Saturday, July 9, 2011

The Most Important Thing: Chapters 7 and 8


Value investor Howard Marks shares his investment philosophy in his book, The Most Important Thing: Uncommon Sense for the Thoughtful Investor. "This is that rarity, a useful book," according to Warren Buffett. Marks' estimated net worth is over $1 billion and his firm, Oaktree Capital, manages $80 billion.

What makes the best managers great is their ability to reduce and manage risk. Over the course of most managers' careers, their results will not be determined by the winners, but rather by the number of losers and the magnitude of their losses.

But investment managers are recognized for their returns. This is because risk is invisible to most; during good periods, it's difficult to tell whether someone is taking too much risk. Similarly, one cannot tell the difference between a responsible builder and one who cuts corners, until an earthquake hits that is.

Marks urges investors to recognize that most things go in cycles. Trees do not grow into the sky, and neither do most things go to zero. But when a cycle is rising or falling, there will always be those who extrapolate a short-term trend into the future, and argue that "it's different this time". When this opinion becomes the consensus, this is usually a sign for investors that opportunity knocks, because assets are likely mispriced.

For Marks, the credit cycle is one of the most important cycles. When times are good, capital providers compete for business and therefore don't demand great returns on their money. Eventually, terrible loans/investments are made and come crashing down. At the other end of the cycle, competition is low and therefore providers of capital are able to demand great returns.

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