Episode Transcript

Mo Lidsky  00:04

Hi, and welcome to today's session of Lunches with Legends™ where we connect with some of the most illustrious individuals in the financial world while supporting the vital health care organizations in our community. Before we begin, I'd like to thank our key sponsors of this series, especially our gold series sponsor KPMG. We are deeply grateful to KPMG for their friendship and very generous support. We would also like to thank our three silver series sponsors Venterra Realty, the Creaghan McConnell Group and TD Bank. We are so appreciative of your generosity. I just want to remind everyone that 100% of the dollars you donate through Lunches with Legends™ goes toward COVID-19 relief and pediatric mental health. So, if you have not already made your donation, please take a moment go to the donation page at the top right at this site, we would be most grateful for your support. Now without any further ado, I'd like to introduce our very special guest today, the legendary Howard Marks. To give you a little bit of background so Howard, who holds degrees with distinction from Wharton and University of Chicago launched his career with various investment leadership roles and positions at Citi Group. After 16 years at Citi, he joined TCW Group where he led various investment teams as the Chief Investment Officer for domestic fixed income. In 1995, Howard co-founded and currently serving as Co-Chairman of Oaktree, which is one of the largest asset managers in the world, managing approximately 150 billion and employing over 1,000 people being particularly renowned for their distressed debt and credit investing expertise. Aside from earning the fiduciary trust of the world's most respected investors, Howard has also been an extraordinary thought leader of his many books. My personal favorite is The Most Important Thing: Uncommon Sense for the Thoughtful Investor. On a personal level, I've given away dozens of copies of this book, and it’s required reading for all capital allocators. But on top of that, his most recent book, Mastering Market Cycles and on top of that he really shares his famous memos which are eagerly consumed in every corner of the financial world. And if that wasn't enough, he's also a professor of practice at King's Business School in London. Philanthropically, Howard has been deeply involved with higher education in the arts, serving as the trustee and chairman of the Investment Committee at the Metropolitan Museum of Art. He serves on the advisory board of Duke University and the Investment Committee of the Royal Drawing School and is an emeritus trustee of the University of Pennsylvania, where he previously chaired the Investment Board. Ladies and gentlemen, I am so excited for this conversation, and it gives me great pleasure to welcome our distinguished guest, Mr. Howard Marks. Howard, thank you so much for joining us.

Howard Marks  03:04

Well, thank you all for having me. I feel at home because I'm an honorary Canadian now that we have partnered with Brookfield.

Mo Lidsky  03:12

That's right. That's right. So, we're going to get to that. And I'd love to dive into that. But before we do, many of us have been reading your memos and books for years and some of the brightest minds in the industry. I mean, for God's sakes, even Warren Buffett says, You're one of the few people he reads without fail. On top of that, you've also endowed it’s called the Mark's Family Writing Center at the University of Pennsylvania. It seems like the written word and simplifying complexity has some resonance with you, or unique resonance with you. How did that come about? What in your upbringing might have contributed to that resonance?

Howard Marks  03:49

Well, as a child, I don't remember any particular emphasis, although my parents did emphasize language. In other words, they cared about words, and we had fun with words when I was little. The most formative experience was when I went to University of Pennsylvania as an undergraduate and I was a finance major in Morton. But at that time, Wharton had in a very enlightened requirement that you had to have a non-business minor. And you had to take one course in the literature of a foreign country. And for some reason, back in 1965, which I can't remember the reason I took it, most people took either French, English, or British or I guess those two and for some reason I chose Japan. And I took my required course in Japanese literature and loved it so much that I made it my nonbusiness concentration Japanese studies and I took 15 credits in in there, and the main professor, for my five courses was a kind of an aesthete. an Oxford dawns. But he put great emphasis on writing. And if he didn't like something, you'd say, write this over or you bad sentence structure, wrong word. And those days, we didn't have word processes. If he said, do it over that means type it again, on a typewriter. But I think that raised my writing. And then when I started work at the bank, I concluded that one way you could distinguish yourself was, but if you wrote better than everybody else, so that was helpful. And as in 1990, I started writing the memos for someone own reason. I enjoy writing it's, it's a creative outlet for me. If you look, you'll see that there's usually a memo in January and a memo in September. That means that I wrote over Christmas vacation, and I wrote over the summer, and I'd rather be writing than sitting on the beach.

Mo Lidsky  06:02

Could do both, I guess, theoretically. Thank you for all those memos. They've been formed all of us and kind of our own understanding of the financial world. So, let's come to Oaktree. So, you founded that Oaktree more than 25 years ago now, and you've done many more things, right than wrong, and have a remarkable track record. But I guess if I'm curious, if you were restarting Oaktree today, what might you do differently? And by the way, if the answer is nothing, perhaps I could ask you what might have been the most enlightening mistakes you made along the way. But let's see, what would you have done differently if you were restarting Oaktree today?

Howard Marks  06:39

Well, of course I always think about the movie Back to the Future. And you remember, the guy who traveled back to the past said he wouldn't change anything, because if he changed the past, the future may be different. I mean, what now is, and I feel that way I wouldn't change anything. Having said that I started work at Citibank, my reporter for a summer job in the summer of 68, full time job in the summer of 69. And the bank subscribed to what was called nifty 50 investing most of the banks did, and by the way, the banks were the big investors at that time. there were no boutiques, and so forth. So, the nifty 50, we invested in the 50 best and fastest growing companies in America, companies that were so good that nothing could ever go wrong, and so good that there was no price too high. So, we bought without reference to price didn't work out. So, well. If you if you if you bought the stocks the day I got to the bank, and held them for five years, you lost almost all your money, investing in the bit best companies in America. And so, it was informative but traumatizing. My sayings are that experience is what you got when you didn't get what you wanted. As I say, informative, but traumatized. And then I was by 75, I was the bank's director of research, and, but the performance was terrible, because of those things. And the five-year record was terrible. The 10-year record was terrible. And so, the bank brought in a new chief investment officer who wanted to bring in his own director of research. So, he said to me, what do you want to do next? Well, he gave me a break because he didn't fire me. And, and I said, Well, I don't know I said, but I don't want to spend the rest of my life choosing between Merck and Lilly, because I believe in the concept of market inefficiency, and I think you can't choose between mark and Lilly profitably. He said, I, I'd like you to start a convertible bond fund, because he used to work at JP Morgan where they had one, and city didn't have one. This is I like to start. So, I, so I go from managing a big department with a big budget, and I'm on all the important committees to working by myself with no budget, and no committees, and I'm the happiest guy on Earth. Because all I have to do is read information on companies and figure out which ones are better. And, and, and, and it was really an obscure backwater of the investment world. And, and you could find incredible bargains, I mean, giveaways, literally. And I could tell you about some, but now I'm investing in the worst public companies in America, and I'm making money steadily and safely. Especially when I got the call in the summer of 78. August, from the head of the bond department. He says to me, there's some guy named like Milken or something like that out in California. And he deals in something called high yield bonds. Do you think you can figure out what that means? And I was smart enough to say yes. And in 78, I started Citibank high yield Bond Fund, which was the first I believe was the first high yield bond fund from mainstream financial institution. And that was the beginning of the high yield bond era 7778 and it revolutionized the world prior, the emphasis of investing was to invest in The best companies and what they used to say gilt edge, or the nifty 50, which were the best and fastest growing, or at least, there are 90 odd percent of all investment organizations had a rule against buying bonds that were not investment grade. So, what does that mean? So that means when, when they started to be issued, they weren't received so well. And the few of us who would buy them would get a special deal. And I was probably better suited for fixed income than I was for equities I was I was very good at preventing losses, and not so good at making money. So fixed income is the place I say that I was way as a background, because being traumatized early in your career by big losses, and then finding comfort in fixed income with the way you give up upside to secure the downside connected with me. So, we started Oaktree. So, what I am, by the way, so I started with converts in high yield in 78. And then distressed that in 88, when my partner Bruce Karsh, joined me and, and we branched out into other fixed income strategies, credit strategies, they call it today. We didn't call it that then. And so, when we when Bruce and I and three other fellows left TC w in 95, to start Oaktree, that's what we did the same business.

Howard Marks  11:35

The point is, though, that everything we had done was about going into these risky asset classes, with the risks under control. And, and when we drew up our investment philosophy, we put risk control, first, consistency, second, etc. But my point is that we have a great business most of the time. We, we tend to excel in bad times, which is when you get the greatest bargains, especially in the distressed debt business. But we are not a good horse for prosperity. We don't have many prosperity-oriented strategies. So, the big mistake, I'm sorry, it took so long for me to get there. The big mistake is that we have had in in horse racing, that there are monitors, and which do best on a bad track. And then you have horses that do best on a good track. We do best on a bad track. And we didn't diversify. Probably the biggest single movement of the last 40 years was the creation of the private equity industry. We could easily have had private equity within our circle of competence, and we didn't.

Mo Lidsky  13:04

I'm going to come back to the specific capabilities and how you're managing risk today. But let me just touch on something that probably top of mind for many of usa couple of years ago, you wrote the book, Mastering the Market Cycle, getting the odds on your side. You've obviously thought deeply about market cycles. But then after the book came out, we were confronted with this global shutdown, rapid drawdown, rapid recovery, just an experience like no other. How has the last 12 months impacted your thinking about cycles? In other words, if you were rewriting that book today, what would you add? What would you take out? Or what would you want to highlight?

Howard Marks  13:41

I don't think I would change much. I don't forget what I said on the side here, but I would make a very explicit mention of the fact that I believe in cycles, but not everything is cyclical. The important thing to note, if you're studying cycles, is that the pandemic and the market collapse and the government actions and the market recovery. None of that had anything to do with cycles. That was a non-cyclical event. I believe that most cycles in the economy and in the markets occur, because although these things companies and markets and economies have been a positive underlying trend line. But if being on the trend line is a balance of optimism, pessimism, fear, and greed, the point is that people and let's say that the trend line is indicative of fair value. The point is sometimes when things go well, people get more optimistic, and the let's say the market price line goes above the trend line and it gets to pet pot. too optimistic. And that I would call an excess. And then the error of the excessive pessimism, optimism becomes clear when things don't go as well as people expected. And then it turns down back toward fair value. Well, it was it was overvalued at the high, if you could figure it out when that was, and then it's you had an excess and a correction, then it gets to fair value, but it keeps going out of x out of a rising tide of pessimism and bad events. And it goes down to low quite far from fair value, that's another excess to the negative side, and then it corrects eventually back to the trend line. So, it's exactly I think of cycles as excesses and corrections. And the raw material for these excesses and corrections is endemic, it is part of the economy, people, the participants in the economy get too optimistic, build too many factories, then it turns out, there's no need for the factories and they sit idle, and then that depresses people and then they get pessimistic. So, and same for the market enthusiasm, take stocks to irrational highs, and then they correct, and they went when people are overly depressed, they go to excessive lows. So, the raw material for cycles is endemic to the thing that is cycling. But that wasn't descriptive of last year. Last year, there were no FX excesses in the economy, the market was okay, but nobody, nobody thought it was terribly old value. And then we got hit with a media, which was the pandemic exogenous event had nothing to do with the decisions that economic units had made in the economy or the or the excessive bullish market bullishness on the part of investors. And it was totally unpredictable. So that doesn't change how I think about cycles. But what I would do is I put a big warning label is that there are things other than cycles that matter. And so, the, the, the knock to the economy was manmade, we had the pandemic, and we closed the economy in order to prevent spread. Then the recovery was manmade, because the Fed and Treasury came out with big stimulus packages and rate cuts, bond buying and all that. The market recovered manmade, I say manmade meaning intentional creations, and so that that wasn't simple, and I don't think it changes the way to think about cycles. The point is, there are things to think about other than cycles.

Mo Lidsky  17:57

Well, just to pick on that point. So manmade markets, let's call it. What are some of the second order consequences of monetary and fiscal policies that most people aren't considering?

Howard Marks  18:15

Well, the obvious one - so, one of the things that the Fed cleverly did that really helped is that they took the interest rate for the Fed funds rate to zero. Now, see, what happened is that the Fed learned a lot, and the Treasury learned a lot in the global financial crisis. And they developed tools to fight the weakness. And it took a month, but this time, since they had them in their arsenal, they did them in weeks and days. Andin the global financial crisis, it took I think, 11 rate cuts to take the Fed funds rate from five and a quarter in September of Oh, seven to zero in January, oh nine. And so, it was a protracted crisis. This time, they took it from one and a half to zero in one cod in March, boom really shock therapy. And that that made that change the markets, it makes people want to invest because they don't want to have their money in cash. It lowers the demand and return on assets, which means an increase in price, it resurrects risk taking because the only way to get a good return in a low return environment is by taking incremental risk. And it caused the capital markets to reopen because people have money to put to work and the crises that I've managed money through three crises in the past, and they were all marked by big debt crises and a lot of defaults and the ability to buy a lot of that cheap, especially in distress. And that didn't happen this time. I mean, it was on the way to happening between, let's say, March 9 and the 23rd. But the Fed came out on 23rd. And said, we're going to do even more than we had said. And the market started to go up on March 24 and has gone almost straight up since. So now, what do you do as one of the negative consequences? So, number one, low interest rates, artificially low interest rates, and I think zero is artificially low reward risk takers. And penalize savers. That's very important. And how would you like to be working on a fixed income amount of conservatism you put your money into T bills or short treasuries? And how would you like to have the banker call up and said that your return on your account is now zero. So that's number one. Number two, when the Fed rides to the rescue, it creates? Well, we used to the first really activist Fed Chairman, as far as I'm concerned with Alan Greenspan, starting in the mid-90s, through the late aughts, and or the middle ones, and that we used to talk about something called the Greenspan put, because anytime there was the slightest, Rick ripple of unpleasant events in the economy. Greenspan would squirt in some more liquidity, which would say today, he did it with y2k, he did with the tech bubble bust, he did it repeatedly. And so, people started to reach the conclusion that they can always count, if there's a problem, they can always count on the Fed to bail them out. Well, that create that leads to something called moral hazard. And moral hazard is the belief that it's okay to do risky things because there's somebody who will bail you out. And of course, as you can imagine, that leads to bad behavior. It leads to risky behavior if people believe that there are no negative consequences for risk. And in one of my recent memos, I mentioned that bankruptcy is to capitalism, as hell is to Catholicism. And if you're not scared of bit of bad consequences, then you will engage in undesirable activities. So that's a real risk. And it's happened now twice in a row, people may really be swayed by that, then the real consequence we have to worry about is the long term. Last year, the Fed increased its balance sheet by $2.7 trillion to buy bonds in the market, which supported the market. And the Treasury, probably expanded the deficit from it was probably going to be 1.2 trillion before the pandemic, and it turned out to be close to four. So, another, let's say, 2.7, just to be up. So, five and a half trillion of extra liquidity was pumped into the system last year just by printing money and given out to citizens and given out to businesses and so forth.

Howard Marks  23:07

I think they're going to the Fed is continuing to buy bonds at the rate of one and a half trillion a year. The deficit, I think, is going to be in the three's, at least for a few more years. That's a so that's another let's say, 5 trillion a year, for at least two years. So, we'll have pumped in at least 16 trillion of extra liquidity in three years. Here's the question. What will be the consequences? Now there's something called modern monetary theory which says that for a country which is in control of its currency, you don't have to worry about deficits today. Do you believe that can you really add well, it'll be 60 70% to the to the national debt in in three years and add so much to the economy that so much liquidity without consequences seems too good to be true to me. Can you pay for infrastructure, raises, benefits and all kinds of relief, with money you don't have? At infinitum without consequences? It's hard for me to believe. What would classical economics say will be the consequences? Increased inflation, rising interest rates, a weaker currency, maybe downgrades of the US credit, and downgrade of the US dollar status as the reserve currency of the world. But the Fed is unworried. They express a lack of concern with inflation. So, who am I to say they're wrong? There's now a theory called modern monetary theory. I think it's exactly that, it's a theory. But the Democrats, who are now in control, are using it to justify spending massive increases in the deficit.

Mo Lidsky  25:27

Let me bring that home a little bit. Since all the participants of this series are either active investors or family office principals, I think it'll be fascinating to hear how you're investing your own money in your own family office today? What are your allocations say about your belief? Or how do the beliefs you've shared translate into your allocations? If you have legacy positions, perhaps you could answer how might your portfolio look differently if you were building it from scratch today?

Howard Marks  25:59

Yeah, I really didn't have much in the way of legacy positions because I turned negative at the end of all four, began to turn negative. I didn't have any investments. I liquidated everything, if it wasn't an Oaktree, that stuff at Oaktree, I left because I have confidence in it. And also, it was mostly enclosed in funds. So, I had no choice, which was okay. Everything else, every penny I had outside of Oaktree, I put into Treasury notes, 1-2-3-4-5-6-year maturity. We call that a ladder, and you put equal amounts into several years. That means you always have one note, which is within a year of, of maturing, and the firt. The distant one gives you a locked-up rate for six years, but the closest one gives you money. When it comes to you buy, it goes to the back of the line, and you buy another six year, and the six year becomes only five years and so forth. It's the dumbest form of investing on demand. But I was making between five and 6%. That way, with no risk in what I thought was a deteriorating environment, I was ecstatic. But anyway, the point is that through going into the global crisis, I had all the old treasuries. When the crisis was over, it was time to create a portfolio. And I mostly went into more Oaktree funds, but also a few others, most of which didn't work out very well. So, I don't have legacy positions. My current portfolio consists of two parts: we have a very good allocation of labor in my family, because I manage the conservative part and my son manages the rest apart. The goal is to produce income and steady returns. I would say on average, today, I would say I'd be very happy if I could make 8%, eight or 9% a year steadily from credit products. My son invests in equities, and there is a crypto currencies. He's trying to knock the cover off the ball. He's very hardworking, very creative, and he's doing very well so far. So that's what we have. We have equities, he's in charge of making money. I'm charging, not losing money. I used to invest almost all my money to not lose money. Now we have division of labor, which is excellent. He sees upside that I never saw, maybe it was the reasons I described earlier, the trauma of my first experience, or maybe I was never that much of a dreamer or an optimist. He is. And he's probably going to prove to have been too optimistic, just as I was too pessimistic, or too cautious, I should say. But we have a good balance.

Mo Lidsky  29:05

Your targets historically, how you were ecstatic with 8%, or 8-10%, and you've generally delivered a very healthy insert of competitive returns through your variety of Oaktree funds. Just given the implication for all risk assets in a low rate, low return environment, how are you managing the return expectations of your investors? In other words, in the years ahead, where do you expect to find the yields or the returns anything akin to what we've seen over the last few decades as rates were falling?

Howard Marks  29:41

Let me clarify one thing before I go on Mo and I hope you'll remind me of your question, but Oaktree, which started off with those three categories, and an emphasis on risk control, maintained the risk control, but has branched into other fields of investing distressed debt, real estate, private Equity, emerging markets. Now the common thread is that we continue to do all of those with the same emphasis on risk control. But we started when we started Oaktree, we wrote down, I wrote down a motto, which says that if we avoid the losers, the winners take care of themselves. And that's a very good model for fixed income, in what I call more aspirational, asset classes. Avoiding the losers is not enough, you have to find some winners. And we have made that transition and our closed end funds for these more aspirational investments have very good records in the double digits for the long term, net of fees. We've done it. I don't want to give the impression that all of the strategies are as conservative as I am, but they all have this overlay of insisting on risk control and consistency. Now I'm ready for your question.

Mo Lidsky  31:01

Maybe I should have clarified on the more conservative end of the spectrum of the strategies that you employ, which could be in high quality credit or potentially even interest rates and even equities. When we're in a high valuation, low-rate environment, what are the return expectations that you're setting for your investors?

Howard Marks  31:21

Well, look, you the most important thing for everybody to know is that I believe we're in a low return world. There's this thing called the capital market line, and it looks like this. It goes from the lower left to the upper right, you have you have a return on the vertical axis and risk on the horizontal axis. The line goes like that, which is what we call a positive correlation, an upward sloping line from lower left to upper right. Most people think, Well, what does that mean? It means that riskier assets have higher returns. That's baloney, because if riskier assets could be counted on to produce higher returns, they wouldn't be risky. So, there must be something wrong there. When you hear somebody say, Well, if you want to make more money, the way to do it is to take more risk, there's something wrong there. What they should be saying is, if you want to take more money, make more money, you should go into riskier securities to have a chance of making a higher return, but also a chance of losing money. As you go out the risk curve, your, your range of outcomes becomes wider, and the bad ones become worse. That's the nature of risk. Remind me of the question.

Mo Lidsky  32:42

I'm curious about the expectations, given that returns have historically been higher than what we anticipate in the US.

Howard Marks  32:51

You have the capital market line, it goes like this, and it starts at the left axis, which is zero risk with something called the risk-free rate, which is usually the 30-day t bill rate. It proceeds up from there, because every time you increase the riskiness of the apparent riskiness of something, you have to increase the apparent offered return, or else nobody will buy it. So that curve has to be upward sloping. People are risk averse, they're not going to accept a riskier investment at the same prospective return as the safer investment, they want an increment of return possibility. So, it looks like this, and it starts from the risk-free rate. When I started managing money in 78, the Fed funds rate was 9%. The thing is, rates have come steadily down for the last 40 years, I have a note on the wall of my office saying that I had a loan outstanding from a bank, and it says the rate on your loan is now 22 and three quarters. Early last year, I borrowed some money at two and a quarter. The point is that the Fed especially late last March pulled down the risk-free rate from whatever it used to be maybe 434 or five was normal, pull it down to zero, the whole curve follows. Now the relationship between risk and return a wonder curve is still logical and fair, except that all prospective returns are now lower than they used to be. So, I do a presentation about it investing in a low return world. And it has a last slide which says well what do you do? How do you invest in a low return world, and it used to have six bullet points now it has five because I took out the first one? The first one said, invest as you always have, and expect the same returns you always made. But that was facetious because that's out the window. If so that I took that one off. The first one now says invest as you always have and accept that your return will be lower than it used to be. The second one says reduce your risk. Because you think they're, we're in an uncertain world, and except that your return will be lower still. The third one says, if you're really concerned about a correction in the markets, eliminate your risk by going to cash and acknowledge that your return will be zero. The fourth one says, rather than those three, let's go in the opposite direction, let's increase the risk in order to get a higher return in the low return world, but is now in an uncertain world where prospective returns are so low Is that really the time to increase your risk. Or number five, try to do better by investing in what I call special niches and special people. That is, corners of the market where you can get a better deal if they exist, and people who are capable of finding them for you. But all of these have limitations. The last one, which sounds great on paper, the risk is that most of your investments then are going to be private. So, you have the risk of illiquidity. And these are alpha markets where you're dependent on the skill of the manager. And if you hire the wrong manager, you're going to get negative alpha. So, you have manager risk, none of them is risk free. What that means, Mo, the bottom line is that in a low-risk environment, there can't be a safe, dependable way to get high returns. It basically comes down to saying, I don't want to increase my risk, and I'll settle for low returns. Or I'm willing to increase my risk in pursuit of high returns. There's no low risk, high returns strategy, unless you can find special niches and really special people.

Mo Lidsky  36:53

Let's double click on that, because look, the reality is most people, in a world where $16 trillion of cash has been flushed in, they're not going to sit on their hands and say, well, I'm losing money by sitting here. And most people want to see some return, they want to exceed inflation. So, let's talk a little bit about those special niches and people. I actually find it fascinating. In your last memo, you advocated this, breaking this rigid dichotomy between value and growth investing, right? You talked about the need for today's investors to actually factor in more qualitative, as opposed to quantitative considerations, using more good judgment about the future, potentially being in these niche areas. Then on top of that, by the way, investors need to stay current on those qualitative and predictive considerations and keep finding those issues. That seems to be a lot to ask from investors. What would you say are the characteristics of those that are capable of this, and those that aren't capable of this? What else might distinguish the winners or losers in the environment that we're in?

Howard Marks  38:08

There's a book called Lake Wobegon written by an author named Garrison Keillor. Lake Wobegon is this fictitious town. I think it's probably in, in Minnesota, if I'm not mistaken, aware, quote, all the children are above average. And, and as we know, even though most investors claim to be in the first quartile, they can't all be in the first quartile. You have to so to be to be able to really do what to really be able to increase return without commensurately increasing the risk. You have to have an exceptional investment ability. That's the only place it comes from it can't come from, in my opinion, it can't come from the methodology and algorithm of computer it can from there's no magic solution to the question of diversification versus concentration, of all these all these important questions that are on a portfolio. It they have the, the, I wrote a memo in 2015 or so about where these things come from, where does superiority and performance come from, it comes from superior insight. and I know superior investors, and they have a superior ability. This, this was the one of the themes in the book on cycles. A superior investor is superior, because she has a superior appreciation for when the odds are in her favor as opposed to against her. And for individual investment situations that embody more return potential than they do risk. And the investor, the superior investor just sees those things better. So, there's lots of different kinds of people who are good investors and from many different backgrounds and within different methodologies, but methodology alone will not do it. It has to be whatever methodology if you need an appropriate methodology, there are many, there's not just one way to skin, the cat, but you need somebody to operate that machine who has above average insight. It's a, it's an innate skill, I think some people just get it better. And, and, and, and there are few people who tend to outperform for long periods of time, not consist not every day, because there's no approach that will work that will succeed in all years. But the great investors have great long-term careers because they have it, and most people don't. And by the way, it's because most people don't. That's why the passive investment industry and the indexation industry has grown so much. You had 1000s of people managing money for fees, where only the few people with superior insight can earn their fees, by definition. I think that's the most important thing. Thinking at a different level than other people, and better.

Mo Lidsky  41:20

What does that practically look like? When somebody is has greater predictive capacities, because so much of today's valuations are in the growth businesses in the venture side of the equation, where God forbid, we actually have an, an earnings number, because then we'd have to apply multiple to it. Valuations are kind of being pulled out of thin air. How do you distinguish those that actually have that unique ability, which have greater insight? Your son is managing the growth side. How do you adjudicate or how does he adjudicate where those growth potential is going to come from?

Howard Marks  42:02

Well, that's obviously a very key question Mo, and a very good one. I came across something last night, for some reason. It popped up in my feed or YouTube. It was a recording. It was Warren Buffett's first interview on TV. It must have been, in the mid-60s, it was conducted by a guy named Adam Smith, which was a pseudonym for the writer of the book, the money game, and super money, and books that were classics in the 60s. And Buffett said, I don't think of buying stocks as buying pieces of paper, because I think they'll go up next year, I think of buying stocks as buying a piece of a business. And I'm not going to sell it next year. And I don't care if it goes up next year. If it's as if it turns out I bought a piece of the right business, I'm going to make money in the long run. So, if you it's very hard with companies that have no profits. And remember back in 20 years ago, it was 21 years ago, it was very easy to raise money for companies with no had no sales. But now I think what you have to do you have to think about what might have sales today, what might the sales grow at? What's the size of the market? And how much can it penetrate the market? And what share of the market will this company get? And then what might be the profitability, what could the profit margin be, and so forth? And the reason it has no earnings today is because they're spending a lot of money on acquiring clients and developing new products. If they did a little less of that, what might the profitability be in 10 years, or 15 or 20 years ago. So, you have to make those judgments. Now, you can't make them with precision, or reliability, but you have to have some sense of the range. And if you can, if you if you can talk about what the profits might be in 15 years, you can kind of think about what you pay for that. If you can't, then there's no there's no milestone to judge the price to pay. So, you have to have some of that now. It's really interesting. Last April, I was scheduled to come to Toronto to participate in Prem Watts's conference growth, value investing conference. And of course, it was cancelled, because it was the very front end of the pandemic. And I was I was starting to think about value investing to speak at that conference and what would I say? And I was thinking about how value investing has evolved. But if a year ago, I had that talk, what I might have said is what are the characteristics of, quote, value investing maybe with a capital V. What is it that theology and, and what I would have said I think isbasically mundane companies, not future innovators with moderate growth, not the fast-growing high Tech's, with a, with a high degree of predictability and stability, where the story is in the here and now not some conjecture about the future, with high level of reinvestment of cash flow? But, but, and I should say, with a good return on reinvested cash flow, but lots of free cash flow and a low p e ratio. I think you're nodding; do you agree? Okay. So that is classic capital V value investing, right? But if you if you think about what are the really the essential principles of value investing, which I enumerated at the beginning of page two of that of that memo, the essential characteristics are thinking about investing, as owning a piece of business. And thinking about what it could produce in the future. And thinking about the fairness of the price relative to that potential value. And buying when, when the price is below the intrinsic value, but not buying when it's above. That's value investing. Doesn't say anything about having to have low earnings growth, having to avoid tech. Many people say tech and value are not companionable, but that doesn't say that. What about low multiples? Why does value investing have to be buying mundane companies at low prices? Why can't it be buying good companies at, what looked like high prices today, but are going to be low tomorrow. In fact, Buffett has changed his tune. Buffett used to practice something that we call Cigar Butt investing. Smart Cigar Butt investing is the belief that you can find a cigar butt in the gutter with a few puffs left. You can get them really inexpensively because they're in the gutter. Buffett has talked about buying dollars for 50 cents. But Charlie Munger, his partner, leaned on him and convinced them, over time, to change his tune and stop going for cigar butts. Buffett later said, "I'm not that interested in buying fair companies at low prices, I want to buy great companies at fair prices". For a long time, he barred technology, but then he invested in Amazon and made a lot of money a couple of years ago. He's made a lot of money and Coca Cola was which was a growth company. So, he's not insistent that value investing has to be about low growth and low multiples. Coke was not a cheap company.

Mo Lidsky  48:51

I think at the end of the day, the challenge for most investors is really when you talk about above or below intrinsic value, what is intrinsic value? That's really the challenge that that most traditional value investors face when thinking about high growth technology businesses, right. You talked about that your son, Andrew, was also a successful capital allocator. You credited him with updating your thinking on investing. Succession and education of the next generation is top of mind for a lot of our families. What advice would you give those on the line that you've learned in terms of succession and educating the next generation that our families might be able to apply to their own children and grandchildren?

Howard Marks  49:38

Well, I personally think that it's not what you say, it's what you do. It's how you live your life. You can't kids are not going to do what you tell them to do. They're going to do what you demonstrate for them. My kids are very responsible about money and thoughtful. They're different. My daughter's tight, and my son is loose. But they do it thoughtfully. The reason is we always talked about money at the dinner table, not in a gross or showy way. We didn't say how much money you think he has, or she has, but we talked about how money can be used, what it can accomplish, and how you should think about it. I think that the single most important educational tool for children is the dinner table. That's the main time you get their attention. We used to talk about things at the dinner table, and I, my son, happened to enjoy talking about business, from maybe 12 years old. Maybe he was trying to emulate me, or maybe it really interested in, but he's always been interested. And so, you must instill values early. When we set up trusts for our kids, a lot of people I know - I have partners who set up trust with their kids, they get a little at 30 and some a 35, and most of it at 40. But we gave our kids access to their money the whole way, right away. Because I believe that if you install the values, the rest is okay. If the kids don't have the values, isn't it a shame that you have to lock up the money for decades? It all goes down to values.

Mo Lidsky  51:37

Interesting. You've served on many boards and management committees throughout your career, and recently, as you said, you're an honorary Canadian by virtue of being a director of Brookfield. What principles or behaviors do you think make great or terrible governance that you've seen? Which of those lessons can be applied within the context of families?

Howard Marks  52:11

We all have our own personal opinions and our biases. I happen to be anti-committee. When I was 29 years old and became Director of Research at Citibank. I was immediately on five committees that met 16 hours a week, and I would climb the walls, because I have a limited attention span and, and sitting power. I felt that those hours, those committees, the meetings lasted as long as the person who wanted to speak the most wanted to speak, especially if he was senior on the committee. And so, I I'm kind of anti-committee, and I wrote extensively about my opinion of committees in a memo called there to be great in Oh, five or six. It wasn't pretty, but it's all at Oaktree. We primarily have no committees. We don't have a central Investment Committee, we decentralize the investment power to the, to the group heads who form a committee if they want. And I as far as I know, there's only one or two of our groups that have that have committees. I think that Dave Swenson Swensen, who manages the endowment at Yale and has done a fabulous job for over 30 years, and killed itit's investing is a game of inches, he's killed everybody else by yards. He wrote a book called pioneering portfolio management. And he had a great quote in there. And he said that, that, that investment management requires non institutional behavior from institutions. Setting up a conundrum. I think that's great. Just think about that, because we're talking about companies, pension funds, universities charities, and they are, by nature bureaucratic. It's not the people's own money. It's the, it's the entities money, and the people who work are called agents. And that's what that's the word we use for people who are not investing their own money, their ages. And so, they tend to develop institutional behavior. And we all know what we mean by the word institution. It's not a compliment. My dad used to say that, that marriage is a great institution for people who like to live in institutions. But what does institutional behavior mean? And one of the things that means more than anything, is it's the importance of avoiding embarrassment. So, I believe I’ve been doing this a long time. I believe it's safe to say and I don't think it's unfair to say that for most institutional investors, the operative rule is, I would never invest so much in something that if it didn't work, I'd look bad. Or it would go down as a big mistake. But if that is your rule, and I understand that in certain settings, that's a good rule to have for self-preservation. If that's your rule, you have to accept that that means you'll never invest enough so that if it works, it'll move the needle. What does that lead to? Over diversification? So, most institutional portfolios are over diversified. And they have a little bit of almost everything because they don't want to miss an asset class that performs. But they don't have so much in the ones they think are better and they still have some, in the ones they think are worse. If you want to be an exceptional investor, by definition, you have to commit real dough to the things that you think will work. And not much, if any, to the ones that you feel less good about. For example, I think that in the 90's, when index funds were transitioning from non-entities to the importance they have today. In the 90s, they were maybe halfway on that trip or something like that. Everybody said, “let’s put we have 40% in equity, let's put 2% in an index funds". It's lip service, can't make a difference. Today, what's the one of the biggest issues in investing? It's how much you're going to put in China. So, they say, "let's put in 9%, in emerging markets, and two of that in China".

Howard Marks  56:45

If China turns out to lead the world, and in 15 years, 2% is not enough. You and I could probably agree on the decisions that today will determine whether we have great performance or terrible performance, and how much to put into China is one of them. But if that's true, then it's unlikely that the right answer is two. I would say to invest two in China, you have to be very pessimistic on China. If you're optimistic on China, it should be 10. You have to invest enough to make a difference. When I join a new investment committee, I go through the portfolio, and I circle all the positions that are less than 1%. They all have a lot of them. Why have them? They're probably more work than they could contribute to the outcome.

Mo Lidsky  57:45

That's a great segue. You mentioned China, and I don't know if that's just by virtue of an example. But broadly speaking, given all that is happening in the world today, what are you most excited about? As you look to the future, which potentially dramatic changes are you thinking about the most?

Howard Marks  58:11

I don't know if you noticed up there in Canada, but we have a new administration in the United States that I think will lead to a better four years and hopefully try to heal some of the division. Although the cultural divisions are very difficult  because they are fed by the mass and stratified communications that we have. I'm optimistic about how life can be improved by technology, both information technology and biotech. The other fields of life are going to be changed in massive ways that we can't anticipate and I'm a China optimist. Those are the things that I feel great about.

Howard Marks  59:05

The things that worry me are the effect of automation on working people. Where are working people going to find jobs in the future? We tend to offshore repetitive jobs, and we're going to an information economy. How many workers do you need in an information economy? Productivity goes up. In theory, you need your workers, and we have more people all the time. So where are they going to find jobs? I'm worried about that a lot. I worry about society, healing the ills, and especially racial inequalities which are important in the United States. I worried that we have this rise of political correctness. In most universities, you can't bring in a conservative speaker, they'll stone them, or the students will sign a petition that they don't want that kind of stuff. How are we going to discuss these things? How are people going to learn about both sides of the story? Governing in our country has become so partisan, that the main goal of each party is to make sure the other doesn't accomplish anything. I don't think that's a good outcome. Those are the kinds of things I'm worried about. Markets will go up and down. I don't worry about that.

Mo Lidsky  1:00:53

Virtually all of the concerns are socially focused.

Howard Marks  1:00:57

Let me say one thing, I'll give a pitch for some memos. By the way, they're all free and they're all on the Oaktree website. In the summer of 2008, things were actually pretty quiet a month or two before the Lehman bankruptcy. I wrote a memo called What Worries Me, and you might look there. I was thinking about things like some of these then. I mentioned that Dare to be Great, I think was 2006. And then in, I think, 2015, or 16, I wrote Dare to be Great II in which, I said, talking about institution behavior, that if you want to be a great investor, you have to dare to be wrong. You have to be you have to dare to be different, because how can you distinguish yourself from the from the mass of investors if you don't behave differently? And you have to expose yourself to the risk of being wrong, because if you manage your money with saying, my goal is to never make a mistake, by definition, you can't be great because you have to hedge every question. One of the biggest decisions for a family office, for example, is you happy with the conventional, moderate return earned safely and dependably? Or do you want to be great? If you want to be great, will you take the chance of being wrong? So that that's one of my favorite memos, and I encourage your clients to take a look.

Mo Lidsky  1:02:41

Thank you, Howard. That was fantastic. I can't thank you enough for joining us today for sharing your incredible insights with us and really appreciate your generosity of your time and hope we can do it again soon.