Howard Marks' skills as an investor have turned him into a multibillionaire. The New York native co-founded the asset management firm Oaktree Capital Management in 1965, and funds run by Marks over the years have generated average annual returns of 19%.
Needless to say, Marks has honed his craft over time and has been able to generate superior returns throughout his career. For investors looking to do the same, Marks recommends a somewhat unorthodox approach. Let's take a look at what he had to say.
Think about market psychology
When it comes to investing, those who buy and sell equities are often told to remove emotion from their decisions. While Marks is a big believer in this approach, in an op-ed he recently wrote in the Financial Times, he explained that few investors are actually able to do this. He said that's why investors need to focus on reality.
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Marks wrote:
Everyone can study economics, finance, and accounting and learn how the markets are supposed to work. But superior investment results come from exploiting the differences between how things are supposed to work and how they actually do in the real world.
The key to doing this is by taking the temperature of the market, says Marks, and really thinking about investor psychology. In the op-ed, Marks offered several key tips for how investors can do this:
- You should study market history to recognize patterns. This will help you better understand investor psychology and how the market might react to events.
- You should remember that investors typically are emotional which pushes them to be either too positive or too negative. "A strong movement in one direction is more likely to be followed by a correction in the opposite direction than by a trend that 'grows to the sky'," Marks explained.
- Being a contrarian is often the key to making money, but the contrarian view isn't always obvious. The consensus view tends to not be far off most of the time, so being a contrarian requires deep knowledge.
- You should be able to remove emotion from the investment process.
- Keep an eye out for "illogical propositions" that don't seem to add up or seem too good to be true.
Over the years, Marks has cited various examples where he managed to take the market's temperature and successfully use this strategy to make some big market calls. For instance, in the fall of 1999, on the eve of the dot-com crash, Marks wrote in a memo that he spotted the same kind of speculative bubble in the tech, telecommunications, and internet sectors, as he had read about in "past manias" that were the subject of Edward Chancellor's book Devil Take the Hindmost.
In 2007, just as the Great Recession was kicking into high gear, Marks explained how Oaktree raised an $11 billion "reserve fund" for distressed debt opportunities. The company began to make investments from the fund, and then Lehman Brothers went bankrupt. In that case, Oaktree had to decide whether to slow down or ramp up and it chose the latter.
In late 2008, Marks wrote in a memo:
I think the outlook has to be viewed as binary: Will the world end or won't it? If you can't say yes, you have to say no and act accordingly. In particular, saying it will end would lead to inaction, while saying it's not going to will permit us to do the things that always have worked in the past.
Marks and the other executives at Oaktree would come to the realization that if they invested and the financial world imploded, it wouldn't matter anyway, which gave them the green light to invest. Oaktree invested $6 billion, most of which was put to work in the final quarter of 2008.
What can investors learn?
In his op-ed and memos, Marks taught us a lot: namely, that the market's emotional state is a huge driver and consideration in investing. Marks also taught us that if there is an overly extreme market psychology in one direction or the other, investors should try and closely examine what's going on to see if there is an opportunity.
In late 2021, most of the market was as bullish as could be and investing as if valuations didn't matter. The market proceeded to tank. Heading into this year, most analysts and economists expected a bad start to the year. The market has risen more than 17%.
Again, this doesn't mean to always take the opposite view, as there have been plenty of years and situations when the contrarian view didn't work out. But the takeaway here is this: look for extremes, try to find patterns, and do your best to keep emotion out of your investing decisions.
