Howard Marks: “If you act like every other investor, you can’t expect better returns” - Longest news push test

Exclusive republication in Korea of a Howard Marks memo

Use “second-level thinking” and “contrarian investing”

Learn David Swensen’s investment approach

“You can’t act exactly like other investors and expect better results.”

Howard Marks, chairman of Oaktree Capital, said this in a memo sent to investors titled “I Beg to Differ.” Marks’ credo is that “if you seek relatively superior investment performance, you must invest in assets that other investors have not yet crowded into.”

He also underscored the importance of “second-level thinking.” He said, “Predicting that a stock price will rise simply because a company’s prospects are bright is ‘first-level thinking,’” adding that “to achieve superior investment performance, ‘second-level thinking’ that differs from others is required.”

He also laid out the capabilities needed to develop “second-level thinking”: △the ability to accurately understand the implications of disclosed information △the ability to analyze a company’s quantitative aspects △the ability to look ahead, among others, according to Marks.

He also introduced the concept of “contrarian investing.” He said, “When the market races toward a peak or a trough, most investors are more likely to make the wrong judgment,” adding that “in such periods, you can bring an investment to a successful conclusion if you can act against the crowd’s psychology.”

He added that “contrarian investing” does not mean making every decision in the opposite direction of the crowd. He said, “For proper contrarian investing, you must broadly examine how the crowd behaves, the basis for that behavior, and how to respond.”

As a successful example of “second-level thinking” and “contrarian investing,” he cited David Swensen, Yale University’s chief investment officer (CIO). Swensen, who served as CIO from 1985, pursued a strategy of identifying alternative assets such as hedge funds, venture capital, and real estate, investing with long-term diversification, and delegating management to external specialists. It was an unfamiliar approach at the time, but it was highly successful, and major U.S. universities began investing based on the Yale model, he explained.

Finally, Marks emphasized that “an investment approach that differs from others inevitably entails risk.” He said, “An approach that seeks above-average returns comes with the risk of producing below-average returns,” adding that “you must decide for yourself whether to take risk in pursuit of high returns, or to follow the market consensus (the average) and maintain ordinary returns.”

Oaktree Capital, founded by Marks in 1995, is a mega asset manager overseeing more than $160 billion. His investor memos draw significant attention—Warren Buffett, regarded as an investing master, has said, “If I have a letter from Marks in my mailbox, that’s the first thing I read.”

Below is the full text of the memo Marks wrote for Oaktree clients.

I Beg to Differ

I’ve said on many occasions that I entered the investment business in 1969, when the “Nifty Fifty” stocks were at their zenith. Many of the other “money-center banks” (the leading investment management institutions of the day), including my first employer, First National City Bank, were captivated by Nifty Fifty companies that had solid business models and seemingly perfect futures. Their attitude toward these companies’ stocks was uniformly positive, and portfolio managers judged various indicators to be very safe. Taking IBM as an example—one of the era’s emblematic growth companies—there was even a saying making the rounds that “no one ever got fired for buying IBM.”

I have also described in detail the fate of these stocks. In 1973-1974, S&P 500 fell a total of 47% due to OPEC’s oil production cuts and the ensuing economic downturn. Many of the Nifty Fifty stocks—said to be such that “no price is too high”—were hit far harder, and their price/earnings multiples, which had reached highs of 60-90, collapsed into single digits. Nifty Fifty devotees thus lost nearly all the money they had invested in the “universally admired” blue-chip stocks. This was my first experience of what can happen to assets placed atop what I call a “pedestal of popularity.”

In 1978, I was assigned to the bank’s bond department and told to form a fund to invest in convertible bonds; soon after, I was put in charge of high-yield bonds. At that time, by investing in securities that most fiduciaries not only considered “uninvestable,” but that virtually no one knew about, cared about, or thought desirable … I was earning returns steadily and safely. I quickly realized that the very fact that I was investing in securities that virtually no one knew about, cared about, or thought desirable was a partial reason I was able to achieve superior results. It aligned precisely with the core return-generation principle of the Efficient Market Hypothesis that I first encountered at the University of Chicago Booth School of Business. If you seek superior investment performance, you must invest in assets that other investors have not yet crowded into and that have not yet been fully valued. In other words, you have to do something different.

The key difference

In 2006, I wrote a memo titled Dare to Be Great. Its central theme was to set ambitious goals. It sharply criticized conformist attitudes and investment bureaucracy, while asserting that unconventional approaches are required to achieve outstanding returns. The part of that memo people still ask me about is the simple two-by-two table shown below.

Category Traditional behavior Unconventional behavior

Favorable outcome Average good performance Above-average performance

Unfavorable outcome Average poor performance Below-average performance

I explained the situation as follows.

Of course, the distinction is neither easy nor clear, but I think this is the general case. If your behavior and that of your manager is traditional, you are likely to achieve traditional—good or poor—results. Only if your behavior is unconventional is your performance likely to be unconventional … and only if your judgment is superior is your performance likely to be above average.

The consensus of market participants is reflected in market prices. Therefore, an investor who lacks insight superior to the average of the group that forms that consensus can only expect average risk-adjusted returns.

Many years have passed since I wrote that memo, and the investment world has become far more specialized. Still, the message I sought to convey through that table—and the accompanying explanation—remains just as valid. Put simply, I compressed the theme of that memo into a single sentence: “Breaking news: you can’t act like everyone else and expect better results.”

The best way to understand this principle is to run an analysis through a highly logical and nearly mathematical process (as always, simplified to an extreme for illustrative purposes).

Over a given period, all investors collectively earn a certain amount (though not a specific amount) in individual stocks, a given market, or all markets. That amount is determined as a function of (a) how companies or assets perform in fundamental terms (e.g., profits rising or falling) and (b) how investors assess those fundamentals and how they view asset prices.

On average, all investors achieve average performance.

If you are satisfied with average performance, it is sufficient simply to invest broadly by buying portions based on the asset’s weight in the relevant sector or index. Pursuing average behavior in this way ensures average performance. (Clearly, this is the basic principle of index funds.)

If you want to be above average, you must depart from consensus-based behavior. You must overweight certain securities, asset classes, or markets, and underweight others. In other words, you have to do something different.

The problem is that (a) market prices are the product of the collective judgment of all participants, and (b) it is difficult for any individual to consistently identify the points at which market consensus is wrong and asset prices are excessively overvalued or undervalued.

Nevertheless, an “active investor” makes active decisions in order to be above average.

Investor A judges overall stock prices to be too low and sells bonds to increase equity exposure. Investor B thinks stock prices are too high, sells some of their stocks to Investor A to reduce exposure, and invests the proceeds in bonds.

Investor X judges the price of a particular stock to be too low and increases exposure by buying that stock from Investor Y, who believes the same stock is too expensive and is trying to reduce exposure.

It is important to note that in all of the above cases, one investor must be right and the other must be wrong. Now return to the initial assumption: since the amount all investors collectively earn is limited, the sum of all active decisions results in a zero-sum game (and, after fees and other costs, a negative-sum game). The correct investor earns above-average returns, while the incorrect investor, in theory, records below-average returns.

Thus, active decisions aimed at above-average returns entail the risk of recording below-average returns. It is impossible to make active decisions such that you win if successful but do not lose if unsuccessful. Financial innovation is often marketed as though it can achieve this impossible goal in modified form, but such promises inevitably cannot be kept.

The above can be summarized simply as follows: if you don’t make active decisions, you can’t expect above-average returns; but if your active decisions are wrong, your returns will fall below average.

To me, investing has much in common with golf. Like hole placement, the day’s playing conditions and a player’s form can differ. There are days when a particular strategy is appropriate on a course, and other days when different tactics are required. To win, you must choose a better approach than your opponent or execute that approach more skillfully—or both may be required.

The same is true for investors. The principle is simple: if you hope to achieve differentiated performance, you must break away from the herd. But once you leave the herd, you can only create a positive difference if you choose the right strategy and tactics and/or execute them more skillfully than others.

Second-level thinking

In 2009, Columbia Business School Publishing, which was considering whether to publish my second book, , asked me to send a sample chapter. As I often do, I sat at my desk and wrote about a concept that, until then, I had never put into writing or named. It developed into the first chapter dealing with second-level thinking—one of the most important themes of my book. Second-level thinking is by far the topic readers ask about most frequently among the concepts covered in the book.

The concept of second-level thinking is grounded in what I said in my memo Dare to Be Great. First, I repeated the view that success in investing means outperforming others. Every active investor (and, clearly, every financial asset manager who wants to make a living) seeks superior returns.

But this universal goal also contributes to making it hard to beat the market. Millions of people compete for investment gains down to the last penny. Who wins? The person who is one step ahead. In some fields, standing out from the crowd requires studying harder than others, spending more time at the gym or in the library, sweating more, building physical strength, or having superior equipment. But in investing, the importance of these virtues is diminished, and—at the level I call second-level thinking—more cognitive thinking is required.

The foundational principle of second-level thinking can be summarized simply: to achieve superior performance, you need thinking that is different from others’ and better than others’.

Remember that your investment goal is not to achieve average returns. You want above-average returns. Therefore, your thinking must operate at a higher level than other investors’ and surpass them decisively. Since other investors may be smart, well-informed, and highly computerized, you must possess a competitive advantage they lack. You must think of what others fail to think of, catch what they miss, or have insight they lack. You must react differently and behave differently. In short, simply being right may be a necessary condition for investment success, but it is not sufficient. You must be more right than others—and that means your thinking must differ from others’.

On that premise, I distinguished investors who engage in second-level thinking from investors who act at the first level as follows.

First-level thinking is simple and superficial, and anyone can do it (a bad sign in a field where people seek to outperform). A first-level thinker can rely on a predictive opinion such as “the company’s prospects are bright, so the stock price will rise.”

Second-level thinking is deep, complex, and difficult. A second-level thinker considers many factors.

What range of outcomes is possible in the future?

What outcome do I expect?

How likely is it that I am right?

What is the market consensus?

How does my expectation differ from the market consensus?

How much does today’s asset price reflect the market consensus outlook? How much does it reflect mine?

Is the consensus psychology embedded in the price excessively optimistic or pessimistic?

If the consensus turns out to be correct, what happens to the asset price? If I am right, what happens?

The number of factors to consider shows a stark contrast between first-level and second-level thinking, and the number of investors capable of second-level thinking is extremely small compared with first-level thinking.

A first-level thinker looks for simple formulas and easy answers. A second-level thinker understands well that investment success is at odds with simplicity.

This difficulty in investing brings to mind an important concept that arose in a conversation I had with my son Andrew during the COVID-19 lockdown (which I described in my January 2021 memo Something of Value). In that memo, which examined closely how much markets had become more efficient over the preceding decades, Andrew articulated a precise view: “Quantitative information about the present that is available at any time cannot be a source of superior performance.” In any case, information of this type—about U.S.-listed equities and required under the SEC’s Regulation FD—can be accessed by anyone, and today all investors must know how to manipulate data and run-chart screens.

So how can an investor who seeks market-beating performance achieve that goal? As Andrew and I mentioned while discussing Something of Value on a podcast, an investor must move beyond quantitative information about the present that is available at any time. Instead, superior performance must be achieved on the basis of capabilities such as:

The ability to more accurately understand the implications of disclosed information

The ability to more accurately analyze a company’s quantitative aspects and/or

The ability to more accurately foresee the future

Clearly, none of these factors can be judged with certainty, empirically measured, or addressed by applying a fixed formula. Unlike current quantitative information, there is no reliable source that provides easy answers. Ultimately, it all comes down to judgment or insight. A second-level thinker with strong judgment is likely to earn superior returns, while an investor with weak insight is likely to record inferior performance.

I recall what Charlie Munger said to me around the time I published . He criticized the notion by saying, “It’s not supposed to be easy. Anyone who finds it easy is stupid.” Anyone who believes that a formula guaranteeing success exists (and that they can obtain it) does not understand at all the complex, dynamic, and competitive nature of the investment process. The reward for superior investing can materialize as large gains. It is never easy to make more money than others on the fiercely competitive battlefield of investing.

Contrarian investing

In the investment world, there is a concept closely associated with investing differently from others: the contrarian strategy. “Investor herds” refer to groups of individuals (or institutions) that push stock prices in one direction—up or down. Their behavior drives asset prices beyond bull markets and sometimes inflates bubbles, or conversely pushes them through bear markets and often into crashes. At these extremes—which are inevitably excessive—contrarian investing is essential.

If you go along with such volatile markets, you end up owning or buying assets at high prices and selling them or hesitating to buy at low prices. For this reason, it is important to break away from the herd and act in a way that runs counter to how most other investors behave.

I devoted a chapter to contrarian investing in . The logic I laid out was as follows.

Markets swing sharply—from bull to bear, and from overvaluation to undervaluation.

The behavior of “the crowd,” “the herd,” “most investors” drives market moves. Bull markets form when there are more buyers than sellers or when buying psychology outweighs selling psychology. Markets rise when people turn from selling to buying and when buying sentiment strengthens and selling sentiment weakens. (Markets do not rise unless buying pressure dominates.)

At extremes, inflection points emerge. This occurs when an uptrend or downtrend reaches an extreme. By analogy, the peak forms at the moment the last buyer completes their purchase. Once the peak is reached, all buyers have joined the bull-market herd, so the uptrend can no longer continue and the market reaches the highest level possible. Buying or holding becomes precarious.

With no investors left to turn bullish, the market stops rising. If the next day one person switches from buyer to seller, the market begins to decline.

At such extremes formed by the judgment of “most investors,” most investors are wrong.

Therefore, the key to successful investing must be found in breaking away from the crowd and acting in the opposite direction. Those who identify others’ mistakes can earn enormous profits through contrarian investing.

In sum, when extreme highs and lows reach excessive levels due to the collective misjudgment of most investors, it becomes necessary to step away from the crowd and act contrarian.

David Swensen, who served as Yale’s CIO, explained in his 2000 book why institutions are likely to conform to current market consensus—and why they should instead embrace contrarian investing. (For details on Swensen’s investment approach, see the “Appropriate example” section below.) Swensen also emphasized the importance of building a foundation that allows contrarian investing to be practiced effectively.

If an institution fails to take contrarian positions during difficult periods, the resulting damage places a significant burden on the institution’s finances and reputation.

Investment positions chosen lazily by relying on consensus have little chance of achieving superior results in the fiercely competitive field of investment management.

Unfortunately, while it is a necessary virtue, overcoming the tendency to follow the crowd is not sufficient to guarantee investment success … choosing a different path can indeed raise the odds of success, but if careful investment principles do not support that courage, investors may end up tasting failure.

Before finishing the discussion of contrarian investing, there is one point that must be made clear. A first-level thinker may mistakenly believe contrarian investing simply means doing the exact opposite of most investors—selling when the market rises and buying when it falls. But interpreting contrarian investing in such an overly simplistic way is not very helpful. Instead, contrarian investing must be understood through second-level thinking.

In , four professional investors and academics provided commentary on my writing. My close friend and outstanding stock investor Joel Greenblatt aptly criticized mechanical contrarianism with a metaphor: “… just because no one else is jumping in front of a speeding eighteen-wheeler on the highway doesn’t mean you have to do it.” In other words, the crowd is not always wrong; and because the crowd is wrong in most cases, a strategy of always doing the opposite is not always right. Rather, to practice effective contrarian investing, you must determine the following factors.

What is the herd doing?

Why is it doing that?

If the herd is wrong, what is wrong?

How should you respond?

Like the second-level thinking process described on page 4, smart contrarian investing is deep and complex. It goes far beyond simply doing the opposite of the crowd. Still, wise investment decisions made to capture the best opportunities—at moments when market extremes reach excessive levels—inevitably contain elements of contrarian thinking.

Decisions that accept the risk of being wrong

Because I know the number of topics I can write about is limited, and I cannot absorb all knowledge about them without omission, I sometimes go back to my past writing to build on it. In that context, I wrote a memo in 2014 that served as a sequel to Dare to Be Great (2006), giving it the creative title Dare to Be Great II. In the introduction, I again emphasized the importance of being different.

If your portfolio is much the same as everyone else’s, you can achieve good results like others or poor results like others, but you cannot achieve different results. And if you want a chance to outperform, you must be different—absolutely.

I then described the difficulty that accompanies acting differently.

Most successful investing starts with discomfort. Assets that make most investors comfortable—where the basic premise is widely accepted, recent performance is positive, and the outlook is bright—are unlikely to be offered at low prices. Rather, bargain opportunities are usually found in assets that are controversial, viewed pessimistically by investors, and have had poor recent performance.

Then I developed the argument around what may be the most important concept: the bold possibility of being wrong that naturally derives from boldly acting differently. Most investment manuals describe how to be right and say nothing about the possibility of being wrong. But investors who pursue active investing must recognize the reality that every attempt to seek success inevitably comes with the possibility of failure. As explained at the top of page 3, the two can never be separated.

In a reasonably efficient market, any action that departs from consensus in pursuit of market-beating returns may result in below-average returns if it is proven to be a mistake. Every decision—overweighting and underweighting, concentration and diversification, holding and selling, whether to hedge—cuts both ways. Make the right decision and you gain; make the wrong decision and you lose.

One quotation I often cite is from a Las Vegas casino pit boss. He said, “The bigger the bet, the bigger the win.” No one can argue with that. But he ignores the converse: “The bigger the bet, the bigger the loss.” Clearly, these two concepts travel together.

Whenever I present to institutional clients, I use a PowerPoint animation that vividly depicts this situation.

A bubble descends bearing the phrase “seek to be right.” This is the essence of active investing. Then a second phrase appears on the bubble: “accept the risk of being wrong.” The point is that you can never achieve the former without bearing the latter. The two are inextricably intertwined.

Next, a bubble descends bearing the phrase “cannot lose.” Strategies exist in investing under which you cannot lose. If you buy U.S. Treasury bonds, you will not record negative returns. If you invest in an index fund, you cannot underperform the index. But then a second bubble appears bearing the phrase “cannot win.” An investor who chooses a strategy that cannot lose inevitably gives up the possibility of winning. A Treasury-bond investor cannot earn more than a minimum return. An index-fund investor cannot outperform the index.

Then, in my imagination, an ignorant client presents me with a goal: “Take only the first part of each bubble—follow a strategy that can’t lose, while still beating the market.” But unfortunately, that combination is impossible.

The above shows that active investing comes with a cost—beyond fees and management charges—in the form of the risk of inferior performance. Thus, every investor must make a conscious decision about which path to choose: accept the risk of lagging the herd and seek superior returns, or conform to consensus and be satisfied with guaranteed average performance. You must clearly recognize that if you are unwilling to accept the risk of below-average performance, you cannot expect superior returns.

I remember a line from a fortune cookie served as dessert 40-50 years ago. It contained a short sentence: “A cautious man makes no mistakes, but leaves no great poem.” In college, I took a Japanese studies course and learned about Zen koans; defines a koan as “a paradoxical statement or question used in Buddhism to reveal the inadequacy of logical reasoning and to provoke enlightenment.” I think the fortune-cookie saying resembles a koan in that it posed a paradoxical question that nevertheless offers insight.

So what does that fortune mean? Does it mean a cautious person makes no mistakes, so you should be cautious? Or does it mean a cautious person cannot achieve great accomplishments, so you should not be cautious?

It can be interpreted either way, and both seem plausible. Thus, the key question is: “Which meaning is right for you?” As an investor, which do you prefer: avoiding mistakes or seeking superior performance? Which path is more likely to lead you to the success you envision? Which is more feasible for you? You can choose either path, but you cannot choose both.

In this way, investors must answer a very basic question. Do you (a) accept costs, lack of certainty, and the possibility of below-average results in pursuit of above-average performance, or (b) reduce costs but settle for average performance, watching enviously when winners boast of their success? In Dare to Be Great II, I described this situation as follows.

How much weight will you place on diversification, risk avoidance, and preventing below-average performance, versus how much weight will you place on giving up those elements while expecting superior performance?

I explained several factors to consider as follows.

The only way to achieve superior investment results is through unconventional behavior, but it is not something just anyone can do. Successful investing requires, separate from superior ability, the capacity to endure for a time being seen as acting wrongly and to overcome mistakes. Therefore, each investor must judge whether they are temperamentally capable of that—and, as an inevitable consequence, whether such behavior is possible given their circumstances when a crisis hits and, in the early stages, they appear to be wrong—considering the influence of their firm and clients, and other people’s opinions.

You cannot have both. And as with many aspects of investing, there is no absolute right or wrong—only what is right or wrong for you.

An appropriate example

As mentioned earlier, David Swensen managed Yale’s endowment for 36 years, from 1985 until his death in 2021. He was a true pioneer and developed an investment framework that later came to be known as the “Yale model” or “endowment model.” Unlike almost all institutions at the time, he sharply reduced Yale’s allocation to publicly listed stocks and corporate bonds and concentrated on innovative, illiquid strategies such as hedge funds, venture capital, and private equity. He selected managers who achieved superior performance in their fields, some of whom later gained renown in the investment industry. Yale’s investment results overwhelmed almost every other university endowment. In addition, Swensen trained many talented people who went on to achieve results envied by other institutions in the endowment-management field. Many endowments began adopting Yale’s approach around 2003-2004, after suffering severe damage as the tech/internet bubble burst. But there were virtually no cases of replicating Yale’s success. They followed the same strategy, but were late or managed poorly.

Summing up the above, one can say Swensen boldly acted differently from others. He did what others did not. He acted long before most people found the thread. He acted to a degree others could not approach. And he executed with outstanding skill. It was a great formula for excess returns. In , Swensen described the central challenges at the heart of investing, especially institutional investing. The passage below is one of the best investment guides I have ever encountered, and for me it includes a two-word phrase (bolded for emphasis) that reads like poetry. I have quoted it countless times.

… Active management requires non-institutional behavior by institutions, a paradox that only a tiny minority can solve. Maintaining a nontraditional investment program requires accepting uncomfortably idiosyncratic portfolios, portfolios that often appear imprudent from the perspective of traditional investment.

Like many great quotations, Swensen’s aphorism conveys deep implications in a short phrase. Interpreted, it means the following.

Idiosyncratic – When all investors favor a certain asset, buying is likely to drive prices higher. Conversely, when they avoid an asset, selling may drive prices lower. Thus it is advantageous to buy assets most investors avoid and sell assets they favor. By definition, such behavior is highly idiosyncratic (“odd,” “eccentric,” “unusual”).

Uncomfortable – The investing crowd sets positions based on reasons they can accept. We often witness investors taking the same actions and being influenced by the same news. Yet we recognize that to achieve above-average performance, our responses to given conditions—and our behavior—must in many cases differ from others’. For any reason, if one million investors do action A, action B can be received as very uncomfortable.

And if we actually carry out action B, it is unlikely to be immediately proven right. If you sell a market-favored asset because you judge it overvalued, the price probably will not begin falling the very next day. In most cases, the popular asset you sold will keep rising for a while—and in some situations, for a long time. John Maynard Keynes said, “The market can stay irrational longer than you can stay solvent.” There is also the saying, “Being too far ahead of your time is indistinguishable from being wrong.” These align with Keynes’s remark that “worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.” Deviating from the mainstream can put you in an awkward and painful position.

Non-institutional behavior by institutions – We know what Swensen meant by the word “institution.” Institutions are bureaucratic, rigid, conservative, conventional, risk-averse, and governed by consensus. In short, the concept is far from rebellion. In such settings, the potential benefit of being right by acting differently may be outweighed by the intolerable cost of being wrong by acting differently. From the stakeholders’ perspective, taking an action that produces losses (an error of commission) is far more dangerous than forgoing an action that might have produced gains (an error of omission). Thus, “institutional” investors are inherently unlikely to engage in idiosyncratic behavior.

Early in his Yale tenure, Swensen took the following steps.

He reduced publicly listed stock holdings to a minimum. He significantly increased allocations to strategies classified as “alternative investments” (he invested in the area long before the term existed). In the process, he devoted a substantial portion of Yale’s endowment to illiquid assets with no trading market. Based on what he called investment sense, he selected managers who did not have long track records.

In his words, these actions likely appeared “imprudent from the perspective of traditional investment.” Swensen’s actions were clearly idiosyncratic and non-institutional, but he understood that accepting the risk of being wrong was the only way to achieve superior performance—and by taking that risk, he delivered outstanding results.

One way to break away from the herd

Finally, I would like to share a recent anecdote. In mid-June, following Los Angeles, Oaktree held its biennial meeting in London. At both meetings, my topic was the market environment. While preparing for the London meeting, I found myself in a quandary, because there had been a tremendous change between the two meetings. On May 19, the S&P 500 stood around 3,900, but about a month later, on June 21, it had fallen nearly 4% to 3,750. I debated whether to update somewhat dated slides, or to use the Los Angeles slides as-is in order to deliver consistent content to both audiences.

I decided to use the Los Angeles slides as-is as a starting point for discussing how much had changed over that short period. My London presentation largely consisted of discussing the biggest concerns in a stream-of-consciousness manner. I told attendees that I pay attention to the issues I get asked about most at any given time, because that offers a window into public perception. The topics I have been asked about overwhelmingly often recently are as follows.

The inflation outlook

How far the Fed will raise rates to bring inflation under control

Whether those moves will lead to a soft landing or a recession (and if the latter, how severe)

Not fully satisfied with what I had said from the lectern, I reconsidered it over lunch. When the meeting resumed in the afternoon, I returned to the lectern for two minutes. What I said then was as follows.

All discussion about inflation, interest rates, and recession has one thing in common: it is short term. Even so, there is not much we can know about the short-term future (more precisely, we cannot know much with certainty beyond the market consensus). Even if one has a short-term outlook, it cannot be relied on heavily (or should not be relied on). Even if you reach a conclusion, there is little you can do about it—most investors cannot, and do not intend to, meaningfully modify their portfolios based on such views. We really should not obsess over the short term—after all, we are investors, not traders.

I think the last point is the most important. The question is whether you agree. For example, whenever I am asked whether the economy is heading into recession, I reply that if we are not in recession now, then we are on the path to the next one. The issue is timing. I believe cycles will always repeat, meaning recessions and recoveries are always waiting. Does the fact that a recession is waiting mean you should reduce investing or change portfolio composition? I don’t think so. Since 1920, there have been 17 recessions, including the Great Depression, world wars and numerous regional wars, multiple global-scale natural disasters, and today’s COVID pandemic. Yet, as I noted in my January memo Selling Out, the S&P 500 has produced average annual returns in the 10½% range over a century. If an investor repeatedly moved in and out of the market to avoid the risk intervals described above, would performance have improved—or would it have diminished? Since quoting Bill Miller in the memo, I have been impressed by his philosophy that what produces true wealth accumulation is “time, not timing.” Therefore, if you want to enjoy the benefits of long-term compounding, ignoring short-term factors is advantageous for most investors.

Oaktree’s six investment principles include (a) Oaktree does not base investment decisions on macro forecasts and (b) Oaktree does not follow trends. I told the London audience that Oaktree’s primary goal is to buy repayable bonds or make loans and to acquire equity stakes in companies that generate solid performance and cash flow. That goal has nothing to do with the short term.

When circumstances are judged to warrant it, Oaktree does adjust the balance between aggressive and defensive investing by changing things like the size and pacing of closed-end funds and the level of risk tolerated. But Oaktree takes those actions not by predicting the future, but based on current market conditions.

Everyone at Oaktree has their own views on the short-term phenomena mentioned above. We simply do not rely entirely on the assumption that those views are correct. Bruce Karsh and I met clients in London and discussed at length the severity of short-term concerns. The note Bruce handed me said the following.

… Will things be as bad as expected, worse, or better? We don’t know … Likewise, we don’t know how much is in the price—i.e., what the market truly expects. Some say recession is priced in, but many analysts dispute that. This is very tricky … !!!

Bruce’s view highlights another vulnerability that arises when focusing on the short term. Even if we believe we know what will unfold in terms of inflation, recession, and rates, there is no way to predict how market prices will respond to those expectations. This is more important than most people realize. If you have formed your own view of today’s issues or have encountered the views of experts you usually respect, pick any asset and ask yourself, from that perspective, whether the asset is priced high, low, or fairly. That process matters for those who seek investments at reasonable prices.

The possibility—even the certainty—that negative conditions lie ahead is not, by itself, a basis to reduce risk. Investors should act that way only if such conditions lie ahead and are not appropriately reflected in asset prices. As Bruce said, there is usually no way to know.

When I first entered the workforce, equity investing meant thinking in 5-6-year terms. Holding for less than one year was considered a short-term trade. One of the biggest changes I have witnessed since then is that the horizon has shortened unbelievably. Asset managers can check returns in real time, and many clients fixate on a manager’s performance in the most recent quarter.

No strategy—and no matter how excellent the capability—can succeed every quarter or every year. A strategy’s effectiveness expands or contracts as the environment changes, and its popularity also rises and falls. In fact, managers who strictly adhere to a defined approach based on rigorous principles tend to record the worst results when that approach works against them. Regardless of the suitability of the strategy or the quality of investment decision-making, every portfolio and manager experiences quarters or years of strong performance and quarters or years of weak performance—and in such cases, no one talks about the manager’s competence. Weak performance is often caused by developments that were not expected or could not have been expected.

So what does it mean when someone or something posts weak performance over a certain period? Managers should not be fired or strategies altered based on short-term performance. Investment clients should, from a contrarian perspective, consider increasing allocations rather than withdrawing capital from underperforming investments (but that almost never happens). To me, the logic is simple: if you wait long enough at a bus stop, you will eventually catch a bus; but if you keep moving from one bus stop to another, you may never get on a bus.

I think most investors have the wrong focus. Performance in any single quarter or year means nothing, and at worst it risks diverting attention and producing negative effects.

Yet most investment committees still begin meetings and spend the first hour analyzing the most recent quarter’s returns and year-to-date returns. If most people are absorbed in what doesn’t matter and overlook what does, then an investor who breaks away from the herd—endures short-term worries—and focuses precisely on long-term capital allocation can achieve returns.

The final paragraph quoted below from succinctly summarizes how institutions can pursue the superior performance most investors want. (The concept applies to individuals as well.)

A sound investment process contributes greatly to successful investing and helps investors pursue long-term contrarian positions that produce returns. Freed from short-term performance pressure, managers gain the freedom to build portfolios that capture opportunities created by short-term market actors. Fiduciaries can raise the probability of successful investing by encouraging managers to invest in shunned assets that may produce awkward results.

Oaktree is likely among a very small minority in being relatively indifferent to macro forecasts, particularly in the short term. Most investors make a fuss over short-term predictions, but it is questionable whether there is anything they can actually do in response—and whether it helps.

Many investors—especially institutions such as pensions, endowments, insurers, and sovereign wealth funds, which generally face lower risks of sudden withdrawals—have the leeway to focus on long-term performance if they take advantage of that benefit. Therefore, I suggest you step away from the investment crowd that fixates pointlessly on the short term and join in investing that focuses on what truly matters.

Hyunju Jang, reporter blacksea@hankyung.com