Invert Investment
"The Most Important Thing" by Billionaire Howard Marks
InvertInvestment
Publish date: Sat, 25 Aug 2018, 05:26 PM
Howard Marks needs little introduction, he is one of the world's most well-known value investors and also the co-founder and co-chairman of Oaktree Capital Management. According to 2017 Forbes, he has a net worth of $1.91 billion.
"When I see memos from Howard Marks in my mail, they're the first thing I open and read."
- Warren Buffett
By that you can see the importance and influence Howard Marks has in the investment community, and I encourage you to read his memos https://www.oaktreecapital.com/insights/howard-marks-memos. Enough of introduction, let’s start the discussion of what I've learned from the great book "The Most Important Thing" by Billionaire Howard Marks.
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1. Investing Is Full of Randomness
In this world full of randomness and uncertainties, good decisions fail to work all the time, and bad decision work all the time. You can't tell from an outcome whether a decision was good or bad.
For example, you may have done lots and lots of research for a stock and you were so sure that it will thrive, nonetheless it ended up becoming a disappointment due to unforseen events such as political events, wars and natural disasters which you couldn't have predicted at the time you were making that decision. Does that make your decision less prudent? NO, provided your research was correct and you had a margin of safety. Vice versa, if you made a bad decision and some events bailed you out, that doesn't mean you decision was good.
"Risk means more things can happen that will happen"
- Elroy Dimson, London Business School
Today there are a whole lot of sifus (experts) out there, touting their investment skills of how they’ve made 100% or 200% gains on a single stock. To me, a single stock or a single year or two don't prove anything. They could just took a longshot and got lucky.
Action Item: Before you buy investment lessons or tips, ask "Can you show me your track record"?
2. Macro Forecasts are futile
Howard doesn't believe in macro forecasts like GDP, interest rate, stock markets and so forth. He's not saying forecasters are always wrong. In fact, many are right most of the time. For instance, last year GDP grow 2%, many forecasters then forecast that GDP will grow this year at 2% too. This works most of the time because usually the future looks like the recent past. The problem is these forecasters don't make any money because the GDP of 2% was cooked into the prices of securities long ago. Forecasts that make money are forecasts of radical change. For example last year GDP growth was 2%, you forecasted 6% this year and if you are right, you are going to make a lot of money. But it's very difficult to make deviant forecast correctly, and consistently.
"Most of the time when people forecast right, it's because they predicted extrapolation and nothing changed. Once in a while, something changes radically, and invariably somebody predicted it, but if you look at the person's forecasts over the years, you will notice that person always made radical forecasts and never was right any other time."
- Howard Marks
I could relate this very well, I very much hate all the short term forecast about the KLCI index. When there's dip, you will see all the analysts worry about the negative sentiment and are of the opinion that tomorrow there will be a dive again. But when the market turns positive, you will then see they write in their reports that they foresee winning streak is coming and expect KLCI to close higher. It's not uncommon to see analysts change their opinions a few times in a week. To me, these so-called analyses don't provide much value other than pure extrapolation which a 5 year-old kid can do equally well.
Action Item: Ignore forecasts and spend more time researching individual mispriced stocks
3. Investing Is More of a Loser’s Game
Howards got this idea from "The Loser's Game" by Charles Ellis. The idea is that if we look at amateurs' tennis (or any racket sports), we win not by hitting winners but by avoiding hitting losers, i.e. we want to just outlast the opponent because there's no need to hit the tough shots that are so fast and well-placed as that will just force ourselves into making errors. The same applies in investing.
By the same token, Howards thinks that rather than chasing those once-in-a-while superior returns by taking on more risks, controlling risk is more important. He would rather have reduced risk at a given return than higher return at a given risk. It's because when the markets are rising, risk control is invisible and even penalized by having lower returns, but when the tide goes out (as Warren Buffett observes), we can then tell which swimmers are clothed and which are naked.
He has an interesting anecdote which tells that there was a pension fund which had never been above the 27th percentile or below the 47 percentile of all funds for 14 years, it was solidly placed in the second quartile. But guess how did the pension fund perform for the entire 14 years? The fund was in the 4th percentile! It beats 96% of all funds although it was never been above the 27th percentile! It's truly amazing and counter-intuitive. It shows that we need to be just above the middle on a consistent basis over the long term and we will beat most of the people, there's no need to take extra risks which will burst you out of the game.
Action Item: Don't try to be the hero who takes unnecesary risks to gamble in stock markets. You could get lucky and get some handsome returns say 100%, but at the same time, you are exposed to more risks which means you could easily blow up and lose say 50% of your money. And everyone knows how much we have to break even after losing 50%, right? It's 100%, and it's not easy.
(To be continued...in part 2)
Do comment below what you find interesting/counter-intuitive/useful/profound/wrong about this article. My favourite one is definitely the pension fund anecdote. If you enjoy this article, you can like my Facebook page to see more articles like this. They are coming out weekly. Thank you.
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25 Aug 2018
- InvertInvestment
More articles on Invert Investment
"The Most Important Thing" by Billionaire Howard Marks - part 2
Created by InvertInvestment | Sep 08, 2018
Discussions
1 person likes this. Showing 20 of 20 comments
this is much better than coming out with lots and lots of investment education theories from gurus...
all these knowledge carry no values...it brings you no where..
unless you are happy with low risk low returns..slightly better than FD
I think everyone here in i3 looking forward for exceptional returns (above the average).
as such, the objective in i3 should be about unmasking the risk of a high risk high return stocks
hope, my message gets through to all the aspiring sifus
2018-08-25 18:07
Yeah, Howard Marks is amazing.
He's required reading really. Cant wait for his latest book coming out in October.
2018-08-25 18:21
how is that Ricky?
i am looking at in the same analogy of roulette...
https://casimg.com/w/articles-attachments/1/5a4/b7bdf9998f.png
example betting on Even or Odds is considered less riskier with lesser return than betting on 1-12 with same capital size but the latter having less probability of striking (about ~1/3 odds) compared to former (about ~1/2 odds).
Posted by Ricky Yeo > Aug 25, 2018 07:20 PM | Report Abuse
If a stock is high reward, it can't be high risk.
2018-08-25 19:28
what i think market perceive as high risk..is the odds of happening...the lower the odds the higher the risk for the same bet size
example if a company started having potential to get awarded with big contract ensuring high revenue stream for a long period...
and due to this its selling at a rather high price (relative to being not awarded)...
the risk is basically the odds of not getting the contract
2018-08-25 19:32
and the contract is considered a big reward if gets it...the price it should sell after getting the contract is much much higher..
meaning there is a very high reward waiting for those willing to take a higher risk now (at current price)
2018-08-25 19:35
This bro got track record. Alex listen.
Probability bro, u heard of Kelly? Macam yes when used in poker, but when it comes to trading, one edge will work until it stops working. The edge is calculated by pulling historical data to test a certain trading technique.
Too canggih, quant stuff like that. No money to subscribe database also. I believe this is one example on risk and return. In fact, my upcoming PhD project will center on decision science.
2018-08-25 19:52
Because the expected value of
1) High Risk, High Reward,
2) Medium Risk, Medium Reward, and
3) Low risk low reward.
Is exactly the same.
You fuck up, when you take high risk for medium reward, and you are doing well when you take medium risk for high reward etc.
In those cases, the expected value is higher.
=====
Posted by probability > Aug 25, 2018 07:28 PM | Report Abuse
how is that Ricky?
i am looking at in the same analogy of roulette...
https://casimg.com/w/articles-attachments/1/5a4/b7bdf9998f.png
example betting on Even or Odds is considered less riskier with lesser return than betting on 1-12 with same capital size but the latter having less probability of striking (about ~1/3 odds) compared to former (about ~1/2 odds).
2018-08-25 19:53
everything is about Edge, Alex....
ROIC is about competitive edge..
getting the most beautiful chick is about your edge
getting higher salary in company is about your competency edge
even in animal kingdom..the strongest (having an edge) is to survive..
those who write TheEDGE also have an edge...
the ability for unmasking risk is about your edge against others
Posted by Alex™ > Aug 25, 2018 07:52 PM | Report Abuse
This bro got track record. Alex listen.
Probability bro, u heard of Kelly? Macam yes when used in poker, but when it comes to trading, one edge will work until it stops working. The edge is calculated by pulling historical data to test a certain trading technique.
Too canggih, quant stuff like that. No money to subscribe database also. I believe this is one example on risk and return. In fact, my upcoming PhD project will center on decision science.
2018-08-25 19:59
it all depends on your perceived risk...
for an insider who knows the chances of getting the reward is 90%..the risk is almost nil...for an outsider its big risk..
for a technical guy who understands the business, the plant operating process, he is sure to be able to forecast the future...
for him its less risk to pay a high price for the business..for a layman from accounting background..that could sound very risky...
Posted by Jon Choivo > Aug 25, 2018 07:53 PM | Report Abuse
Because the expected value of
1) High Risk, High Reward,
2) Medium Risk, Medium Reward, and
3) Low risk low reward.
Is exactly the same.
You fuck up, when you take high risk for medium reward, and you are doing well when you take medium risk for high reward etc.
In those cases, the expected value is higher.
2018-08-25 20:02
Yes.
You can apply it to whatever scenario you want.
Just make sure you are accurate about the risk you are taking on, and the possible profit and losses.
That's it.
Simple but hard.
2018-08-25 20:06
thats why always play in the game of your own competence...
one needs to know if they have an edge in the first place.
when we plot the investment return graphs of investors, it would be a bell curve...
those on the right having a higher return than the average (middle) are said to have an edge against those at the left of the curve...
2018-08-25 20:11
THAT IS WHY YOU MUST WATCH INSIDER'S MOVES.
IF ALL INSIDERS ARE BUYING AND BUYING QUIETLY LIKE NO TOMORROW CHANCES ARE THE STOCK GOING TO DO WELL SOME TIME IN THE FUTURE.
INSIDERS ARE LIKE PILOTS WHO CAN SEE FROM THE COCKPIT.
OR PIONEERS WHO ARE THE FIRST IN DISCOVERY.
OR SOMEONE WHO FOUND A HIDDEN SECRET FORTUNE YET UNKNOWN TO ALL.
ON THE OTHER HAND IF INSIDERS ARE SELLING LIKE NO TOMORROW AND ABANDONING SHIP...
CHANCES ARE SOME BAD OMEN GOING TO HAPPEN LATER..
IF THE PILOT HAS PARACHUTED WILL THE PASSENGERS DO OK?
SO IF INSIDERS DUMP EVERY SHARE TILL ZERO IS A WARNING SIGN TO GET OUT.
SO AS A GENERAL RULE BUY WHEN INSIDERS ARE BUYING QUIETLY WHEN THERE IS PESSIMISM. AND MUST CERTAINLY SELL WHEN SOME REAL OR PERCIEVED GOOD NEWS ARE OUT AND INSIDERS ARE SELLING IN EUPHORIA.
2018-08-25 21:00
>calvintaneng
>>>SO AS A GENERAL RULE BUY WHEN INSIDERS ARE BUYING QUIETLY WHEN THERE IS PESSIMISM. AND MUST CERTAINLY SELL WHEN SOME REAL OR PERCIEVED GOOD NEWS ARE OUT AND INSIDERS ARE SELLING IN EUPHORIA.
Agree, insiders' moves is one of the important aspects.
2018-08-26 12:02
To me, high risk in investment comes from too-high prices due to optimism and high expectation. How much risk is determined by odds offered and potential rewards, i.e. Expected Value.
A good company can be risky if you pay more than it's worth.
A bad company can be less risky if you pay less than it's worth.
Posted by probability > Aug 25, 2018 07:32 PM | Report Abuse
what i think market perceive as high risk..is the odds of happening...the lower the odds the higher the risk for the same bet size
example if a company started having potential to get awarded with big contract ensuring high revenue stream for a long period...
and due to this its selling at a rather high price (relative to being not awarded)...
the risk is basically the odds of not getting the contract
2018-08-26 12:47
Haha probability bro... Relationship is an edge too. If so and so is my uncle, and he is kaya, then my chance to get an edge with him is increased substantially...
Relationship at workplace too. Easier naik pangkat if ur boss like you, but not lick boot type la.. Haha
2018-08-26 12:50
Love this
Posted by probability > Aug 25, 2018 07:59 PM | Report Abuse
everything is about Edge, Alex....
ROIC is about competitive edge..
getting the most beautiful chick is about your edge
getting higher salary in company is about your competency edge
even in animal kingdom..the strongest (having an edge) is to survive..
those who write TheEDGE also have an edge...
the ability for unmasking risk is about your edge against others
2018-08-26 18:05
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This book is the result of the author's many years of experience and observation throughout his 26 years in the stockbroking industry. It was written for general public to learn to invest based on facts and not on fantasies or hearsay....
probability
thanks for sharing, i find there is a big secret hidden on risk vs reward decision making....
what we need to first define is..
what is perceived as 'risk'?
and how is it perceived to give a higher 'rewards'?
I think if we can identify a stock under high risk high reward category, we can actually work to reduce the 'risk' or manage it such that we are certain to reap the fantastic rewards...
and i think i3 is a fantastic platform for sharing these and achieving it
2018-08-25 18:01