22,000-Character News Test

Exclusive republication of Howard Marks’s memo in Korea

Must apply “second-level thinking” and “contrarian investing”

Should learn David Swensen’s investment approach

“You can’t behave like everyone else and expect better results.”

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

He also stressed the importance of “second-level thinking.” He said, “Predicting that a stock price will rise because a company’s outlook is bright is ‘first-level thinking,’” adding that “to generate superior investment performance, you need ‘second-level thinking’ that differs from others.”

He also set out the capabilities needed for “second-level thinking.” According to Marks, investors should cultivate: △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.

He introduced the concept of “contrarian investing” as well. He said, “When the market races toward a peak or a trough, most investors are more likely to make the wrong call,” adding that “in such periods, you can successfully complete an investment when you are able to 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 need to broadly examine how the crowd behaves, the basis for that behavior, and how to respond.”

As a successful case 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 in them through long-term diversification, and delegating management to external specialists. It was an unfamiliar approach at the time, but it delivered major success, and leading U.S. universities began investing by emulating the Yale model, according to Marks.

Lastly, Marks emphasized that “an investment approach that differs from others inevitably comes with risk.” He said, “An approach that seeks above-average returns carries the risk of producing below-average returns,” adding that “you must decide for yourself whether to accept the risk in pursuit of higher 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—so much so that Warren Buffett, a legendary investor, has said, “If I see a memo from Marks in my inbox, I read it first.”

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

I Beg to Differ

I’ve said many times that I first entered the investment business in 1969, when the “Nifty Fifty” stocks were at their zenith. A number of “money center banks” (the leading investment management institutions of the day), including my first employer, First National City Bank, were enamored of the Nifty Fifty companies, which had strong business models and were thought to guarantee a perfect future. Attitudes toward these companies’ stocks were uniformly positive, and portfolio managers judged a range of indicators to be very safe. Taking IBM, one of the era’s representative growth companies, as an example, the saying went around that “no one ever got fired for buying IBM stock.”

I’ve also described in detail what became of those stocks. In 1973–1974, OPEC oil production cuts and the ensuing economic contraction drove the S&P 500 down a total of 47%. Moreover, many of the Nifty Fifty stocks—praised as “no matter how high the stock goes, it can’t be too high”—suffered far more severe damage, and price-to-earnings multiples that had peaked at 60–90 collapsed into single digits. In this way, Nifty Fifty adherents lost almost all the money they had invested in “universally acknowledged” blue-chip stocks. This was the first time I experienced what can happen to an asset that sits atop what I call a “pedestal of popularity.”

In 1978, I was assigned to the bank’s bond department and instructed to form a fund investing in convertible bonds, and shortly thereafter I took charge of high-yield bonds. At the time, I was investing in securities that most fiduciary institutions not only considered “uninvestable,” but that virtually no one knew about, paid attention to, or thought desirable … and I was earning returns steadily and safely. I soon realized that the very fact that I was investing in securities that virtually no one knew about, paid attention to, or thought desirable was part of why I was able to achieve superior results. It was exactly in line with the core return-generating principle of the efficient market hypothesis, which I first encountered at the University of Chicago Booth School of Business. If you seek above-average investment performance, you must invest in assets that other investors have not yet crowded into and that have not been fully valued. In other words, you have to do something different.

The Critical Difference

In 2006, I wrote a memo titled “Dare to Be Great.” The central theme of that memo was to set high goals; it sharply criticized conformist attitudes and investment bureaucracy, while asserting that to achieve exceptional returns you must apply unconventional approaches. What people still ask me about from that memo 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, it’s not easy or clear-cut to distinguish, but I think this is the typical situation. If your behavior and that of your manager is traditional, you may achieve traditional—good or bad—performance. Only if your behavior is unconventional can your performance also be unconventional … and only if your judgment is superior can your performance be above average.

The consensus of market participants is reflected in market prices. Thus, an investor who lacks insight above that of the average of the group that arrives at the 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. Nevertheless, the message I sought to convey through the table above and its accompanying explanation remains just as valid. Put simply, I compressed that memo’s theme into a single sentence: “Breaking news: you can’t behave like everyone else and expect better results.”

The best way to understand this principle is to conduct an analysis through a highly logical, almost mathematical process (as always, extremely simplified for illustrative purposes).

Over a given period, all investors collectively earn a certain (but not specifically determinable) amount of money in individual stocks, a particular market, or all markets. That amount is determined as a function of (a) how companies or assets perform in fundamental terms (e.g., whether earnings rise or fall) and (b) how investors evaluate those fundamentals and interpret asset prices.

On average, all investors achieve average performance.

If you are satisfied with average performance, it is enough to invest broadly by buying some portion based on the weight the target asset represents 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 outperform the 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 when the market consensus is wrong and assets are materially overvalued or undervalued.

Nevertheless, “active investors” make active investment decisions in order to outperform the average.

Investor A decides overall stock prices are too low and sells bonds to increase equity exposure. Investor B believes stock prices are too high; he sells some of his 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 thinks it is too high and wants to reduce exposure.

In all of the examples above, it is important to note that one investor must be right and the other must be wrong. Now return to the initial assumption: since the total amount earned collectively by all investors is limited, the sum of active decisions amounts to a zero-sum game (and, after fees and other costs, a negative-sum game). The investor who is right earns above-average returns, while the investor who is wrong, in theory, records below-average returns.

Thus, active decisions that seek above-average returns entail the risk of recording below-average returns. There is no active decision that lets you win if you succeed and yet not lose if you fail. Financial engineering is often marketed as though it can achieve this impossible objective in modified form, but such promises inevitably cannot be kept.

The above can be summarized simply as follows: if you do not make active investment decisions, you cannot expect above-average returns; but if your active decisions are wrong, your returns will be below average.

In my view, investing resembles golf in many ways. Just as hole layout matters, the conditions of a given day and players’ performance can differ. There are days when one approach on a course is appropriate, and other days when different tactics are required. To win, you must choose a better approach than your opponent or execute it more skillfully—or both may be required.

The same applies to investors. The principle is simple: if you hope to achieve differentiated results, you must break away from the crowd. But once you step away, you can create a positive difference only if you choose the right strategies and tactics and/or execute them more skillfully than others.

Second-Level Thinking

In 2009, as I was considering whether to publish my second book, <The Most Important Thing (The Most Important Thing)> , Columbia Business School Publishing asked me to send a sample chapter. As I often did, I sat at my desk and wrote down a concept I had never put into writing or named until then. That became the first chapter on second-level thinking—one of the book’s most important themes. Second-level thinking is, by far, what readers ask about most frequently among the concepts covered in the book.

The idea of second-level thinking is grounded in what I discussed in the memo “Dare to Be Great.” First, I reiterated the view that success in investing means achieving performance ahead of others. Any active investor (and certainly any financial asset manager who wants to make a living) seeks superior returns.

But that universal goal also makes market-beating performance difficult. Millions of people compete for every last dollar of investment profit. Who wins? The one who is one step ahead. In some fields, standing out from the crowd may require studying harder, spending more time in the gym or library, sweating more, building stamina, or having better equipment. In investing, however, these virtues matter less, and a more cognitive form of thinking is required—at the level I call second-level thinking.

The basic principle underlying second-level thinking can be summarized simply: to achieve superior results, you must think differently and better than others.

Remember that your investment goal is not to achieve average returns. You want above-average returns. Therefore, your thinking must be on a higher plane than other investors’ and must decidedly surpass theirs. 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 have not, capture what they miss, or have insight they do not. You must respond differently and act differently. In short, being right may be a necessary condition for investment success, but it is not sufficient. You must be more right than others, which means your thinking must differ from theirs.

On that premise, I distinguished investors who think at the second level from those 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 that seeks superior performance). A first-level thinker can get by with an opinion that predicts the future, 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 is the range of likely future outcomes?

Which outcome do I expect?

What is the probability that I’m right?

What is the market consensus?

How does my expectation differ from the market consensus?

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

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

If the consensus proves correct, what happens to the asset price? If I am right, what happens?

The number of factors to consider shows a clear and stark difference between first-level and second-level thinking, and those capable of second-level thinking are a tiny minority.

First-level thinkers look for simple formulas and easy answers. Second-level thinkers understand that investment success runs counter to simplicity.

This difficulty in investing brings to mind an important concept that came up in a conversation I had with my son Andrew during the COVID-19 lockdown (as explained in the memo “Something of Value,” published in January 2021). In that memo, which closely examined how much more efficient markets have become over recent decades, Andrew offered an apt view: “Quantitative information about the present that is available at any time cannot be a source of superior performance.” In any case, anyone can access this type of information—about U.S.-listed stocks, required under the SEC’s Regulation Fair Disclosure (Reg FD)—and today every investor must know how to manipulate data and run-chart screens.

So how can an investor seeking market-beating performance achieve that goal? As Andrew and I mentioned while discussing “Something of Value” on a podcast, investors must move beyond quantitative information about the present that is available at any time. Instead, they must generate superior performance based on 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 look ahead

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 where you can find easy answers. Ultimately, it all comes down to judgment or insight. A second-level thinker with strong judgment may be able to achieve superior returns, while an investor with weak insight may record inferior results.

I remember what Charlie Munger said to me when I published <The Most Important Thing> . He criticized, “It’s not supposed to be easy. Anyone who finds it easy is stupid.” People who believe there is a formula that guarantees success (and that they can obtain it) do not understand the complex, dynamic, and competitive nature of the investment process. The reward for superior investing can crystallize into large sums of money. In the fiercely competitive arena of investing, it is never easy to make more money than others.

Contrarian Investing

In the investment world, there is a concept closely associated with investing differently from others: the contrarian strategy. “Investor herds” refers to crowds of individuals (or institutions) that drive stock prices in one direction, up or down. Their actions push asset prices beyond a bull market into bubbles, or beyond a bear market into crashes. At such extremes—inevitably excessive—contrarian investing is essential.

Riding along with those volatile markets leads you to own or buy at high prices and sell or avoid buying at low prices. For this reason, it is important to break away from the herd and act in a way that runs counter to the behavior of most other investors.

I devoted a full chapter to contrarian investing in <The Most Important Thing> . The logic I presented was as follows.

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

The behavior of “the crowd,” “the herd,” and “the majority of investors” drives market swings. Bull markets form when there are more buyers than sellers, or when buying psychology outweighs selling psychology. Markets rise when people shift from selling to buying and when buying sentiment strengthens while selling sentiment weakens. (If buying pressure doesn’t dominate, markets don’t rise.)

At market extremes, inflection points appear. This occurs when the uptrend or downtrend reaches its limit. By analogy, the peak forms at the moment the last buyer completes a purchase. Once the peak is reached, all buyers have joined the bull-market herd, so the advance cannot continue and the market reaches the highest level it can. Buying or holding becomes precarious.

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

At extremes shaped by the judgment of “the majority of investors,” the majority turns out to be wrong.

Therefore, the key to investment success lies in breaking away from the crowd and acting in opposition. Those who recognize others’ mistakes can reap enormous profits through contrarian investing.

In sum, when extreme peaks and troughs reach excessive levels due to the collective misjudgment of the majority, it becomes essential to step away from the crowd and go contrarian.

David Swensen, who served as Yale University’s CIO, explained in his 2000 book <Pioneering Portfolio Management> why institutions are likely to conform to the market’s current consensus and why they should instead embrace contrarian investing. (For more on Swensen’s investment approach, see “A Suitable Example” below.) Swensen also emphasized that it is important to create a foundation that enables contrarian investing to be practiced effectively.

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

Investment positions chosen complacently by relying on consensus have little chance of achieving superior performance 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 does increase the probability of success, but if careful investment principles do not support that courage, the investor 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 means doing the exact opposite of the majority—selling when the market rises and buying when it falls. But interpreting contrarian investing in this overly simplified way is of little help. Instead, contrarian investing must be understood through second-level thinking.

In <The Most Important Thing: Expanded Edition> , four professional investors and scholars added commentary to my writing. My close friend and outstanding stock investor Joel Greenblatt criticized mechanical contrarianism with an apt analogy. He pointed out that “… just because no one is jumping in front of a speeding semi on the highway doesn’t mean you should.” In other words, the crowd is not always wrong; and because the crowd is wrong in most cases, acting opposite the crowd is not always right. Rather, to practice effective contrarian investing, you must understand:

What the herd is doing.

Why it is doing it.

If the herd is wrong, what is wrong.

How to 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. Even so, the smartest investment decisions made to seize the best opportunities—at moments when market extremes have reached excessive levels—inevitably incorporate elements of contrarian thinking.

Decisions That Accept the Risk of Being Wrong

I sometimes go back to my past writings to reinforce them, since the topics I want to address are limited in number and I know I cannot possibly absorb every last piece of knowledge about them. Against that backdrop, in 2014 I wrote a follow-up memo to “Dare to Be Great” with the creative title “Dare to Be Great II.” In the opening, I again stressed the importance of being different.

If your portfolio is broadly similar to everyone else’s, you may perform well like others or poorly like others, but you cannot produce results different from others. And if you want a chance to outperform others, you must be different—absolutely.

I went on to explain the difficulties that accompany acting differently.

Most successful investments begin with discomfort. Assets that most investors feel comfortable with—those whose basic premise is widely accepted, whose recent performance is positive, and whose outlook is bright—are unlikely to be offered at bargain prices. More commonly, bargain opportunities exist in assets that are controversial, viewed pessimistically, and have had weak recent performance.

Then I advanced the argument to what is perhaps the most important concept: the possibility of being boldly wrong, which naturally arises from boldly doing something different. Most investment guidebooks talk about being right and are silent about the possibility of being wrong. But any investor pursuing active management must recognize the reality that every attempt to succeed inevitably comes with the possibility of failure. As explained at the top of page 3, the two cannot be separated.

In markets that are even moderately efficient, any departure from consensus undertaken in pursuit of above-market returns may prove a mistake and thus lead to below-average returns. Every decision—overweighting and underweighting, concentration and diversification, holding and selling, whether to hedge—cuts both ways. Make the right decision and you profit; make the wrong decision and you lose.

One of my favorite quotes comes from a Las Vegas casino pit boss. He said, “The bigger the bet, the bigger the payoff if you win.” No one can dispute that. But he ignores the flip side: “The bigger the bet, the more you lose if you lose.” Clearly, the two go together.

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

A bubble descends with the phrase “Seek to be right.” This is the essence of active investing. Then, on top of it, another phrase appears: “Accept the risk of being wrong.” The point is that you can never achieve the former without bearing the latter. They are inseparably intertwined.

Next, a bubble descends with the phrase “Cannot lose money.” There are strategies that cannot lose money in investing. If you buy U.S. Treasury bonds, you won’t post a negative return. If you invest in an index fund, you cannot underperform the index. But then a second bubble appears that reads “Cannot succeed.” Investors who choose a strategy that cannot lose money inevitably forgo the possibility of success. Treasury investors cannot earn more than a minimum return. Index fund investors cannot outperform the index.

Then, in my imagination, an ignorant client presents a goal: “Take only the first part of each bubble—beat the market while also following a strategy that cannot lose money.” But unfortunately, that combination is impossible.

The above underscores the reality that active investing entails, beyond fees and management costs, the additional “cost” 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 crowd in pursuit of superior returns, or conform to consensus and be content with assured average results. 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 person makes no mistakes, but cannot leave great poetry behind.” In college, I studied Zen koans in a Japan studies course, and <Oxford Languages> defines a koan as “a paradoxical dialogue or question-and-answer used in Buddhism to reveal the absurdity of logical thought and to attain enlightenment.” I think the fortune cookie’s prediction was like a koan in that it posed a paradoxical and enlightening theme.

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

It can be interpreted either way, and both seem reasonable. Therefore, the key question is: “Which meaning is right for you?” As an investor, do you prefer avoiding mistakes or pursuing superior results? Which path is more likely to lead to what you consider success? Which is more feasible for you? You can choose either path, but you cannot choose both.

In this way, investors must answer a very fundamental question. Do you (a) accept costs, no guarantees, and the possibility of below-average outcomes in pursuit of above-average performance, or (b) settle for average performance that saves costs but leaves you merely watching with envy 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 results, and how much weight will you place on giving up those elements while expecting superior results?

I explained several factors to consider as follows.

The only way to achieve superior investment results is unconventional behavior, but it is not something just anyone can do. Successful investing, apart from superior skill, requires the ability to withstand, for a time, being seen as wrong and to overcome mistakes. Thus each investor must judge whether they temperamentally possess that ability, and—inevitably—whether, when a crisis hits and in the early stages it appears they are wrong, such behavior is feasible given their situation, considering the influence of opinions from their organization, clients, and others.

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.

A Suitable Example

As mentioned earlier, David Swensen ran Yale’s endowment for 36 years, from 1985 until his death in 2021. He was a true pioneer and developed the investment model that later became known as the “Yale model” or the “endowment model.” Unlike almost all institutions of the time, he sharply reduced Yale’s allocations to public equities and corporate bonds and concentrated on innovative, illiquid strategies such as hedge funds, venture capital, and private equity. He selected managers who had achieved superior results in their fields, and some of them later gained renown in the investment industry. Yale’s investment performance outstripped almost every other university endowment. In addition, Swensen cultivated many talented professionals who went on to produce results in endowment management that other institutions envied. Many endowments began adopting Yale’s approach around 2003–2004, after the tech/internet bubble burst inflicted serious damage. But there were virtually no cases of fully replicating Yale’s success: they followed the same strategy, but did so too late or executed it poorly.

Summarizing the above, it can be said that Swensen boldly chose to behave differently from others. He did what others did not. He did so long before most people found the thread. He did so to a degree others could not match. And he demonstrated outstanding ability. It was a great formula for excess performance. In <Pioneering Portfolio Management> , Swensen described the difficult problem at the heart of investing, particularly institutional investing. The excerpt below is one of the best pieces of investment guidance I have ever encountered, and it includes a two-word phrase (bolded for emphasis) that feels to me like poetry. I have quoted it countless times.

… active management requires institutional nonconformity and creates a paradox that only a tiny minority can solve. Establishing and maintaining an unconventional investment profile requires accepting an uncomfortably idiosyncratic portfolio, and such portfolios often appear imprudent from the perspective of traditional investing.

As with many great aphorisms, Swensen’s dictum packs deep implications into a short passage. Interpreted, it means the following.

Idiosyncratic – When all investors prefer a particular asset, buying is likely to push prices higher. Conversely, when they shun it, selling is likely to drive prices lower. Thus it is advantageous to buy assets the majority avoids and sell assets the majority favors. By definition, such behavior is highly idiosyncratic (“odd,” “quirky,” “unusual”).

Uncomfortable – The investor crowd sets positions based on reasons they can accept. We often witness investors acting the same way and being influenced by the same news. Yet we know that to achieve above-average performance, our response to given conditions—and our actions—often must differ from others. For any reason, if a million investors do A, doing B can feel very uncomfortable.

And if we actually execute B, it is unlikely to be immediately proven right. If you sell a popular asset because you think it is overvalued, the price likely won’t begin falling the next day. In most cases, the popular asset you sold will continue rising for some time, potentially for a long period. John Maynard Keynes said, “The market can remain irrational longer than you can remain solvent.” There is also the adage that “being too early is no different from being wrong.” These notions align with Keynes’s remark that “worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.” Departing from the mainstream can put you in an awkward and painful position.

Institutional nonconformity – We understand what Swensen meant by “institution.” Institutions are bureaucratic, rigid, conservative, customary, risk-averse, and disciplined by consensus. In short, they are far from rebellious. In such settings, the potential benefits of being right by acting differently can be outweighed by the intolerable costs of being wrong by acting differently. From the insider’s perspective, taking an action that causes losses (an error of commission) is far riskier than forgoing an investment expected to earn profits (an error of omission). Thus, investors who act “institutionally” are inherently unlikely to engage in idiosyncratic behavior.

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

He reduced public equity holdings to a minimum. He greatly increased allocations to investment strategies that would later be classified as “alternative investments” (he invested in them long before the term existed). In doing so, he devoted a meaningful portion of Yale’s endowment to illiquid assets for which no trading market existed. Based on what he called investment sense, he selected managers who did not have long investment track records.

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

One Way to Leave the Herd

Finally, I’d like to share a recent anecdote. In mid-June, Oaktree held its biennial client meeting in London, following the one in Los Angeles. The topic I was responsible for at both meetings was the market environment. As I prepared for London, I found myself in a quandary because there had been a significant change between the two meetings. On May 19, the S&P 500 was around 3,900, but roughly a month later, on June 21, it was 3,750—down nearly 4%. I debated whether to revise slides that were now somewhat dated or to use the Los Angeles slides unchanged to deliver a consistent message to both audiences.

I decided to use the Los Angeles slides as a starting point for discussing how much had changed over that short period. The London presentation largely consisted of discussing key 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, as they offer a glimpse into prevailing perceptions. Recently, the questions I have received overwhelmingly most often are:

Inflation outlook

How much the Fed will raise rates to control inflation

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

Not fully satisfied with what I said from the podium, I thought it over again during lunch. When the meeting resumed in the afternoon, I returned to the podium for two minutes. What I said then was:

All discussions about inflation, interest rates, and recessions share one thing in common: they are short-term. Yet there is not much we can know about the short-term future (more accurately, we cannot know much more than the market consensus). Even if we have a short-term forecast, we cannot place much faith in it (or should not). And even if we reach a conclusion, there is little we can do about it—most investors cannot meaningfully modify their portfolios based on such views, nor do they want to. We really should not fixate on 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’m asked whether the economy is headed into a recession, I answer that if we are not in a recession now, then we are somewhere on the path toward the next one. The issue is timing. I believe cycles will always repeat, meaning recessions and recoveries are always ahead. Does the mere fact that a recession is coming mean we should reduce investments or change portfolio construction? I don’t think so. Since 1920, there have been 17 recessions, including the Great Depression, World War II, numerous regional wars, several global-scale natural disasters, and the current COVID-19 pandemic. And yet, as I mentioned in my January memo “Selling Out,” the S&P 500 recorded an average annual return in the 10½% range over the century. If an investor repeatedly entered and exited the market to avoid those risky windows, would performance have improved—or would it have been reduced? Since quoting Bill Miller in that memo, I’ve been impressed by his philosophy that true wealth accumulation comes from “time, not timing.” Thus, 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. In front of the London audience, I said Oaktree’s primary objective is to buy recoverable debt or originate loans, and to acquire equity stakes in companies that generate sound performance and earnings.

That objective has nothing to do with the short term.

When circumstances warrant, it is true that Oaktree adjusts the balance between aggressive and defensive investing by changing the size and pace of closed-end funds and the level of risk that is acceptable. But Oaktree takes such actions not by forecasting the future, but based on current market conditions.

All members of Oaktree have their own views on the short-term phenomena mentioned above. We just do not rely entirely on the assumption that those views are correct. Bruce Karsh and I spent a long time in London discussing with clients the severity of short-term concerns. The note Bruce handed me read:

… Will conditions be as bad as expected or worse? Or better than expected? We don’t know … We also don’t know how much is priced in—what the market truly expects. Some say a 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 think we have a handle on what will unfold in terms of inflation, recession, and rates, there is absolutely no way to predict how market prices will respond to those expectations. This is a more important issue than most people realize. If you have organized your own views on today’s problems, or have seen the views of experts you respect, pick any asset and ask yourself—through that lens—whether its price is high, low, or fair. That process matters if you seek investments at reasonable prices.

The possibility—indeed, the certainty—that negative conditions lie ahead is not, by itself, a basis for reducing risk. Investors should act that way only if such conditions lie ahead and are not appropriately reflected in asset prices. As Bruce says, in most cases there is no way to know.

When I first started working, stock investing meant thinking in terms of 5–6 years. 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. Financial 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 great the skill—can succeed every quarter or every year. Strategies wax and wane with changing environments, and popularity rises and falls. Indeed, managers who adhere strictly to a disciplined approach tend to record the worst results when that approach is out of favor. Regardless of the appropriateness of the strategy or the quality of investment decisions, every portfolio and every manager experiences both good quarters/years and bad quarters/years whose impact does not persist, and those episodes do not define capability. Poor performance is often caused by developments that were unexpected or unforeseeable.

So what does it mean when someone or something posts poor performance over a given period? Managers should not be fired or strategies altered based on short-term results. Investment clients should, from a contrarian perspective, consider increasing allocations to underperforming investments rather than redeeming capital (but they rarely do). To me, the logic is simple. If you wait long enough at a bus stop, you will eventually ride a bus; but if you keep moving from stop to stop, you may never get on.

I believe most investors are aiming at the wrong target. Performance in any one quarter or year is meaningless and, at worst, can distract attention and have adverse effects.

Yet most investment committees still start meetings by devoting the first hour to analyzing last quarter’s returns and year-to-date returns. If others are absorbed in what doesn’t matter and overlook what does, investors who step away from the herd—enduring short-term concerns and focusing precisely on long-term capital allocation—can achieve results.

The final paragraph I quote from <Pioneering Portfolio Management> neatly summarizes how institutions can pursue the superior results most investors want. (The idea applies to individuals as well.)

Appropriate investment processes contribute materially to successful investing and help investors pursue long-term contrarian positions that deliver returns. Freed from short-term performance pressure, managers gain the freedom to build portfolios that seize opportunities created by short-term market forces. Fiduciaries can increase the likelihood of successful investing by encouraging managers to invest in shunned assets that may produce uncomfortable outcomes.

Oaktree is probably among a tiny minority in being relatively indifferent to macro forecasts, especially in the short term. Most investors become agitated about forecasts that attempt to predict short-term phenomena, but it is questionable whether there is anything they can actually do in response, and whether doing so would help.

Many investors—especially institutions such as pensions, endowments, insurers, and sovereign wealth funds, which face relatively less risk of sudden withdrawals—have the latitude to focus on long-term performance if they take advantage of that edge. Therefore, I suggest you break away from the investing crowd that fixates needlessly on the short term, and join investing that focuses on what truly matters.

Jang Hyun-joo, reporter blacksea@hankyung.com