vanguard’s skew the data. That metric doesn’t reveal what the average active manager in a new small mutual fund, for instance, is charging. I would hope it’s come down some. In any case, the fees in aggregate have come down mainly because retail investors are voting with their feet and are tired of paying too much. And I think that’s fine, even if it means in some cases investment via algorithm. There are some truly active human based managers who charge reasonable prices. Dodge & Cox, Primecap and Vanguard Wellington come to mind. Whether they can beat the algorithms is an interesting question.

I too hope human managers don't disappear. I just think they should charge much less. The debate over whether human can beat algorithm reminds me a bit of the one over whether chess masters could beat IBM's Deep Blue: https://en.wikipedia.org/wiki/Deep_Blue_versus_Garry_Kasparov At the very least watching a human win offers some romantic hope for humanity besting machines. But having high fees is essentially tying one hand behind Garry Kasparov's back while he plays. I also don't think most people should sacrifice their retirements for a romantic notion about genius money managers.

Addendum: Apparently, chess computers have moved well beyond Deep Blue. No human has ever beaten Alphazero at a chess match: https://morethansport.com/can-a-human-beat-alphazero/