Speaker 1: Masters in Business is brought to you by the American
Speaker 1: Arbitration Association. Business disputes are inevitable, resolve faster with the
Speaker 1: American Arbitration Association, the global leader in alternative dispute resolution
Speaker 1: for over ninety years. Learn more at a d R
Speaker 1: dot org. This is Masters in Business with Barry Ridholts
Speaker 1: on Bloomberg Radio. This week on the podcast, I have
Speaker 1: the one and only Howard Marks of oak Tree Capital.
Speaker 1: Dear Lord, this was a master class in everything from
Speaker 1: investing to valuation two cycles to managing your own emotions.
Speaker 1: This is one of those podcasts that I guarantee you
Speaker 1: will listen to two or three or four times. My
Speaker 1: job was to just push Howard a little bit in
Speaker 1: one direction and then stay the hell out of his way.
Speaker 1: He is so experienced, knowledgeable, smart, insightful, full of wisdom,
Speaker 1: charming and and he also has a bit of a
Speaker 1: devilish sense of humor, which I don't know if you'll
Speaker 1: hear it. But the things we discussed um off camera,
Speaker 1: so to speak. I just find his his insights and
Speaker 1: his perspective delightful. I I could go on at great
Speaker 1: length of all the things we discussed. I won't. I'm
Speaker 1: just gonna say, with no further ado, my ninety minutes
Speaker 1: with Howard Marks. This is Masters in Business with Barry
Speaker 1: Ridholtz on Boomberg Radio. My special guest today is Howard Marks.
Speaker 1: He is the co founder and chairman, co chairman, co
Speaker 1: chairman of oak Tree Capital Management, and he has a
Speaker 1: long and storied history on Wall Street. Rather than go
Speaker 1: through all of the details, will discuss it as we
Speaker 1: as we get to it. I am compelled to mention
Speaker 1: that oak Trees seventeen distress debt funds have averaged after
Speaker 1: fees for the past twenty two years, far outpacing it's
Speaker 1: their peers. That's about as much of an intro as
Speaker 1: I think we really need. Let's jump right into this.
Speaker 1: I find your history really fascinating. You minored in Japanese studies.
Speaker 1: Ever plan on doing something besides finance? I never did.
Speaker 1: I was a Wharton kid. But at those days, in
Speaker 1: the mid sixties, you were required to have a non
Speaker 1: business minor and also to have one semester of the
Speaker 1: literature of a foreign country. Most people took English or
Speaker 1: French for some reason. I have no recollection of I
Speaker 1: took Japanese and I loved it, and so I turned
Speaker 1: that into my minor, and I took fifteen credits in
Speaker 1: the You would uh what was then called the Oriental
Speaker 1: Studies Department, and and you had always wanted to go
Speaker 1: into finance, and I think that's reflected you ended up
Speaker 1: graduating from Wharton with a major in finance an MBA
Speaker 1: from University of Chicago, and then you move over as
Speaker 1: an equity analyst at City Corps. Eventually you become the
Speaker 1: director of research there. Before you find your way to
Speaker 1: the Trust Company of the West and there you end
Speaker 1: up focusing on distress that high yield bonds and convertible securities,
Speaker 1: before you became their c i O for fixed income.
Speaker 1: How do you transition from equity analysts to fixed income analysts?
Speaker 1: It was a real life story, not a dream story. Um,
Speaker 1: as you say, I was director of research for equities
Speaker 1: from seventy five seventy eight. The bank was what was
Speaker 1: called the nifty fifty investor. We've invested in the fifty
Speaker 1: best and fastest growing companies in America. And it was
Speaker 1: a disaster because the official dictum was it didn't matter
Speaker 1: what price you paid. The prices paid were highly excessive.
Speaker 1: That corrected in the seventies. The the investor in these
Speaker 1: great companies probably lost eight of his money, haven't Haven't
Speaker 1: we heard that expression it doesn't matter what price you pay,
Speaker 1: you just have to own this. Well, we do hear that,
Speaker 1: And of course that's exactly the wrong thing to say.
Speaker 1: What I say is there no such thing as a
Speaker 1: good idea or a bad idea in the investment world
Speaker 1: without reference to price. It's not what you buy, it's
Speaker 1: what you pay. And finally, investing is not a matter
Speaker 1: of buying good things. It's a matter of buying things
Speaker 1: well and meaning at at the appropriate value. And people
Speaker 1: or less, and people who don't know the difference shouldn't
Speaker 1: be in the business. Well that that seems to be
Speaker 1: an issue that comes up anyway. The bank faltered with
Speaker 1: this fifty fifty. They thought it would be great if
Speaker 1: they had somebody other than me as director of research.
Speaker 1: Uh and Uh. I asked my boss, uh, Peter Vermilier, Uh,
Speaker 1: What's what's next? He said, I'd like you to start
Speaker 1: a convertible bond fund. So I moved over to the
Speaker 1: bond department in May of seventy eight, started the fund
Speaker 1: in August, and in August I got the phone call
Speaker 1: to change my life. My The head of the bond
Speaker 1: department said, there's some guy named Milken or something in
Speaker 1: California and he deals with something called high yield bonds
Speaker 1: and can you figure out what that is? A client
Speaker 1: had had come in and asked for Ohio bond fund
Speaker 1: and they asked me to be the manager and that
Speaker 1: that put me in the right place at the right time.
Speaker 1: So it was a pure luck, just serendipity. You he
Speaker 1: hasn't invest you in this client, and I'd come in
Speaker 1: with that is my only contribution. Barriers that I was
Speaker 1: smart enough to say, yes, I'm gonna I'm gonna challenge
Speaker 1: you on that a little later. So that leads to
Speaker 1: an interesting question, how did your experience with both being
Speaker 1: an equity analyst and the obvious problems with buy it
Speaker 1: at any price in the how did that affect your
Speaker 1: approach to either high yield or subsequently distressed assets. Well,
Speaker 1: what I would say is number one, you learn nothing
Speaker 1: from success. You only learned from failure. You learn from experience.
Speaker 1: Experience is what you got when you didn't get what
Speaker 1: you wanted. And so so the experience of buying top
Speaker 1: quality assets and losing was very instructive, and it, as
Speaker 1: I say, it convinced me that the key is the
Speaker 1: price you pay. Any there's no asset which is so
Speaker 1: good that it can't be overpriced. There are few assets
Speaker 1: which are so bad that they can't be underpriced. So
Speaker 1: when I switched into the HYO bond field that everybody
Speaker 1: thought was disreputable and unseemly and non fiduciary, and they
Speaker 1: called the junk you know, and I said, well, maybe
Speaker 1: maybe if it's so disparaged, maybe you can find a bargain.
Speaker 1: And in fact that was the case. The common thread
Speaker 1: between working in equities and working in high yield bonds
Speaker 1: or distress is that in most of the fixed income world,
Speaker 1: high grade fixed income treasuries and that kind of thing,
Speaker 1: the only thing that matters is the direction of interest rates.
Speaker 1: Interest rates up, price down, because everybody assumes there's no
Speaker 1: credit risk. When you get down into hyel bonds and
Speaker 1: distress debt, there is credit risk. I describe it as
Speaker 1: fixed income where what the company does matters, so you
Speaker 1: had better be able to judge the future of the company,
Speaker 1: just like you do as an equity analyst. So it
Speaker 1: was really the right skill set applied to the right
Speaker 1: asset class. I'm still taken by the phrase experience is
Speaker 1: what you get when you don't get what you want.
Speaker 1: Do do we credit you for that? Or or has
Speaker 1: that been around longer than you? Well, I'm too old
Speaker 1: to remember where I got it, so you may. I'm
Speaker 1: Barry rid Hilts. You're listening to Masters in Business on
Speaker 1: Bloomberg Radio. My special guest today really needs no introduction.
Speaker 1: He is Howard Marks. He is the co chairman and
Speaker 1: co founder of oak Tree Capital, which is now a
Speaker 1: publicly traded company and has done extremely well for its
Speaker 1: long term clients. Let's talk about what you're probably best
Speaker 1: known for, the Chairman Chairman's Men memos, which you put
Speaker 1: out every quarter. And I will quote no lesser an
Speaker 1: authority than Warren Buffett who said, when I see memos
Speaker 1: from Howard Marks in my mail that the first thing
Speaker 1: I opened and read I always learned something new. But
Speaker 1: but that's today, and when you first began these a
Speaker 1: few decades ago, that really wasn't what the response was like.
Speaker 1: Tell us about what happened in the early When did
Speaker 1: the memos begin? I started in I'm not again, I
Speaker 1: don't exactly remember why, um, but I remember the events.
Speaker 1: I went to the Midwest. I met with the head
Speaker 1: of pension funds of General Mills, and he explained to
Speaker 1: me that over the fourteen years he had run the fund,
Speaker 1: he was never above the seven percentile or below the
Speaker 1: forty seven percentile, and as a result solidly in the
Speaker 1: second quartile for fourteen years. The funny math about it
Speaker 1: in our business is if he can do that for
Speaker 1: fourteen years, you end up in the fourth percentile for
Speaker 1: the entire fourteen year period, because most people who do
Speaker 1: well for a while shoot themselves into foot ten or
Speaker 1: bottom tent exactly. So I was very impressed by that.
Speaker 1: And then I came home and h some famous value
Speaker 1: management firm had had a really tough time because they
Speaker 1: were heavy in the banks, and the banks suffered terribly.
Speaker 1: And the president comes out and he says, well, you know,
Speaker 1: of course, if you want to be in the top
Speaker 1: five percent of money managers, you have to be willing
Speaker 1: to be in the bottom five percent. And I said,
Speaker 1: how wrong can you be? I I my clients don't
Speaker 1: care for him in the top five, and they're absolutely
Speaker 1: unwilling to be in the bottom five. I like the
Speaker 1: other approach, where you're to lead just above the middle,
Speaker 1: and that puts you at the top for the long run.
Speaker 1: Second quartile over long periods of time leads to top
Speaker 1: five percent if you never have that terrible year to
Speaker 1: pull you down. So so I published the first memo
Speaker 1: called the Route to Performance. The Road to Perform its
Speaker 1: the route to the route and the interesting question what
Speaker 1: kept me going because as you say, I had, the
Speaker 1: response was thundering. I never had a response. For the
Speaker 1: first ten years, I never had one response. I never
Speaker 1: nobody ever said, good memo, and nobody said I got it,
Speaker 1: and I wrapped the fish in it. I have to
Speaker 1: I have to stop here and emphasize this. This is
Speaker 1: pre Twitter, pre Facebook, pre email. You were literally spending
Speaker 1: time running a memo, printing them out, folding them, addressing envelope,
Speaker 1: stamping them, inserting paper into envelopes, and taking him to
Speaker 1: the They used to have this thing called the mail
Speaker 1: um the post office, and you could mail envelopes that way.
Speaker 1: So you're doing this for a decade and I might
Speaker 1: as well have thrown them in the drain because I
Speaker 1: never heard back nothing. But of course to hear back,
Speaker 1: somebody would have had to either write me a letter
Speaker 1: and put a stamp on it and put it in
Speaker 1: that thing called the post office, or pick up the phone,
Speaker 1: and nobody did. So it's a solid So the question
Speaker 1: that that naturally leads to is you have to be
Speaker 1: very self motivated to express your views if you're sending
Speaker 1: this out to deafening silence. And I I was writing
Speaker 1: about stuff I believed in, and this was it was quarterly.
Speaker 1: Then is that right? No? No, there was only one
Speaker 1: in ninety and one in ninety one, and and uh,
Speaker 1: then it started to pick up a little bit. I
Speaker 1: don't remember. I never did it with the regularity in mind.
Speaker 1: And by the way, during the crisis, I probably did
Speaker 1: ten a year because there was so much to write about. Sure,
Speaker 1: so that that's amazing you kept going and then something
Speaker 1: changed into thousand. On the first day of two thousand,
Speaker 1: I wrote a memo called bubble dot com about the
Speaker 1: possible fragility of the tech bubble. Uh, and that had
Speaker 1: two virtues. Number one, it was right, and number two
Speaker 1: it was right quick. It was timely. So because if
Speaker 1: you're right, but it takes three years to happen, they
Speaker 1: don't remember you. You know, there there's there's there's saying
Speaker 1: in our business. Well, that's right if it was saying
Speaker 1: in our business that being too far ahead of your
Speaker 1: time is indistinguishable from being wrong. But this was right quickly.
Speaker 1: And so I say, I think I said in the
Speaker 1: introduction to my book that that made me after ten years,
Speaker 1: I became an overnight success. And I remember that memo.
Speaker 1: Barrens picked it up in the Wall Street Journal picked it.
Speaker 1: It made the rounds, and it was suddenly that that's
Speaker 1: exactly right, just like Playboy magazine at Summer Camp. Right,
Speaker 1: it made the rounds, to say the least. So so
Speaker 1: you don't recall what motivated you to start it. And
Speaker 1: aside from that dot com memo, what the bubble dot com?
Speaker 1: What other ones really are memorable and stay with you?
Speaker 1: I think two indicate the process for taking advantage of
Speaker 1: extremes of the cycle, and which is very important to me.
Speaker 1: And in March of oh seven, I wrote a memo
Speaker 1: called the Race to the Bottom, which you talked about
Speaker 1: the fact that when investments are in short supply and
Speaker 1: people are in heat to make them, they will bid
Speaker 1: to an extent that that makes them bad investments. And
Speaker 1: then in of course, then we had the crisis. And
Speaker 1: then in mid October eight, which was the depths of
Speaker 1: the crisis, I wrote one called Current Developments um and
Speaker 1: and another, well maybe the better one called the Limits
Speaker 1: to Negativism, in which I said, you know, everybody knows
Speaker 1: that investing requires skepticism. And most of the time skepticism
Speaker 1: consists of saying no, no, no, that's too good to
Speaker 1: be true. But in the depths of a crisis, skepticism
Speaker 1: requires you to say no, that's too bad to be true.
Speaker 1: And people were telling such horror stories and nobody could
Speaker 1: imagine any assumption which could not be exceeded on the downside.
Speaker 1: And I said, hey, people are just being too pessimistics.
Speaker 1: We actually heard people say stocks are going to zero
Speaker 1: well and and the financial world is going to melt down.
Speaker 1: And and you know, most of my I don't think
Speaker 1: these things up in my head, Barry, most of these
Speaker 1: things stem from some experien experience. And so I had
Speaker 1: a meeting with the pension manager was trying to talk
Speaker 1: that pension fund into investing in a levered loan fund
Speaker 1: of fund of loans that was had leverage and the
Speaker 1: levered return on the fund. Seeing loans was in the twenties,
Speaker 1: and he well, not only that, but he said, well
Speaker 1: what about if they are defaults? And every default scenario
Speaker 1: that I assumed, the c I oh said well what
Speaker 1: if it's worse than that? What if it's worse? What
Speaker 1: if it's worse? No, and I and and eventually I
Speaker 1: ended up saying, do you have any equities in your
Speaker 1: pencrofun And the c IO said yes. I said, well,
Speaker 1: then you better run out and sell them, because the
Speaker 1: the environment you're pushing me to assume everything is valueless.
Speaker 1: And so I ran back to my office and I
Speaker 1: wrote this memo, The Limits to Negativism, which says, sometimes
Speaker 1: you've got to say no, it can't be that bad.
Speaker 1: I'm Barry rit Hults. You're listening to Master's in Business
Speaker 1: on Bloomberg Radio. My special guest today is Howard Marks.
Speaker 1: He is the founder and co chairman, co founder really
Speaker 1: of oak Tree Capital Management, which is now a publicly
Speaker 1: traded company specializing in distress debt, convertible securities, a whole
Speaker 1: run of different fixed income related investment. And let's talk
Speaker 1: a little bit about distress debt. I look at the
Speaker 1: high yield market rates now, and there's low as they've
Speaker 1: been since, which is kind of surprising. What is that?
Speaker 1: What should we take from that? Well, Barry, people ask me,
Speaker 1: are we in a high yield bubble? And my answer
Speaker 1: is no, we're in a bond bubble, generally speaking, across
Speaker 1: the board. Does on the board, the central banks have
Speaker 1: pulled the interest rates so low that you know, all
Speaker 1: the the yields on all fixed income instruments are calibrated
Speaker 1: relative to each other. That's why we have what's called
Speaker 1: the yield curve. So if the maturity is longer, the
Speaker 1: yield is higher. If the quality is lower, the yield
Speaker 1: is higher. If the liquidity is lower, the yield is higher.
Speaker 1: But they all start from the base rate. And the
Speaker 1: central banks said back in twenty nine or ten, let's
Speaker 1: make the base rate zero to get this economy going.
Speaker 1: And so the the incremental turn you get for taking
Speaker 1: time risk, credit risk, a liquidity risk is still about
Speaker 1: the same as history. But you were starting from such
Speaker 1: a low rate. So the yield on all bonds is
Speaker 1: extremely low, including high yield bonds. So you reference the
Speaker 1: Fed taking rates to zero. Should they not have done that?
Speaker 1: Should there have been a fiscal policy instead of a
Speaker 1: monetary policy, what what options presented at that time. I
Speaker 1: think it would have been good to have. Well, in fact,
Speaker 1: we we did have some fiscal also, but not much.
Speaker 1: It would have been good to have some of that,
Speaker 1: you know, the uh we had, you know, deficit spending,
Speaker 1: the famous shovel ready projects and that kind of thing, uh,
Speaker 1: you know, would have been a good idea, were a
Speaker 1: good idea. But I think that the the the monetary
Speaker 1: was essential. And I think that you know, basically, you
Speaker 1: can't quibble with with results. We went through the worst
Speaker 1: financial crisis in eighty years, and we pulled out of
Speaker 1: it very quickly, and here we are in and I
Speaker 1: would say for most people it is a distant memory,
Speaker 1: that's true. And especially when you look around the world,
Speaker 1: if it's if you don't like this economy, well don't
Speaker 1: look overseas, because we're by far the cleanest shirt in
Speaker 1: the hamper. So people, that's a good one. So people
Speaker 1: say to me, you know, how do you grade Geitner
Speaker 1: and Banankee and Poulson and company on their handling of
Speaker 1: the crisis? And I said, you know, I don't know
Speaker 1: if I give him an A, but if you mark
Speaker 1: them on a curve, they get an A plus because
Speaker 1: clearly far they did far the best job in the world,
Speaker 1: and we are out of the crisis we had. We
Speaker 1: have had a modest recovery. But you know, there are
Speaker 1: a lot of bad things that could have happened that
Speaker 1: didn't to to money market funds, to commercial paper and
Speaker 1: so forth. And here we are, uh in a very
Speaker 1: healthy environment. So I don't quibble with the people who
Speaker 1: pull us out of the crisis, and in fact, I
Speaker 1: think they did a hell of a good job. I
Speaker 1: would not have liked to have had that job at
Speaker 1: that time. I'll quibble a little bit and saying you
Speaker 1: can give Paulson the A plus, Bernanking Geythner, we're part
Speaker 1: of the team that helped create the crisis, so I
Speaker 1: have to dock them a few points. But but but
Speaker 1: it certainly is Paulson who gets unmitigated credit to say
Speaker 1: the least's let's let's get back to um distress, Debton
Speaker 1: and and the issue you you raise here um about
Speaker 1: us doing fairly well. I noticed that credit spreads are
Speaker 1: the favorite weapon of the perma bear when they when
Speaker 1: they get too tight. The answer as well, investors are
Speaker 1: so complacent and as soon as they start to widen.
Speaker 1: It's okay, here comes the next disaster. What is going
Speaker 1: on with credit spreads? And and why is it used
Speaker 1: as that double edged sword? Well, credit spreads are to
Speaker 1: some extent that indicator of psychology. Uh um. But you know,
Speaker 1: I don't believe in taking uh my instructions from the market.
Speaker 1: I put out a memo about a year ago um
Speaker 1: as a result of a conversation I hear had here
Speaker 1: at Bloomberg where people were you remember, the markets got
Speaker 1: off to a terrible startlaship and everybody was bugging me.
Speaker 1: You know, isn't that a cell signal? If the market
Speaker 1: is holding into a cell signals? Right? So I ran
Speaker 1: back to my office again, and this time I wrote
Speaker 1: a memo entitled what does the market now? And I
Speaker 1: think it doesn't know much? But I but I do think.
Speaker 1: I do think that the that the credit spread is
Speaker 1: an indicator of the values that are available. And when
Speaker 1: when credit spreads are wide, that means, for the benefit
Speaker 1: of your listeners, that the interest on low grade bonds
Speaker 1: is much higher than it is on high grade bonds,
Speaker 1: then I think you have substantial uh incentive to invest
Speaker 1: in low grade instruments. It also is an indicator of fear.
Speaker 1: That's why spreads are wide. When spreads narrow, it means
Speaker 1: that people are less afraid. As you say, more complacent,
Speaker 1: I would say more risk tolerant, and that the reward
Speaker 1: for bearing incremental risk is on the decline, which is
Speaker 1: not a good thing. I'm Barry Ri Hults. You're listening
Speaker 1: to Masters in Business on Bloomberg Radio. My special guest
Speaker 1: today is Howard Marks of oak Tree Capital. Let's talk
Speaker 1: a little bit about volatility and uncertainty. You have a
Speaker 1: number of delightful quotes about the future, and one of
Speaker 1: my favorite is investing concerns exactly one thing dealing with
Speaker 1: the future. Yet it's clearly impossible to know anything about
Speaker 1: the future. You can't predict, you can only prepare. Discuss
Speaker 1: that well, everybody who wants to engage in investing has
Speaker 1: to reach your conclusion as to whether the future is
Speaker 1: predictable or not. If you believe that is, you'll behave
Speaker 1: one way. You will uh can reach a conclusion about
Speaker 1: what the future holds and put together the perfect portfolio
Speaker 1: for that eventuality. If you don't believe it, you will
Speaker 1: think about different possibilities and you'll put to together a
Speaker 1: portfolio that will suboptimize, that will do well under many
Speaker 1: of them, and not badly. And that's that's a difference
Speaker 1: of approach. I don't believe the future is predictable, you know.
Speaker 1: I I'm from the believers in what John Kenneth Golbreys said.
Speaker 1: He said, we have two kinds of forecasters, the ones
Speaker 1: who don't know and the ones who don't know. They
Speaker 1: don't know. Well, I know, I don't know, and so
Speaker 1: I try to put together portfolios that will do well
Speaker 1: in a variety of environments, but without trying to make
Speaker 1: a prediction about here's what's gonna happen interesting exactly, here's
Speaker 1: what's gonna do, Here's where's the recession exactly. So you
Speaker 1: can have a portfolio which is prepared for a variety
Speaker 1: of eventualities without uh insisting that any one of them
Speaker 1: is going to be the case. And that leads to
Speaker 1: another quote of yours. We can make excellent investment decisions
Speaker 1: on the basis of present observations with no need to
Speaker 1: make guesses about the future. Essentially what you just said.
Speaker 1: That's right, you know. Let me make clear one thing, Barry,
Speaker 1: it would be great if we knew what the future held.
Speaker 1: It's not like I don't care. We would be great
Speaker 1: investors if we knew what the market was going to
Speaker 1: do tomorrow in which stocks would do best. But if
Speaker 1: you reach the conclusion that you can't know, then you
Speaker 1: look for another avenue to deal with the future. And
Speaker 1: I'm in that category, and that's figuring out what's happening
Speaker 1: today and adjusting it. So so I do something I
Speaker 1: call take the temperature of the market. Okay, how does
Speaker 1: one take the temperature of the market. In fact, when
Speaker 1: we look at the market today, let's talk about stocks,
Speaker 1: the vix is pretty much as low as it gets
Speaker 1: for any extended period of time. Um, what does that
Speaker 1: tell about market risks? What does that tell us about
Speaker 1: the temperature of the market. Well, you you want to
Speaker 1: know what kind of thinking is being incorporated in investment decisions.
Speaker 1: If I was considering an investment, I could know only
Speaker 1: one fact. I'd like to know how much optimism is
Speaker 1: incorporated in the price Because if there's a lot of optimism,
Speaker 1: then there's a lot of possibility of disappointment and if
Speaker 1: and if the if, if the truth turns out to
Speaker 1: be less good than the expectations, then the price will fall.
Speaker 1: If there's no optimism, as there was back in October
Speaker 1: of oh eight at the depths of financial crisis, then
Speaker 1: I know we can buy risky assets aggressively because there's
Speaker 1: no possibility of disappointment or the the assumptions that are
Speaker 1: factored into the price are as negative as possible, or war.
Speaker 1: And so you know, oak Tree invested extremely aggressively between
Speaker 1: UM September fift oh eight, which was the day Lehman
Speaker 1: went under, and the end of the year. We invested
Speaker 1: over half a billion dollars a week over that period,
Speaker 1: and that turned out to be mostly fixed income or
Speaker 1: was in a mix. Well, most of what we do
Speaker 1: is what we call credit, you know, non government fixed income,
Speaker 1: and and most of it was distressed at UM. So
Speaker 1: the point is, uh, the temperature of the market was frigid,
Speaker 1: which meant there was no enthusiasm and we could buy
Speaker 1: you know, Buffett says, the less prudence with which others
Speaker 1: conduct their affairs, the greater the prudence with which we
Speaker 1: must conduct our own affairs, which means if other people
Speaker 1: are unworried, we should be terrified. If other people are terrified,
Speaker 1: we should be aggressive. So you've talked a lot about
Speaker 1: second degree thinking. I think a lot of people if
Speaker 1: I were to ask them if I could share with
Speaker 1: you one aspect of a stock or a market, they
Speaker 1: would say, tell me valuation. You're taking that a step
Speaker 1: further and saying tell me sentiment, and what is already
Speaker 1: reflected in valuation? So let's talk about second degree thinking.
Speaker 1: It's a phrase you've referred to repeatedly. Well, I actually
Speaker 1: call it second level second level right, Um, I think
Speaker 1: in terms of degrees because it's been so called out.
Speaker 1: But what is second level thinking? Well, you you agreed
Speaker 1: with me earlier when I said, if you think like
Speaker 1: everybody else, you'll take the same actions as everybody else.
Speaker 1: If you take take the same actions as everybody else,
Speaker 1: you'll have the same results of everybody else. So, and
Speaker 1: by the way, it seems mathematically unarguable, Well, if that's true,
Speaker 1: then in order to be a superior investor, you have
Speaker 1: think different from everybody else. And that about different is
Speaker 1: not enough. He has to be different and right. So
Speaker 1: to some degree, this is Keynes's famous beauty contest. Yes,
Speaker 1: this is absolutely Can's hypothesized a beauty contest in which
Speaker 1: the newspaper ran the pictures of twenty young women. It
Speaker 1: was a very Chopin's time, and and he offered a
Speaker 1: prize or the newspaper offered a prize to the reader
Speaker 1: whose entry ranking the girls in terms of prettiness was
Speaker 1: closest to the average entry. The first level thinker says,
Speaker 1: I'm going to figure out which girls are the prettiest.
Speaker 1: The second level thinker says, I'm going to figure out
Speaker 1: which girls the average reader will say are the prettiest.
Speaker 1: That's how you win the contest. Now, don't you run
Speaker 1: into the next digression, which is the next person thinking,
Speaker 1: I'm going to think how the second level thinkers? At
Speaker 1: what point do investors start to outsmart themselves? Can you
Speaker 1: take that thinking too far? Yeah, well you can go
Speaker 1: to third level and fourth level, but I think second
Speaker 1: level is good enough. You know, I mean you when
Speaker 1: you get into the question of trying to figure out
Speaker 1: which girls the average reader is going to conclude, the
Speaker 1: average reader is going to say that is the produced
Speaker 1: He gets very complex. And so with with the niceties,
Speaker 1: you have to kind of factor in the realities of
Speaker 1: can you do it? So if you can merely come
Speaker 1: up with a better sense of value and write price
Speaker 1: than others on a consistent basis. I think that's good
Speaker 1: enough without going to third and fourth levels. I like
Speaker 1: the way that sounds. Let's let's talk a little bit
Speaker 1: about the opposite of um trying to guess how other
Speaker 1: people are going to guess and bypass it, and talk
Speaker 1: a little bit about the shift towards passive investing. In indexing.
Speaker 1: Some people have said, we don't want to try and
Speaker 1: guess what's the best stock is, or what other people
Speaker 1: are gonna think what the best stock is, just by
Speaker 1: the whole thing and not worry about it well, and
Speaker 1: in fact, Barry, some people are observing that most people
Speaker 1: who try to do that don't do it well, and
Speaker 1: that the average UH mutual fund doesn't add value. Well,
Speaker 1: it's obvious that on average, the average investor does average
Speaker 1: before fees and below average after fees and trading impact.
Speaker 1: So now there's a ground swell toward what's called passive
Speaker 1: investing or indexation. You're buy an index fund, you buy
Speaker 1: a fund. Ad bused a little bit of everything. By
Speaker 1: the way, this theory was advanced fifty years ago when
Speaker 1: I started at the University of Chicago, So it's nothing new.
Speaker 1: It's a sign of how thinking goes. That it took
Speaker 1: fifty years for it to take hold. But the point
Speaker 1: is John Vogel at Vanguard and to the Index Fund,
Speaker 1: I don't know, probably okay, forty years ago and and
Speaker 1: it's been creeping up. But the movement toward passive has
Speaker 1: become a ground swell in the last year or two
Speaker 1: because a lot of people are throwing in the towel.
Speaker 1: And basically the stems from University's Chicago work on something
Speaker 1: called the efficient market hypothesis, which said that so many
Speaker 1: people are out there trying to make money in the market,
Speaker 1: and they're all intelligent, computer literate, with access to databases,
Speaker 1: highly motivated, objective, and clinical, and that that their efforts
Speaker 1: to find bargains and over pricings cause prices to converge
Speaker 1: with something called intrinsic value, so that there are no bargains.
Speaker 1: And if there are no bargains to be found or
Speaker 1: over pricings to be avoided, then you can't beat the market.
Speaker 1: That's the theory we've been speaking with Howard Marks. He
Speaker 1: is the co founder, co chairman and co c I
Speaker 1: oh are you still co cee? Dishwasher Code Dishwasher of
Speaker 1: Oak Tree Capital Management. Be sure and stick around where
Speaker 1: we keep the digital tape rolling and continue to talk
Speaker 1: about all things valuation. Uh. Be sure to check out
Speaker 1: my daily column on Bloomberg dot com or follow me
Speaker 1: on Twitter at rid Halts. We love your comments, feedback
Speaker 1: and suggestions right to us at m IB podcast at
Speaker 1: Bloomberg dot net. I would be remiss if I did
Speaker 1: not say you can find all of Howard's really delightful
Speaker 1: and and beautifully written memos at oak Tree Capitol dot
Speaker 1: com or his book. We didn't even get to the
Speaker 1: only thing that matters his book. Uh. The only thing
Speaker 1: that most, the most important thing. The only thing that
Speaker 1: matters is the book, which is the most important thing,
Speaker 1: and you can find that at Amazon or at fine
Speaker 1: bookstores near you. I'm Barry Rihults. You're listening to Masters
Speaker 1: and Nous on Bloomberg Radio. If you're having a business dispute,
Speaker 1: the process can be slow and drawn out, especially if
Speaker 1: you rely on litigation in the courts. You can wait
Speaker 1: for years before your case is resolved, and the longer
Speaker 1: your case proceeds, the more your case can cost. Not
Speaker 1: with the American Arbitration Association, arbitration or mediation with the
Speaker 1: American Arbitration Association is faster. In fact, nearly fifty of
Speaker 1: our cases settled prior to hearings. A d r dot
Speaker 1: org resolve faster. Welcome to the podcast. I don't know
Speaker 1: why I do this every time, Howard, Thank you so
Speaker 1: much for doing this. I always find it delightful and
Speaker 1: instructional anytime we get to sit down. Someone said to
Speaker 1: me the other day we were just in Toronto, I
Speaker 1: guess before winter, at at a c f A events
Speaker 1: and someone said to me, you know, I've either listened
Speaker 1: to or seeing you interview Howard multiple times. You've become
Speaker 1: the Howard Marks whisperer and I'm My response was, I'm
Speaker 1: pretty sure he doesn't need a whisperer. He's pretty uh
Speaker 1: articulate on his own. UM, so let's keep talking about
Speaker 1: the market, because there's so much stuff we didn't get
Speaker 1: to and so many things we were last speaking about
Speaker 1: UM indexing, Bill Miller had a really fascinating quote. He said,
Speaker 1: the problem with active management is an active management. The
Speaker 1: problem with active management is most of those managers are
Speaker 1: essentially high cost closet indexers. UM. What do you think
Speaker 1: of something like that? Well, I do think that most
Speaker 1: people ken for maybe career purposes, to hug the benchmark
Speaker 1: and to have a portfolio which is not very different
Speaker 1: from the benchmark, in which case you're wasting your money
Speaker 1: by paying him or her fees. You can get the
Speaker 1: benchmark for probably six basis six basis points as six
Speaker 1: hundreds of a percent, and active managers probably get close
Speaker 1: to a percent on average. I think those numbers are
Speaker 1: about right. Okay, So that means the average manager is
Speaker 1: charging uh eight four ninety four basis points more, which
Speaker 1: is a straight subtraction from the performance of their funds.
Speaker 1: And if they don't add at least ninety four basis
Speaker 1: points uh to the return per year, you might as
Speaker 1: well go into an index. And that was his point.
Speaker 1: He said, if you want to do active, then really
Speaker 1: do active. Don't waste your time with Well, that's well,
Speaker 1: that goes to what I mentioned before my memo, dare
Speaker 1: to be great, dare to be great. In order to outperform,
Speaker 1: you have to dare to be different from the index,
Speaker 1: which means you have to be dare to be wrong.
Speaker 1: You have to be willing to either accept a draw
Speaker 1: down or a significant under performance in any given year.
Speaker 1: Exactly there is no The interesting thing about investing is
Speaker 1: that there is no approach which is guaranteed to work.
Speaker 1: There can't be, given the nature of markets. Nature's markets
Speaker 1: abhor certainty. Right, And I'm so glad you said that
Speaker 1: because this has been a peeve of mind forever, because
Speaker 1: you I want to repeat what you said, markets abhor
Speaker 1: certainty every time I flicked on the TV. Some clueless
Speaker 1: pondit is saying markets hate uncertainty. And if you think back,
Speaker 1: the only time there's certainty is at extreme tops or
Speaker 1: extreme bottoms two thousand. When you did the dot com
Speaker 1: bubble in in January two thou markets were sure, they
Speaker 1: were certain, valuations didn't matter, Trees go to the sky,
Speaker 1: everybody loves it. And back in oh nine March oh nine,
Speaker 1: markets are going to zero. There is no value that
Speaker 1: is cheap enough. It's all terrible. So I like your
Speaker 1: quote better markets abhor certainty. Well, you know, maybe Barry
Speaker 1: should rephrase No, No, I'm I'm You're stuck with that one.
Speaker 1: I'm keeping it. How would you want to rephrase that?
Speaker 1: Because that's pithy. I think that investors like certainty, it's
Speaker 1: just that it's usually wrong and wrongest at the extremes.
Speaker 1: That's a that's a good it's less of a sound bite.
Speaker 1: It's less of a sound bite, but it explains exactly
Speaker 1: markets a poor certainty because investors listen. If you're comfortable,
Speaker 1: then it's probably not a lot about performance because to
Speaker 1: get to that point, you have to do something that
Speaker 1: is intuitively uncomfortable and and countervailing to what the crowd
Speaker 1: is doing. Well. Dave Swenson, who runs the Endowminant Yeah,
Speaker 1: which is been a performing endowment for decades for He's
Speaker 1: been doing it for thirty years and he has great,
Speaker 1: great results. He said in his book Pioneering Portfolio Management
Speaker 1: that that investment management requires the maintenance of uncomfortably idiosyncratic positions, which,
Speaker 1: in the light of so called common sense or conventional wisdom,
Speaker 1: appear uh irrational. In other words, what everybody believes, common sense,
Speaker 1: common wisdom is is factored into the price of the stock.
Speaker 1: If you're going to find a bargain, you have to
Speaker 1: find the times when consensus is wrong. You have to
Speaker 1: diverge from consensus, which can can only be uncomfortable. Makes sense, Yeah,
Speaker 1: you have to be idiosyncratic, and people will look at
Speaker 1: you and you say, who is that not selling out
Speaker 1: of his tech stocks in the first quarter of two thousands,
Speaker 1: which raises the question You're not just in an ivory
Speaker 1: tower penning notes and sending them out and not caring
Speaker 1: if people responding. Your oak tree is now running forty
Speaker 1: hundred d hundred billions. In two thousand, you guys were
Speaker 1: still running billions of dollars. So you have real clients
Speaker 1: with real assets at risk, real money at risk, and
Speaker 1: their jobs on the line. Because your clients are primarily institutional,
Speaker 1: How do you handle when something looks idiosyncratic? People say
Speaker 1: how it has finally gone off the deep end this time?
Speaker 1: And the phone start lining up in the office, Hey,
Speaker 1: what are you guys doing? How do you manage that?
Speaker 1: As as a as a company? How does the organization
Speaker 1: handle well? I think one of the money manager's most
Speaker 1: important jobs is client education. And hopefully we've convinced our
Speaker 1: clients by now that you have to be contrarian, and
Speaker 1: you have to look wrong for a while, and and
Speaker 1: and so forth, um and and it's our job to
Speaker 1: hold their hands when we do extreme things. You know.
Speaker 1: I wrote this memo current Developments back October the eighth
Speaker 1: of eight, probably the low point of credit. And I
Speaker 1: mentioned that I was talking to a reporter at that time.
Speaker 1: He said, what are you doing? I said, we're buying.
Speaker 1: He said to me, you are like that with an
Speaker 1: exclamation point. Well, everybody else he spoke to a selling, right,
Speaker 1: and and uh. And so when everybody, if there are
Speaker 1: a hundred money managers in are selling, what do you
Speaker 1: want to do? You want to buy or sell? You
Speaker 1: want to be the Well, actually the answer is most
Speaker 1: of the time the crowd is right. It's at those
Speaker 1: extremes where I want to be on the opposite side.
Speaker 1: But only at the extremes. Are ninety nine out of
Speaker 1: a hundred selling, that's right? And and if a hundred selling,
Speaker 1: then there must be no optimism in prices. Prices cannot
Speaker 1: be high relative to intrinsic value. You can't lose by buying.
Speaker 1: So what about the process. We've seen this happen over
Speaker 1: and over again with especially with value stops. I assume
Speaker 1: it's similar with distressed assets or anything credit related, which
Speaker 1: is just because something is cheap doesn't mean it's not
Speaker 1: going to get cheaper. There's there's a famous quote, um
Speaker 1: David Einhorn said, a stock that's down is a stock
Speaker 1: that was down before it got got in half. So
Speaker 1: how do you know? I love that line. How do
Speaker 1: you know when you're early? You're not. You're not necessarily
Speaker 1: gonna take the bottom. You're prepared to buy something and
Speaker 1: keep buying it as it continues to fall out of bed.
Speaker 1: You never know when you're at the bottom. It is
Speaker 1: logically impossible because what is the bottom. The bottom is
Speaker 1: the price below which things never went. You went. That's
Speaker 1: a past tense work. You can only assess the bottom
Speaker 1: in the past tense. So if you can't find the bottom,
Speaker 1: what can you do? You can buy that that smile
Speaker 1: at the bottom of what I would say. You can
Speaker 1: buy when it's cheap. That's all you can do, even
Speaker 1: if it's quote unquote early, even if it's early, because
Speaker 1: you don't know if you're early or not. But if
Speaker 1: you're if you're really no value, then you know when
Speaker 1: things are cheap. So the debt, by the way, and
Speaker 1: you have to bear in mind everybody wants to be
Speaker 1: a successful investor has to bear in mind the cheap
Speaker 1: and going up tomorrow are not synonymous. And so if
Speaker 1: you buy because it's cheap, it goes down, you buy
Speaker 1: more it's still cheap, you keep buying. No, it's cheaper,
Speaker 1: it goes down more, you buy more. If you liked
Speaker 1: it at nine, you're gonna love it at eight and
Speaker 1: at seven. And then you run out of money and
Speaker 1: you raise more money and you keep doing it. But
Speaker 1: eventually you have to be proved. Right, So what at
Speaker 1: what point does um At what point do you say
Speaker 1: to yourselves, I'm out of money, I need more capital,
Speaker 1: and you go back to the client base. What what
Speaker 1: do they say in response to that? Well, sometimes they say,
Speaker 1: you know, we have faith in you, here some more money.
Speaker 1: And sometimes they say, you know, you're obviously a moron.
Speaker 1: They actually say that too, Well, not that word, but
Speaker 1: I mean they're like I described that that experience in
Speaker 1: October eight when I went out to get people to
Speaker 1: invest in a levered You raised a lot of money
Speaker 1: for that fund, didn't well, not the levered loan fund.
Speaker 1: We reached a point where on the levered loan fund
Speaker 1: where we we needed money and we couldn't get the
Speaker 1: clients to put it up anymore. We had a shortfall. Uh.
Speaker 1: The irony is I felt that it was my responsibility
Speaker 1: and I put it up myself, your own cash because
Speaker 1: the clients did the last dollars. It would have been
Speaker 1: unfair if I would have stepped in front of them
Speaker 1: and put my money into in place of them, but
Speaker 1: if they refused, I put it in. It was one
Speaker 1: of the great investments I ever made. What were the
Speaker 1: returns of that from eight Well, certainly more than really yeah,
Speaker 1: not too bad, not too bad. But but the point
Speaker 1: is um the degree of faith in you that your
Speaker 1: clients have tells you how long they'll stick with you
Speaker 1: when things go tough. But every client is probably going
Speaker 1: to reach a point where he says, I'm out of money,
Speaker 1: I'm fatigued. I love you, but you know, maybe you're
Speaker 1: not right. M you. I recall you were raising one
Speaker 1: of the distressed funds. I don't remember it was in
Speaker 1: the housing bust in oh six, o seven or lift,
Speaker 1: but it was a substantial, substantial funds. Uh that did
Speaker 1: really well. Which which fund am I thinking? Well? Uh?
Speaker 1: On the we had a we had a very big
Speaker 1: fund in No. One oh two which did very well
Speaker 1: because we were able to invest in the telecom meltdown
Speaker 1: and the scandals of and Run and Delphian World Colm. Uh.
Speaker 1: The market snapped back in oh three, we raised more
Speaker 1: funds than OH four, oh five and no fund to No. Six.
Speaker 1: On the first day of oh seven, we went out.
Speaker 1: We said the clients, you know, we think we can
Speaker 1: use three billion three And within a month we had
Speaker 1: eight oh real And we said to the clients, so
Speaker 1: you really have trained your clients well educated and and
Speaker 1: uh and we said to him, we can't use eight.
Speaker 1: We will take three and a half. We closed that fund.
Speaker 1: We said, but we'd like to have the rest of
Speaker 1: your interest in a standby fund. So the first fund
Speaker 1: three and a half billion was seven and we said
Speaker 1: we'd like to have money for seven b and we started.
Speaker 1: We had the first close of that in marcho seven.
Speaker 1: We had the last close in March o eight, and
Speaker 1: by that time it was eleven billion UM. And we
Speaker 1: told people it's a standby fund. We're not going to
Speaker 1: spend it on the time is right. We're not going
Speaker 1: to charge any fees until we're into the investment process.
Speaker 1: So from March oh seven until Juno eight, we didn't
Speaker 1: charge any fees. Juno eight we started to spend the
Speaker 1: money very gradually. Uh, that's fairly early in that's right.
Speaker 1: And and Lehman went bankrupt. On September we were twelve
Speaker 1: percent called. By the end of the year, we were
Speaker 1: called so fully invested, so we called of eleven billion,
Speaker 1: which is six and a billion over fifteen weeks. That's
Speaker 1: all you had to do, you know, all you had
Speaker 1: to do to make money in the crisis in retrospect
Speaker 1: was have money to spend and the nerve to spend it.
Speaker 1: You didn't need caution, conservatism, risk control, patients, selectivity, discipline,
Speaker 1: any of those things. All you needed was money and nerve,
Speaker 1: money and nerve, and money and nerve, capital and and
Speaker 1: but not all the time, because sometime money and nerve
Speaker 1: will get you killed. And and one of most of
Speaker 1: the time, well and money. And so one of the
Speaker 1: keys in investing is to know which is which. That
Speaker 1: that's really that's really fascinating. Um, there's another quote of
Speaker 1: yours that's relevant to exactly what you just said. I
Speaker 1: have to bring up rule number one. Most things will
Speaker 1: prove to be cyclical. Rule number two. Some of the
Speaker 1: greatest opportunities for gain and loss come when other people
Speaker 1: forget rule number one. Why is it that people do
Speaker 1: not understand that this too shall pass, that it's most
Speaker 1: cyclical because of the rule of emotion rather than logic.
Speaker 1: Emotion is a great enemy of all investors. Back in
Speaker 1: nineteen seventy five, probably forty two years ago, I learned
Speaker 1: one of the greatest lessons. Somebody said to me there
Speaker 1: are three stages to a bull market. The first age,
Speaker 1: when a few bright people believed that there could be improvement,
Speaker 1: the second stage, when most people understand that things are
Speaker 1: actually getting better, and the third stage, when every idiot
Speaker 1: believes that things can only get better forever. So so
Speaker 1: where are we today. It's it's February, you know, Barry.
Speaker 1: I don't believe that most people are thinking very optimistically.
Speaker 1: I think most people have reservations. Most people understand that
Speaker 1: economic growth is uncertain. Most people understand that we don't
Speaker 1: know how the central bank experiment with zero rates is
Speaker 1: going to end up, or how it gets reversed. And
Speaker 1: of course most people are concerned about the geopolitical developments
Speaker 1: in the world today. So I believe that enthusiasm is
Speaker 1: not unrestrained, it's tempered. I believe it's tempered. On the
Speaker 1: other hand, people maybe maybe thinking in not a bullish way,
Speaker 1: but I think they're acting in a bullish way. What
Speaker 1: accounts for the difference rates near zero, and when you
Speaker 1: live in a low return world, you have to take
Speaker 1: risk to get returned. People are willing to take risk
Speaker 1: because my late father in law would call them handcuffed volunteers,
Speaker 1: people who do things not because they want to, but
Speaker 1: because they have to have choice there isn't and so
Speaker 1: people are taking more risk than they used to take
Speaker 1: to get the returns they used to get at one
Speaker 1: point in time. Um I recall in the early two
Speaker 1: thousand's the rule of thumb for for foundations and endowments
Speaker 1: and any charity to maintain their tax deferred status is
Speaker 1: they're giving out five percent a year and that's a
Speaker 1: pretty easy bogey to hit most of the time. But
Speaker 1: when you have you know, rates uh rising rapidly in
Speaker 1: stocks not doing especially well, that becomes a real challenge
Speaker 1: to hit. We saw that in the in the early
Speaker 1: to mid two thousands. How much of what takes place
Speaker 1: in direct reference to what you were just saying, comes
Speaker 1: from foundations having no alternative comes from endowments, charities, all
Speaker 1: the big nonprofits having to hit that five percent bogey
Speaker 1: because they're so loath to go into the corpus of
Speaker 1: of their trust. How much of that handcuffed um volunteers
Speaker 1: comes from that segment of the investing world. Well, I
Speaker 1: think of a good bit, although foundations and endowments are
Speaker 1: not a large proportion of the money. Uh. But the
Speaker 1: same is true of pension funds. You know, the management
Speaker 1: of a company puts in an amount of money, and
Speaker 1: then that amount of money is supposed to be invested
Speaker 1: in grown so that by the end or by the
Speaker 1: in the future, there will be enough money to pay pensions.
Speaker 1: And the connection between today's dollars and the number and
Speaker 1: the dollars you need in the future to pay pensions
Speaker 1: is called the actuarial assumption, the rate you need to
Speaker 1: make the math work. And for a long time that
Speaker 1: was eight and say now most in the interests of conservatism,
Speaker 1: most pension funds have switched to seven and a half.
Speaker 1: But if you think about it, that that that the
Speaker 1: five year T bill treasury note used to pay six
Speaker 1: and alf p So how hard is it to make
Speaker 1: eight at that point and today it pays one and
Speaker 1: a half? And stocks used to stocks return in the nineties,
Speaker 1: and it was assumed that they would return at least
Speaker 1: eleven forever, and today it's assumed that they'll pay, they'll
Speaker 1: make five or six. So if if the prospective returns
Speaker 1: have come down so drastically and the expectations of institutional
Speaker 1: investors have not, then I think that they all have
Speaker 1: a real challenge. So I don't know if you can
Speaker 1: really talk about state pension funds, but they seem to
Speaker 1: be somewhat underfunded and wed to these high return expectations.
Speaker 1: What does this tell us about the future obligations that
Speaker 1: taxpayers may find themselves on note, for that's really one
Speaker 1: of the great questions today, Barry that very few people
Speaker 1: are talking about. But the pension, the the the state
Speaker 1: or municipality puts in a certain amount of money and
Speaker 1: then it assumes a rate of return which will enable
Speaker 1: it to pay. But I've noticed if you assume a
Speaker 1: high rate of return, you have less money today, but
Speaker 1: more money down the road, and appreciably more. What that
Speaker 1: assumption should be, and what I think it used to
Speaker 1: be is what we can make. Now I think more
Speaker 1: often it's what we need. But that's not right. It
Speaker 1: should be what they can make, and what you can
Speaker 1: make in this low return environment has come down quite
Speaker 1: a bit, regardless of the assumed rates being too high.
Speaker 1: Lots of funds are underfunded anyway, regardless no's and and
Speaker 1: uh on others. If you ratchet down your return expectations,
Speaker 1: then you're even even more undertunded. I think that most
Speaker 1: public funds are woefully underfunded, and many of them are
Speaker 1: working with their unions to renegotiate the pensions so that
Speaker 1: the that that the UH funds can be returned to viability.
Speaker 1: In some cases you can't do it, like in Illinois,
Speaker 1: where the pension fund is a right that's guaranteed in
Speaker 1: the constitution and you can't play with pens. So it's
Speaker 1: unnoable how these funds will deal with the future. You
Speaker 1: look at Illinois, it just doesn't seem that it's possible
Speaker 1: for insolvency to be avoided really for the for the
Speaker 1: state or for the individual for the fun you know that, Well,
Speaker 1: it requires the state on the hook to make makeup
Speaker 1: the short it is because because the constitutional right. So
Speaker 1: if that's the case, does the state is the state
Speaker 1: looking at either a renegotiation or a default. Well, it
Speaker 1: may do. We've had some small municipal bankruptcies around the country. Yes,
Speaker 1: Stockton for good memory, um, but you know, nobody wants
Speaker 1: to experience these things until they have to. Nobody says,
Speaker 1: you know, if we go on this track, we're going
Speaker 1: to be broken ten years. So that's X y Z
Speaker 1: unless they have to. What's the famous Hemingway quote. It
Speaker 1: was very gradual and until it was very sudden that
Speaker 1: the may I don't know that, I take your word
Speaker 1: for it. How did he go bankrupt? It was very gradual.
Speaker 1: But you know, but there is no provision for state
Speaker 1: bankruptcies in the Bankruptcy Code. What about uh, A territory
Speaker 1: like Puerto Rico, there was no provision for bankruptcy. That
Speaker 1: was one of the challenges in resolving that issue, and
Speaker 1: it had to be done consensually. But but I think
Speaker 1: that uh, you know, if you look at the math,
Speaker 1: you look at the funding status, and you look at
Speaker 1: the assumed returns, a lot of public pension funds are
Speaker 1: going to have big problems down the road. And I'm
Speaker 1: not talking about the twenty second century, uh, And you
Speaker 1: mean a decade or so from from here. I'm not
Speaker 1: an expert on the numbers, but I believe that it's
Speaker 1: more imminent than infinite. And I I just don't think that, uh,
Speaker 1: that the average citizen, uh understands the risk. And you
Speaker 1: know what's let's say that we did begin to have
Speaker 1: states going under with the federal government bail amount It
Speaker 1: depends on who's running the government, that's right. And by
Speaker 1: the way, if you look at the stay which are
Speaker 1: uh most troubled, you'll find out that that that the
Speaker 1: Illinois who else is on that that shortlist? Well, I don't,
Speaker 1: I don't, I shouldn't really go into that where where
Speaker 1: above my depth. California has seemed to get its fiscal
Speaker 1: house in order. Well, I think they're on the way.
Speaker 1: They've taken some steps. But the point is I think
Speaker 1: that that uh, you know, the the expectation that that
Speaker 1: the states will be bailed out by the federal government,
Speaker 1: which which means transferring money. I mean, the federal government
Speaker 1: has no money. It is not a money making organization.
Speaker 1: It is only an intermediary. It collects money and it
Speaker 1: gives it out and print prints a little on the
Speaker 1: side of prince a little. But I mean, but it
Speaker 1: doesn't earn any money. It's not like you and me
Speaker 1: going to work in the morning and and so so.
Speaker 1: The the the federal government redistributes money amongst the states.
Speaker 1: It's it's hard to see a massive trend of taking
Speaker 1: money from the states that have been uh pro economical
Speaker 1: and prudent and giving it out to the ones that
Speaker 1: have been profigate, So that complicates matters. And UM, I
Speaker 1: just think that the precarious state of public pension funds
Speaker 1: is an issue that has received very little attention, but
Speaker 1: will get more in the future in the coming years.
Speaker 1: I want to jump to my favorite questions, but before
Speaker 1: I do, I have to reference something you described, um
Speaker 1: I believe was at the c f A event in Toronto, which,
Speaker 1: for lack of a better phrases, is called organizational alpha.
Speaker 1: You were describing the way your firm more than assets selection,
Speaker 1: the way your firm processes information and create some mechanism
Speaker 1: for identifying opportunities for investment. So so let's talk a
Speaker 1: little bit about that. You referenced some of your colleagues
Speaker 1: your reference Bruce Covener, Cars, Bruce carsh Bruce Kovener, different
Speaker 1: person um the other gentleman, Sheldon Stone, Sheldon and and
Speaker 1: who else are running different portfolios in the office. John
Speaker 1: Brady runs the real estate and Matt Wilson and Jordan
Speaker 1: Crews run the control funds, the Klee Kramer runs the
Speaker 1: European control funds. Uh. You know, we have a lot
Speaker 1: of strategies. We have a lot of great guys running them,
Speaker 1: and even some women and so you um which is
Speaker 1: which is relatively rare these days in in institutional asset management,
Speaker 1: but that's starting to change. Um So you are co chairman,
Speaker 1: co c I O. Is that correct? No, I'm co
Speaker 1: chairman and co founder, co founder. You were ce I
Speaker 1: O for never I misremembering that. Edit that out. We'll
Speaker 1: we'll leave that in. Um So, how so, where I'm
Speaker 1: where I'm getting to with this is how is the
Speaker 1: decision making process about where to allocate capital, how aggressively
Speaker 1: to portion? How are those decisions actually made? Sure? Well,
Speaker 1: Number one, for the most part, Barry, we don't allocate
Speaker 1: capital clients. Institutional clients don't go to a firm like
Speaker 1: oak Tree and say here's a hundred million dollars. Do
Speaker 1: what you think is right to a specific going to
Speaker 1: a fist specific fund or strategy. So we don't have
Speaker 1: the allocation decision. Our job is to manage the money
Speaker 1: within the assignment. Um. When you use the term organizational alpha,
Speaker 1: which I think is a good one. Alpha means perfect
Speaker 1: personal skill, the the ability to add value above what
Speaker 1: the market gives in any given niche Where does it
Speaker 1: come from? And the answer I think is it's it's
Speaker 1: personal or its organizational. Personal means hiring great people, and
Speaker 1: of course we try to do that, but organizationally, I
Speaker 1: think that you can be constructive or destructive. We have
Speaker 1: a very explicit investment philosophy which tells everybody who works
Speaker 1: at oak Tree what our game plan is and how
Speaker 1: we're going to go about adding value for the clients.
Speaker 1: An emphasis on risk control and on consistency, not on top,
Speaker 1: that's how bottom this u and insistence that we will
Speaker 1: only be active in inefficient markets, and a desire for
Speaker 1: a high degree of specialization. We don't have a general
Speaker 1: research pool. We have research teams assigned to every strategy.
Speaker 1: We have a refusal to base investment decisions on macro forecasts,
Speaker 1: which shouldn't come as a surprise to you, and a
Speaker 1: reluctant to raise and lower cash to time the markets,
Speaker 1: which we think is very difficult to do most of
Speaker 1: the time. So everybody knows the game plan. We think
Speaker 1: it's an effective um game plan, especially that everybody knows
Speaker 1: that the way to succeed at oak Tree is not
Speaker 1: by being some cowboy and swinging for the fences, but
Speaker 1: rather to to control the risk and drive out the
Speaker 1: negative surprises. Um So the investment philosophy gives everybody a
Speaker 1: creed to live by and a way to pull together,
Speaker 1: and we don't have. You know, I've seen investment organizations
Speaker 1: torn apart by by battles between the cowboys and the chickens.
Speaker 1: You know, in in the good markets, the cowboys say,
Speaker 1: the chickens are put holding us back, and in the
Speaker 1: bad markets, the chickens say, the cowboys are getting us killed.
Speaker 1: And it's very bad. Uh it's also bad for the clients.
Speaker 1: Our clients want to know what kind of an order
Speaker 1: aization they're hiring, and then they want to get what
Speaker 1: they came for, and an explicit creed like we have
Speaker 1: enables that to be the case. So I think that
Speaker 1: that the the the common creed the investment philosophy is
Speaker 1: extremely important. Then the other thing is that at oak
Speaker 1: Tree we have a structure which is designed to encourage
Speaker 1: team behavior, not individual behavior. Uh So nobody at oak Tree,
Speaker 1: you know, we don't have the philosophy that that exists
Speaker 1: in some places. You eat what you kill. Uh. You know,
Speaker 1: everybody gets paid on their own performance, and you can
Speaker 1: quantify it down to the basis point. Uh. We get
Speaker 1: paid at oak Tree on how the team did, how
Speaker 1: the firm did, how the team did, what we believe
Speaker 1: of your contribution and your potential. We don't keep records
Speaker 1: of who gave which recommendation and how much money did
Speaker 1: it make us or lose it. We don't pay people
Speaker 1: based on their quantitative results in the prior year, because
Speaker 1: quantification is in everything, and the prior year is everything.
Speaker 1: You know, uh m Albert Einstein said, not everything that
Speaker 1: counts can be counted, and not everything that can be
Speaker 1: counted counts. There is so much more in assessing the
Speaker 1: contribution of an individual to the performance of the team
Speaker 1: and the organization than just whether his recommendations worked last year.
Speaker 1: Uh that we uh insist on uh an organization that
Speaker 1: functions as a team for the benefit of the clients,
Speaker 1: and it sounds like it's certainly been working over the years.
Speaker 1: Let's let's jump to some of our favorite questions while
Speaker 1: I while I still have you, you mentioned some folks
Speaker 1: who influenced you at city Who who are some of
Speaker 1: your early mentors. I don't really have the mentors to
Speaker 1: talk about. My uh philosophy was shaped mostly about reading.
Speaker 1: So so wh who affected you well? I mentioned John
Speaker 1: Kenneth galbray Thrower, and I think he was terrific. And
Speaker 1: he talked about the fact that forecast on work, and
Speaker 1: he talked about um, the fact that people in the
Speaker 1: financial world have very short memories and that's why cycles
Speaker 1: tend to repeat. Has a great book called A Short
Speaker 1: History of Financial Euphoria which talked about the extremes of cycles,
Speaker 1: and that was very impactful on me. I read that
Speaker 1: one a long time ago. What other books have you
Speaker 1: read that have been very influential to your philosophy? Fooled
Speaker 1: by Randomness by Nassa Nicholas to Leb talks about the
Speaker 1: fact that the future is indeterminate and that events are
Speaker 1: unpret aredictable in large part because the world is subject
Speaker 1: to randomness. And in a world of random this, you
Speaker 1: can't have events that are predictable and and and I
Speaker 1: think he makes very very sound arguments on that subject.
Speaker 1: So there's any other example against the Gods by Peter
Speaker 1: Bernstein on the subject of of of probability and risk,
Speaker 1: um and and so forth. I UM, not too long
Speaker 1: ago had Meyer Stateman in here, and he said in
Speaker 1: one of his early advisers was Peter Bernstein, demanding guy,
Speaker 1: but he said whatever he worked with on him was
Speaker 1: so much better when it was done. And you know,
Speaker 1: I so I wrote a memo called risk in OH
Speaker 1: six and updated it Risk revisited in fourteen, and then
Speaker 1: in fifteen I found a memo from Bernstein on my
Speaker 1: desk and oh seven, memo from Bernstein who had passed
Speaker 1: away in O nine, and it was entitled can risk
Speaker 1: be reduced to a number? He didn't think so? I
Speaker 1: don't think so. I don't think that risk can be quantified.
Speaker 1: I think it's just a matter of subjective judgment and
Speaker 1: and and it had a profound influence on me, as
Speaker 1: he did in general. His his writing was just so
Speaker 1: dense with thought and so clearly structured, and his prose
Speaker 1: was I find any time I sit down, UM, I
Speaker 1: have his book on gold on my desk, and I'm
Speaker 1: I'm looking forward to diving into any of the books
Speaker 1: you want to mention you You previously mentioned Graham and Dodd.
Speaker 1: Is there anything else you want to reference. Uh, what
Speaker 1: what are you reading now? I'm reading Tim Geithner's autobiogramys
Speaker 1: really Stress Test and how is It's very interesting. It's
Speaker 1: it's not h exciting reading, it's not fun reading, but
Speaker 1: it's very very illuminating. Oh, you get a lot of
Speaker 1: in said as to what was going on behind the scenes.
Speaker 1: I have not read either Bernanke or Paulson's um autobiographies,
Speaker 1: but they are sitting on my shelf, and I'm just
Speaker 1: one of these days I feel obligated to get to
Speaker 1: the well. I think we should because if we don't
Speaker 1: study crises, then we are bound to repeat them quicker.
Speaker 1: If we study them, it will take longer. Of course,
Speaker 1: they'll always but you know, it was Santayana who said,
Speaker 1: those are those who are ignorant of history are bound
Speaker 1: to repeat it, and and reading the books of people
Speaker 1: like Paulson will help us, uh to delay their repetition.
Speaker 1: What do you what do you do outside of the
Speaker 1: office to relax? What do you do for fun? Well?
Speaker 1: I read, okay, and I play some tennis, and I
Speaker 1: uh like houses and architecture. You like architecture, I had
Speaker 1: no idea about that. What do you do? How does
Speaker 1: that express itself. Do you go on architectural tours. I'm
Speaker 1: assuming you've been to oak Brook and done the whole
Speaker 1: I do, right, I do visit uh stand out examples
Speaker 1: of architecture, you know. And the great thing about is
Speaker 1: that when you go on a business trip, right, you
Speaker 1: can find the best one or two examples and you
Speaker 1: can go visit them. It doesn't take very long. You're
Speaker 1: kind of bi coastal. You're in l a part of
Speaker 1: the year, so you have plenty of Frank Gary buildings
Speaker 1: and other such stuff. Your references are too modern. I
Speaker 1: didn't say modern. Okay, that is my bias coming out.
Speaker 1: I actually prefer classical architecture, Okay, such such as well. Uh,
Speaker 1: I mentioned Frank. When you when you go to in
Speaker 1: you should visit potsdown Potsdam has great examples of eighteenth
Speaker 1: century architecture, and and UH, you know when you go
Speaker 1: to UH, when you're down south, you should go to
Speaker 1: Mount Vernon and Manticello and so forth. Um. And it's
Speaker 1: really a highlight to be able to take a little
Speaker 1: bit out of your day to go see a great
Speaker 1: building that's fascinating. I had no idea. UM. You you
Speaker 1: occasionally bump into a millennial or a recent college grad.
Speaker 1: What sort of advice do you give to a young
Speaker 1: person just starting their career if they said, hey, I'm
Speaker 1: interested in finance, UH, what advice would you give them?
Speaker 1: I think the most important thing, Barry, is that you know,
Speaker 1: when I got out of grad school, I applied for
Speaker 1: six different jobs and sift six different fields of finance.
Speaker 1: I didn't know what I wanted to do. Uh, And
Speaker 1: I went into investment management primarily because I had had
Speaker 1: a good summer job at City Bank in nineteen and
Speaker 1: I enjoyed it. Uh. And all those jobs offered about
Speaker 1: the same pay. They all offered between twelve and four dollars,
Speaker 1: and that was a year, not a month. And then
Speaker 1: sometime in the eighties God looked down and he said,
Speaker 1: I'm going to let those people who manage money make
Speaker 1: more than everybody else. And so there's a tendency for
Speaker 1: people to go into investment management hedge fund management in particular,
Speaker 1: because they want to get rich. It's not a good reason.
Speaker 1: And what I always counseled young people is that they
Speaker 1: should try to find something that they will enjoy. And
Speaker 1: if you're doing something every day for your life, which
Speaker 1: is hopefully a long time and you're not enjoying it,
Speaker 1: then you're wasting your life and doing that the pile
Speaker 1: up money that you'll have left at the end. It
Speaker 1: seems so uh futile. So uh, you know, Christopher Morley,
Speaker 1: you're a great one for quotes. Christopher Morley, the English
Speaker 1: writer said my favorite one. He said, there's only one success,
Speaker 1: to be able to live your life your own way.
Speaker 1: And so what that means is number one. Two, follow
Speaker 1: the convention of society into whatever all the cool kids
Speaker 1: think is great at a given point in time is
Speaker 1: an obvious mistake. You should not let society set your goals.
Speaker 1: And number two, the challenge is really, in my opinion,
Speaker 1: to figure out what will make you happy and then
Speaker 1: to pursue it. Uh. But that's what I tell people.
Speaker 1: Try to do something you'll love. Uh. There's nothing like
Speaker 1: spending your day uh doing something you love. You know.
Speaker 1: I always say to people that investment management is great.
Speaker 1: I would do it for nothing if I if I
Speaker 1: had to. Fortunately I don't have to. My wife says
Speaker 1: I'm gainfully unemployed, which which is pretty much exactly what
Speaker 1: you're saying. Well, there's you know, we only get one life.
Speaker 1: You get to be my age. You're getting there one
Speaker 1: of these days, but you realize that it's not finite.
Speaker 1: My wife says, none of us is getting out of
Speaker 1: this alive. So the only thing that makes sense is
Speaker 1: to try to maximize our satisfaction with our lives. You
Speaker 1: get to be seventy nine years old, you look back,
Speaker 1: you say, damn, I should have X y Z. It's unfixable.
Speaker 1: That's what you must think about. What will I how
Speaker 1: will I feel about my life at the end? And
Speaker 1: you have to behave in accordance to not having regret
Speaker 1: at the end. And and from what I'm told, very
Speaker 1: few people will say I should have spent more time
Speaker 1: at the office. Very few. Um and our final question,
Speaker 1: what is it that you know about investing in any
Speaker 1: of its? Guys? Is that you wish you knew when
Speaker 1: you began low back in the nineteen sixties nine seventies. Well,
Speaker 1: I think that that. You know, I've learned a lot
Speaker 1: of lessons through experience. As we discussed getting what you
Speaker 1: didn't want, it's right and and uh, you know, those
Speaker 1: are the things that have shaped my philosophy to be
Speaker 1: what it is today. The the futility of trying to
Speaker 1: guess the future, the importance of understanding cycles, the essential
Speaker 1: character of value, that it's not what you buy, it's
Speaker 1: what you pay. Um, the essential character of value. Yes,
Speaker 1: I mean the relationship between price and value determines your success.
Speaker 1: Not buying high quality assets, not shunning low quality assets,
Speaker 1: but buying assets of of any quality when they're available
Speaker 1: cheaper than they should be. Uh. So, I think that
Speaker 1: these are the kinds of the importance of controlling emotion,
Speaker 1: the importance of contrarianism. In fact, I got great news, Marry.
Speaker 1: My book, The Most Important Thing, has twenty chapters, and
Speaker 1: each chapter says the most important thing is, and then
Speaker 1: it's a different thing. And I've tried to distill the
Speaker 1: important lessons of my career into that book. And uh
Speaker 1: and I'm satisfied with the job I have done, and
Speaker 1: as have everybody who's read the book. I can't recommend
Speaker 1: it enough. Um. The blurb on the cover is Warren Buffett,
Speaker 1: who is essentially the person who you tell a lovely
Speaker 1: story about him, saying, why don't you write a book? Howard?
Speaker 1: I tried, he he wrote me. I always figured that
Speaker 1: when I retired, I would pull the memos to other
Speaker 1: into a coherent uh book and uh in. I got
Speaker 1: a an email from Warren and he said, if you'll
Speaker 1: write a book, I'll give you a blurb for the jacket.
Speaker 1: And that was all the motivation I needed to get going.
Speaker 1: And and the book came out a year later. And
Speaker 1: by the way, I love the fact that Warren Buffett says,
Speaker 1: you know who, I'd like to read a book from
Speaker 1: that Howard Marks guy. Send him an email telling him
Speaker 1: I'll give him a blurb, and a year later I'll
Speaker 1: get a book from him. Well, I mean, the amazing
Speaker 1: thing is the amazing thing is that somebody like Warren,
Speaker 1: despite the respect he enjoys and the success he has enjoyed,
Speaker 1: is still reading. He's a a vociferous read. And by
Speaker 1: the way, he doesn't read his own writing. He reads
Speaker 1: from other people and and and and and glean's what
Speaker 1: is to be gotten? And you know, he's eighty seven.
Speaker 1: I think he's not done learning. He he just said,
Speaker 1: if you've seen the HBO document to me on him,
Speaker 1: it's fascinating. He describes himself as he goes, I'm just
Speaker 1: a cigar, but there's nothing left anymore. But he still
Speaker 1: goes to the office him and Charlie Manger. Manger is
Speaker 1: ninety something and they read three or four hours a day.
Speaker 1: That's just astonishing. Howard, thank you so much for being
Speaker 1: so generous with your time. It's always a delight uh
Speaker 1: an instructional one chatting with you. We've been speaking with
Speaker 1: Howard Marks of oak Tree Capital. Be sure to go
Speaker 1: to oak Tree Capital dot com. You can see the
Speaker 1: entire collection of chairman's memos. Each one is a lesson
Speaker 1: in itself, the most important thing at Amazon and fine
Speaker 1: bookstores near you. If you have enjoyed this conversation, be
Speaker 1: sure and look up an inch or down an inch
Speaker 1: on Apple iTunes and you can see any of the
Speaker 1: other I want to say, we're coming up on a
Speaker 1: hundred and forty such conversations. I would be remiss if
Speaker 1: I did not thank Medina A recording engineer Taylor Riggs
Speaker 1: or booker Michael Batnick, our head of research. We love
Speaker 1: your comments, feedback and suggestions right to us at m
Speaker 1: IB podcast at Bloomberg dot net. I'm Barry Rihults. You've
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