Inside the Head of Howard Marks

Born in Queens, New York, in 1946, Howard Marks embarked on a journey that would significantly influence modern investment thinking. With a steadfast focus on value investing, Marks co-founded Oaktree Capital Management in 1995. Today, Oaktree stands as a premier investment firm managing $180 billion in assets, and is renowned for its resilience in market downturns. This article uncovers why Warren Buffett drops everything as soon as he receives one of Marks' memos in his inbox, and uncovers his core principles for market success: contrarianism, second-level thinking, risk management, and a deep understanding of market psychology. Let's jump right in.

• Founding of Oaktree: Howard Marks co-founded Oaktree Capital Management in 1995, specializing in distressed securities and high-yield bonds. Oaktree's growth to managing approximately $180 billion in assets by 2024 highlights Marks' abilities and influence.

• Investment philosophy: If one were to pick four principles, Howard Marks' investment philosophy revolves around contrarianism, second-level thinking, risk management, and a deep understanding of market psychology.

• Key achievements: Marks' influence extends beyond Oaktree's success to his contributions in investment literature. His book The Most Important Thing and his popular memos are among the most acclaimed investing writing globally.

From an early age, Marks was drawn to the world of finance. He pursued higher education at the prestigious Wharton School, earning a B.S.E. in finance in 1967. He then attended the Booth School of Business at the University of Chicago, receiving an MBA in accounting and marketing in 1969.

Mark's professional career then began in finance at Citibank, where he honed his skills in investment research. However, his career trajectory took a significant turn in 1985 when he joined TCW (Trust Company of the West) and created its high-yield bond operations. During his tenure at TCW, Marks developed a reputation for his prudent and disciplined investment approach, particularly in the high-yield bonds and distressed debt sectors.

Now with experience and driven by a distinct investment philosophy, Marks co-founded Oaktree Capital Management in 1995. Oaktree quickly became a high-profile name, initially known for its investments in distressed securities, high-yield bonds, and private equity. Under Marks' leadership, Oaktree has grown to now manage roughly $180 billion in assets under management.

Howard Marks' investment philosophy is deeply interwoven with his thoughtful observations on market dynamics, risk management, and the psychological nuances that drive investor decisions. He posits that the most rewarding investments often originate from scenarios that initially feel counterintuitive or uncomfortable – a reflection of his belief in contrarian strategies and the potential for high returns in undervalued and overlooked assets. This core idea suggests that the best investment opportunities lie in going against prevailing market sentiments when they are driven by irrational fears or excessive optimism.

Marks has famously communicated his investment insights through detailed memos, which began as internal letters intended to inform and guide the decision-making processes within Oaktree. These memos have since transcended their original internal audience to reach a vast number of investors and analysts around the world, who eagerly anticipate his writings. In these communications, Marks doesn't just report on financial results or market positions but dives into discussions about economic trends, market anomalies, and the psychological underpinnings of investor behavior.

His writing combines rigorous analysis with practical wisdom, often drawing on historical examples and his own extensive experience to underscore his points. For instance, he frequently explores the concept of "market cycles," illustrating how investors can enhance their outcomes by recognizing the phases of these cycles and adjusting their strategies accordingly. By doing so, he helps investors understand not just when to act, but why certain actions might lead to success or failure under specific market conditions.

Howard Marks' profound impact on the investment world is marked by several key achievements, most notably his in-depth exploration and dissemination of concepts related to risk and market behavior. His seminal work, The Most Important Thing, is particularly significant. In this book, Marks articulates his investment philosophy across 20 distinct points, offering a framework that has guided countless investors. Warren Buffett has lauded the book for its practical applicability and depth, highlighting its value to both seasoned professionals and newcomers to investing.

Beyond his contributions to investment literature, Marks' investing skillset has been proven in the real-world crucible of market downturns and financial crises. During the tumultuous periods of 1998, 2001, and 2008 – times characterized by widespread panic – Marks and Oaktree distinguished themselves. They adeptly navigated these challenging times by capitalizing on market inefficiencies and focusing on distressed assets. This approach not only mitigated risk during volatile periods but also achieved substantial returns, thereby cementing Oaktree's reputation for resilience.

One investing idea that Howard Marks is particularly renowned for is "contrarianism." This concept involves going against prevailing market trends or sentiments, often buying when others are selling in fear and selling when others are buying in greed. Marks' contrarian approach is not just a simple opposition to mainstream strategies but is rooted in a profound understanding of market cycles, investor psychology, and value assessment.

Marks believes that markets are driven by fluctuations between extremes of optimism and pessimism, creating opportunities for disciplined investors who can act counter to prevailing emotions. Some might think that this insight isn't unique at all, and probably think of Benjamin Graham's concept of "Mr. Market," from which this type of thinking originated in the first place. However, what distinguishes Marks' insights into market behavior is his depth of thought and the seriousness with which he takes this concept, applying it rigorously in his investments.

Marks suggests that the key to successful contrarian investing lies in having a more accurate and rational assessment of reality than that of the average market participant. This involves recognizing and resisting the emotional cycles of greed and fear that can cloud judgment.

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Implementing a contrarian strategy requires several key elements and, like any investing strategy, carries its own risks and challenges. Timing is a critical factor; contrarians often endure periods of underperformance and criticism. Moreover, the difficulty in determining the exact bottom or top of market cycles means that contrarian positions often initially result in losses. Three key elements of contrarianism according to Howard Marks are:

Patience: Contrarian strategies can require a longer timeframe to pay off, as market mispricings may not be corrected immediately. Investors need to be prepared to hold positions for an extended period, sometimes in the face of continued market opposition.

Rigorous valuation: Effective contrarian investing relies on rigorous analysis to determine the intrinsic value of assets. This ensures that purchases are made at a true discount to their fundamental worth and that sales occur when assets are overvalued. Rigorous valuation is arguably more important in a contrarian strategy than in strategies that focus on buying compounders for the long term. The latter primarily depends on the belief that an investment will generate superior returns due to the sustained superior performance of the company, rather than a significant mispricing when the investment is made.

Emotional Discipline: Perhaps the most challenging aspect of contrarian investing is the emotional discipline required. Buying when there's widespread pessimism and selling during euphoria goes against human nature, which tends to seek comfort in following the crowd.

As for any other asset manager, the goal is simply to find underpriced assets. Here's Howard Marks' list of where to look for them:

• Little known and not fully understood

• Fundamentally questionable on the surface

• Controversial, unseemly or scary

• Deemed inappropriate for respectable portfolios

• Unappreciated, unpopular and unloved

• Trailing a record of poor returns

• Recently subject of disinvestment, not accumulation

What's fascinating about reading this is the heavy emphasis on second-level thinking. If you receive an investment pitch that sounds good in every aspect, a first-level thinker would typically embrace the idea. In contrast, a second-level thinker might actually become more excited if they hear about the shortcomings of a business – which, according to Marks, are often more likely to present a good investment opportunity. As Marks outlined in The Most Important Thing: "Our goal isn’t to find good assets, but good buys. Thus it's not what you buy; it's what you pay for it."

In essence, second-level thinking is a deeper and more complex form of thinking that seeks to understand and exploit conditions that average first-level thinkers might overlook. Here's an example to illustrate second-level thinking in the context of investing:

A company announces higher-than-expected earnings. The first-level thinker might conclude, "The company is performing well, and this good news will surely cause the stock price to go up at some point. I should buy shares." The second-level thinker will dig deeper and consider several other factors such as:

• How much of this good news is already expected and potentially already priced into the stock's current valuation?

• Are these earnings sustainable or just a one-time event?

• What is the broader market sentiment, and how might that influence the stock's movement beyond just this news?

• What are the potential risks that the market hasn't noticed yet which could affect future performance?

In this scenario, the second-level thinker might conclude that although the news is good, the stock may not be a good buy if the market has already anticipated the positive earnings and priced them in. They might even consider selling if they believe the stock's price fully reflects its future prospects and there's limited upside potential. This kind of thinking leads to decisions that are more nuanced and potentially contrary to the prevailing market sentiment, aiming to capitalize on overlooked aspects of certain situations.

Marks asserts that the price at which an investment is acquired is the most critical factor in determining its future performance. He explains that even the best asset can be a poor investment if bought at too high a price, while a mediocre asset can turn out to be a great investment if acquired at a bargain. In his memo, "You Can't Predict. You Can Prepare," Marks writes:

This highlights that the potential for gain or loss is directly tied to the initial valuation. By focusing on price, investors can better manage risk and enhance their chances of achieving favorable returns.

Marks' view on risk management is intricately tied to the concept of price. He argues that understanding and controlling risk is fundamental to successful investing, and the primary way to control risk is through the price paid for an asset. In his memo "Risk Revisited," he states:

From his humble beginnings in Queens to his influential position at the helm of Oaktree, Howard Marks' journey embodies a master class in financial and intellectual rigor. His profound insights into market cycles, risk management, and investor psychology have not only built an incredibly successful investment firm but have also left an indelible mark on the global investment landscape.

Marks' exceptional ability to thrive during times of economic turmoil – leveraging contrarian strategies and a deep understanding of value – illustrates a rare alignment of discipline, foresight, and resilience. As both a thinker and a practitioner, his career offers a blueprint for navigating the complexities of investing, emphasizing that the real key to success often lies not in the assets one chooses but in the price one pays for them.