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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, <The Most Important Thing>, 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 <The Most Important Thing>. 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 Most Important Thing>. 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 <Pioneering Portfolio Management> 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 <The Most Important Thing: Annotated Edition>, 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; <Oxford Languages> 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 <Pioneering Portfolio Management>, 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 <Pioneering Portfolio Management> 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

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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

1. Getting Lost in an оке of Information As the volume of information exceeded what people could realistically process, humanity faced two enormous challenges: a daunting “Chaos of Discovery,” where it’s unclear what to look at first, and a “Barrier to Learning,” where one must learn how to use what has been found. Web2 (Web2) has offered effective solutions to this problem. Powerful search engines such as Google and Naver imposed order on chaos, while platforms like YouTube and Wikipedia—where anyone can produce and consume knowledge—along with structured online courses significantly lowered the learning barriers for complex technologies and services. As a result, many technologies and services were able to expand into the mass market. However, in the world of Web3 (Web3), which champions the new value of decentralization, we are confronting this old problem again. Web3 resembles the early internet before reliable guides or search engines existed—an untamed frontier filled with disorderly, fragmented information. If a user searches for Web3 information on X (formerly Twitter), where Web3 and crypto information spreads the fastest, what they encounter is fragmented content: dozens of influencers strongly recommending different projects. Because it is difficult to determine which sources are trustworthy, it is not easy to obtain high-quality information. To make matters worse, the early Web3 ecosystem relied on reward models based on short-term gains—such as airdrops and liquidity mining—further exacerbating the problem. This competition for rewards turned into “Noise” that interfered with users’ efforts to find valuable “Signals.” As a result, users were swept up in speculative information rather than enjoying the true fun of discovery, and projects wasted resources attracting “airdrop hunters” chasing short-term profits rather than authentic community members. Ultimately, for Web3 to move beyond a niche audience and reach mass adoption, it must provide users with new, trustworthy “guides” amid the flood of information—and, through them, restore the value of “discovery” and “learning.” 2. Two Keys to Web3 Mass Adoption: Discovery and Education For these values to shine again, two solutions are needed. First is the problem of “trustworthy discovery” that helps users avoid getting lost in the vortex of countless projects. Second is the problem of “effective education” that helps users overcome the barriers of complex technology. Only by holding both keys can Web3 adoption expand from a small group of users to the broader public. 2.1 The First Key: Trustworthy Discovery In today’s Web3 ecosystem, discovering new projects is inefficient and risky. Users often rely on fragmented recommendations from Twitter influencers, Telegram “alpha” groups of uncertain credibility, and airdrop campaigns aimed purely at short-term profits. These approaches tend to be driven more by transient hype than by a project’s intrinsic value, increasing exposure to rug pulls and indiscriminate shilling. To address these difficulties in information discovery, platforms like Kaito—which uses AI to analyze and rank projects’ mindshare within the Crypto Twitter environment—drew attention. To encourage user participation, Kaito introduced a rewards system that grants points for activities such as creating or sharing content. However, such reward models also produced unintended side effects. As competition to earn more points intensified, some users focused on simple sharing or repetitive posting rather than in-depth analysis of projects. As a result, voices began to emerge saying it had become even harder to filter high-quality information on X feeds, and this was cited as a limitation that diluted part of the platform’s original value proposition in information discovery. In this way, reward models achieved some success in driving participation, but also created side effects such as degraded information quality and distorted user behavior. In particular, short-term incentive structures shifted attention away from the projects themselves and toward actions designed to maximize points. This trend also burdens projects. Even if they develop innovative technology, without a massive marketing budget they can easily be forgotten by the market. They try to break through by minting tokens and distributing them for marketing—an unavoidable short-term reward tactic—but this leads to a vicious cycle of attracting only “airdrop hunters” and automated bots interested solely in rewards rather than the project’s vision. To solve this “discovery problem,” the ecosystem needs something akin to a “Google of Web3.” A platform that plays this role should not merely list Web3 projects; it must be a trusted gateway that “discovers,” “curates,” and directly “connects” users to valuable projects. In the whirlwind of countless projects and information, it must serve as a “value search engine” users can trust to begin exploring. 2.2 The Second Key: Effective Education While mindshare platforms like Kaito made project discovery easier, users’ actions often failed to remain on-chain. Writing posts and earning points was active, but the share of users who actually connected wallets, tried dApps, or otherwise interacted directly with projects was low. From the user’s standpoint, they discovered projects but did not proceed to participation. To create real value for both users and projects, discovery must naturally flow into direct engagement. In other words, it needs to be “discovery-to-landing.” Users should not just take information and leave; they should proceed to the stage of touching the project’s smart contracts and experiencing the community ecosystem firsthand. The problem is that many users perceive a high barrier to entry for on-chain activity. Wallet connections, gas fees, swaps, staking, bridges—the practical Web3 environment is excessively unfamiliar and complex for beginners. Reading whitepapers running thousands of words or watching hours-long YouTube videos does not make it easy for beginners to solve this. Most users cannot sustain the effort of reading whitepapers and searching for information and end up dropping out. Ultimately, despite abundant information, a “gap between knowledge and action” emerges where users fail to reach real experience. To bridge this gap, effective education and guidelines for Web3 projects are needed. The key is not simple documentation or lecture formats, but pulling users in through hands-on practice. Just as Duolingo turned the grand goal of “mastering a foreign language” into light, repetitive, five-minute game-like activities, Web3 education should break down difficult, abstract technologies into small, actionable units. For example, the goal of “providing liquidity” can be decomposed into quest stages such as 1) swapping specific tokens, 2) depositing into a liquidity pool, and 3) staking LP tokens. Users experience real transactions by completing sequential missions, and they learn naturally through gamified rewards such as XP or badges. This Learn-by-Doing approach is not about injecting information; it helps users learn on their own in a real-world environment. By executing transactions in a safe environment, earning rewards, and feeling their skills improve, users build confidence in Web3. Ultimately, this kind of approach becomes the starting point for engagement that delivers real value to both users and projects. 2.3 Combining the Two Keys Ultimately, achieving Web3 mass adoption requires the two keys—“trustworthy discovery” and “hands-on, experience-based education”—to operate together. When experiential education supports users so that they can understand and use a promising project immediately after discovering it, discovery and participation can connect into one continuous flow. Discovering a good project is meaningless if users cannot try it; and even the best educational content is less effective if there is no project to apply it to. There is a platform that targets precisely this point. Layer3 integrates the two keys of discovery and education into a single user experience. Through Layer3, users can explore reliably curated projects, and then complete quest-based missions to experience and learn those projects in practice—like Google with Duolingo built in. This design goes beyond mere fun or reward mechanisms and focuses on creating sustainable engagement. Participation rooted in real technical experience and understanding—not one-off incentives—delivers better users to projects and deeper experiences to users. This is the most central point that differentiates Layer3 from existing platforms. 3. Layer3: Infrastructure for Attention and Identity Layer3, one of the largest Web3 user onboarding and engagement platforms, integrates the two keys of discovery and education into a single user experience. Through this, it proposes a new direction: converting users’ temporary attention into verifiable, persistent on-chain identity. The platform organically combines three core components—Quests, on-chain credential cubes (CUBE), and omnichain infrastructure—building both an immersive user experience and a powerful identity system. 3.1 Quests: From Simple Clicks to Narrative Experiences At the center of Layer3 are “Quests.” Early on, it offered one-off tasks called “Bounties,” but these only encouraged fragmented participation and did not lead to deep learning or durable relationship-building. To overcome these drawbacks, Quests were introduced to weave multiple individual tasks into a single narrative, designed to immerse users in the storyline of a specific ecosystem. For example, a quest like “Getting Started with the Base Ecosystem” does not simply instruct users to use a particular dApp. Instead, it guides them through a complete sequence—bridging assets to the Base chain, swapping on major DEXs, and minting NFTs on a leading NFT marketplace—like a self-contained story. This gamified structure creates anticipation—“What will happen next?”—dramatically increasing revisit rates and user immersion. Users are not acting merely to claim rewards; they become the protagonist inside a story while experiencing the project. This approach addresses what is known as the “cold start problem” for new users in the complex, fragmented Web3 environment—when they don’t even know where to begin. Quests turn learning and exploration into a game-like, rewarding experience, and encourage “learning through action” rather than listing information, helping users explore Web3 with confidence. It is one of the most effective mechanisms in Web3 onboarding. Highly immersive experiences deliver strong benefits not only to users but also to projects. Through quests, projects can convey their vision and philosophy intuitively, making it an effective way to imprint the brand beyond a simple guide. Users learn not only functions but also the project’s raison d’être and direction. In the end, this process forms the foundation for building an authentic community—users who empathize with a project’s journey and are ready to stay long-term—rather than those chasing short-term rewards. For projects confident in their product, Layer3’s quests can be not just a marketing tool but the most effective way to secure loyal fans and future power users. 3.2 CUBE: An On-Chain Trophy Case The most core component of Layer3’s infrastructure is “CUBE (Credentials to Unify Blockchain Event),” which converts a user’s activity from a one-off event into a persistent, composable on-chain data asset. Technically, CUBEs are non-fungible tokens (NFTs) issued upon quest completion under the ERC-721 standard. Initially deployed on the Base network, they are now supported across multiple Ethereum Virtual Machine (EVM)-compatible chains such as Polygon and Arbitrum. Each CUBE includes rich, specific metadata—wallet address, chain used, applications used, quest completion time—and this data is securely recorded on IPFS (InterPlanetary File System), a decentralized storage protocol. Within just four months of launch, more than 10 million CUBEs had been issued, and as of July 2025 cumulative issuance surpassed 60 million, forming one of the largest on-chain datasets in Web3. These CUBEs function as a user’s “on-chain trophy case,” forming the foundation of an “omnichain identity” that consolidates activity records scattered across multiple chains. In other words, a user’s reputation is no longer confined to a specific platform, but becomes a personal activity history that can be recognized across blockchains. By collecting CUBEs, users can receive benefits within the platform such as XP boosts, fee discounts, and opportunities to participate in higher-level quests. The system’s true potential comes from CUBE’s permissionless and queryable nature. This means any protocol can leverage CUBE data to verify a user’s activity history without a direct partnership with Layer3. For example, a DeFi protocol could offer more favorable loan rates to users holding many CUBEs proving activity across multiple decentralized exchanges, or a game could design incentives by airdropping special items to users holding high-level CUBEs from other P2E games. As external use grows, the value of holding a rich CUBE history rises for users. That, in turn, creates a powerful network-effect flywheel that draws users into Layer3 to mint more CUBEs. Layer3 is building a reputation and identity primitive for the omnichain era, beyond a single application. In this way, while CUBEs are an honorable on-chain trophy for users, they also create new opportunities for projects. Projects can use accumulated CUBE data like an on-chain Customer Relationship Management (CRM) system. For instance, by designing tailored campaigns targeting only “users holding five or more DeFi-related CUBEs,” they can filter out automated bots and irrelevant users in advance. This becomes a high-efficiency marketing tool that reaches the best-fit potential customers directly. In particular, CUBE’s permissionless nature strengthens Layer3’s network effects. Once a CUBE issued by one project begins to be used by other projects as a campaign participation condition, its utility and symbolism rise across the ecosystem. This both naturally spreads brand awareness for the original issuer and induces a virtuous cycle in which users return to that project to obtain the CUBE. 3.3 Omnichain Infrastructure: Connecting a Fragmented World Another feature of Layer3 is its ecosystem-agnostic “omnichain” approach. The platform supports not only major Layer 1 chains such as Ethereum and Solana, but also more than 45 blockchains including Base, Arbitrum, and Polygon. This gives Layer3 the foundation to function as a true aggregator in the fragmented Web3 environment. Users can explore Web3 broadly through a single unified interface—Layer3—without having to hop across multiple platforms to traverse different chains. This not only simplifies the user experience but also positions Layer3 as a powerful sponge that absorbs attention and users across the broader market. For projects as well, it effectively provides an efficient user acquisition channel to access an ambitious user base across Web3 without being limited to a specific chain. This omnichain structure is a strategic weapon that removes growth boundaries for projects. Even projects rooted in a specific blockchain no longer need to confine marketing to that ecosystem. Through Layer3, they can easily reach users already familiar with on-chain activity across Ethereum, Solana, Base, and more. This becomes a highly efficient growth strategy for new projects seeking early liquidity and community, or for existing projects expanding to new blockchains. With a single quest, they can run multi-chain campaigns simultaneously, analyze chain-by-chain user response with real-time data, and execute optimized user acquisition strategies. With these characteristics, Layer3 is positioning itself as one of the most agile and practical partners for ecosystem expansion. 4. Layer3’s Tokenomics and Market Validation Beyond philosophical vision and technical design, Layer3 is proving its value through tangible market performance. Strong fundraising and a sustainable business model show that Layer3 is a core player in the Web3 user acquisition market. In June 2024, Layer3 raised a $15 million Series A co-led by ParaFi and Greenfield Capital. “We believe the network effects currently at work are similar to Amazon and Shopify. As more sellers join, more buyers come in, which in turn attracts more sellers—and activity and value grow exponentially.” — Greenfield Capital A partner at Greenfield Capital said the investment was based on the view that “Layer3 has demonstrated the potential to become a top aggregator in Web3—like an Amazon of Web3—by bringing millions of users on-chain.” Including this round with participation from major investors such as Electric Capital, Immutable, and Amber, Layer3’s total cumulative funding stands at $21.2 million. This is a strong signal that the market highly values Layer3’s vision and execution. 4.1 $L3 Tokenomics and a Sustainable Business Model At the center of the Layer3 ecosystem is its native token, $L3. With a total issuance of 3.33 billion, $L3 is designed to be more than a reward instrument; it functions as an economic engine to accelerate platform growth and align incentives among all participants. The core of this tokenomics is a “value-capture flywheel” structure. Projects seeking to acquire new users must buy and burn L3 tokens to post quests on Layer3 and access the CUBE credential network. This utility-linked buy-and-burn model directly ties user acquisition—the platform’s main objective—to the token’s value. As project demand increases, sustained buy pressure and a deflationary effect lift the token’s long-term value. In fact, since its founding Layer3 has recorded more than $16.5 million in cumulative revenue, and grew revenue 10x in 2024 alone. Notably, about 40% of this revenue came from partner projects and 60% came from CUBEs issued by users to raise their reputation score. This indicates that Layer3 has built robust revenue models on both the B2B (projects) and B2C (users) sides. In particular, user-derived revenue—such as CUBE issuance fees and swap/bridge fees—is used to buy $L3 in the market, strongly supporting token value. Further strengthening this flywheel is the “Layered Staking” model—effectively a “Proof-of-Engagement” system—that goes beyond passive staking where users simply deposit tokens and earn interest. Instead, it differentiates rewards based on users’ active contribution. - Tier 1 (Start of participation): Stake L3 tokens to passively earn $L3 interest or gain the right to participate in governance. - Tier 2 (Exclusive opportunities): Users who stake at least a certain amount of $L3 can participate in exclusive quests from partner projects to earn not only $L3 but also partner tokens such as $OP and $ARB. Higher-tier reward opportunities also open up, such as launchpad access that lets users acquire new project tokens early. - Tier 3 (Contribution-based rewards): The core of the model. A multiplier is applied to $L3 rewards based on the user’s level of activity on the platform. This means rewards are determined by contribution, not merely capital size. For example, a user who completes 10 quests might receive 1.5x rewards, and completing 20 quests yields 2x rewards. This structure prevents a small number of whales holding large amounts of L3 from monopolizing rewards, encourages sustained activity, and serves as a strong economic deterrent against Sybil attacks. The token distribution structure also focuses on long-term ecosystem growth. 51% of total supply is allocated to the community, forming the basis for future airdrops and ongoing incentive programs. Meanwhile, allocations for core contributors and investors are subject to a one-year cliff lockup and linear vesting over the following three years, designed to prevent abrupt early sell pressure and incentivize long-term contribution to project success. 4.2 Partnership Case Studies: Value Proven in Numbers Layer3’s value becomes clear through concrete partnership outcomes, showing it is not just a traffic channel but capable of creating real value and converting users into long-term participants. - Ondo Finance: Through a campaign to promote adoption of USDY, an RWA-backed stablecoin, it attracted $1.04 million in new TVL and acquired 14,769 users in just 30 days. More importantly, after the campaign ended, $960,000 in TVL—92%—was retained, and user retention reached 33.4%. This is strong evidence that users driven by Layer3 were not merely chasing short-term rewards, but understood the product’s value and chose long-term holding—i.e., “high-quality users.” - Jito: Jito, a core liquidity staking protocol on Solana, ran three quests via Layer3. About 9,400 users participated, of whom 5,400 were new to Jito. Remarkably, more than 70% of staked assets were retained even one month after the campaign ended. - EigenLayer: EigenLayer, which is leading the major crypto narrative of “Liquid Restaking,” ran a large-scale educational campaign, “EigenLayer Unlocked,” with Layer3. The campaign was designed for users to learn complex restaking concepts through direct experience. Via quests, users interacted with various Liquid Restaking Token (LRT) protocols in the EigenLayer ecosystem, generating hundreds of thousands of on-chain transactions. This demonstrates Layer3’s ability to effectively educate and disseminate some of the most complex and important technical narratives in Web3. - Monad: Monad, a Layer 1 blockchain with a Parallel EVM architecture, used Layer3 as a core onboarding partner from the testnet stage. Through the “Monad Explorer” campaign, it encouraged many developers and early users to preview dApps in the Monad ecosystem. In addition, more than 50 major projects across Web3 ecosystems—including Uniswap, Base, Arbitrum, and Optimism—are acquiring users through Layer3. The fact that Layer3 users received 20.4% of the entire Arbitrum airdrop and 29.7% of the zkSync airdrop clearly shows that the Layer3 community is among the most active and influential user cohorts in Web3. 4.3 Metrics That Keep Growing Layer3’s growth is visible in hard metrics. As of July 2025, cumulative users surpassed 3.2 million (about 8.2 million unique wallets), and the number of quests completed and transactions on the platform exceeded 167 million. Monthly website visitors reach 1.9 million, and average session time exceeds 15 minutes, indicating strong user engagement. Beyond quantitative expansion, Layer3’s qualitative growth is even more notable. For example, on the Base chain, the 30-day retention rate for users who used Layer3 at least once was 6.1x higher than that of all other Base users, and the 120-day retention rate was 11.3x higher. This suggests Layer3 excels at driving sustained on-chain activity rather than one-off participation. Such high user quality and engagement have also made Layer3 a highly capital-efficient company, achieving industry-leading revenue per employee with a team of just 16. This growth is driven by a classic two-sided marketplace flywheel similar to Amazon and Shopify: more users attract more projects, and more projects provide more quests and rewards, pulling in even more users. Layer3 combines this with a buy-and-burn mechanism for the L3 token, ensuring platform growth translates directly into token value appreciation, adding momentum to the flywheel. 4.4 Market Validation—and the Next Step In this way, Layer3 has turned the narrative of “discovery” and “learning” into a real business through solid fundraising, value-capture tokenomics, and overwhelming market performance. Its L3-centered economic model has built a powerful flywheel that links platform performance to benefits for all participants, and partnerships with major protocols have demonstrated that Layer3 is one of the most efficient and trusted user acquisition channels in Web3. This market leadership is underscored by U.S. retail investing platform Robinhood’s move into the RWA market as a next-generation core business. Robinhood began by tokenizing U.S. stocks and ETFs for the European market, selecting Arbitrum as its initial technical partner. The strategy offers users a new financial experience—24/7 trading and on-chain custody and utilization of assets—and aims longer term to tokenize shares of private companies such as OpenAI and ultimately build its own RWA blockchain, the “Robinhood Chain.” In this process, Robinhood selected Layer3 exclusively as its user education and onboarding partner. Millions of users are designed to learn the new concept of RWA through Layer3’s quest system and directly experience an Arbitrum-based real-world asset investing journey via the Robinhood Wallet. This case shows that Layer3 has positioned itself not just as a dApp marketing tool, but as a strategic partner that global financial companies choose first when launching new businesses. Layer3 is not resting on its success; it continues technical advancement to further accelerate growth. The concrete execution plan is Layer3 v3, unveiled in April 2025. v3 is a pivotal update that elevates Layer3 from a simple quest platform to an “Onchain Operating System.” - Seamless user experience: Through the Layer3 Wallet, it removes concerns about chains and gas fees, introducing one-click transactions and an instant rewards system. This is essential for onboarding the next millions of users who are not familiar with Web3, such as Robinhood users. - Intelligent campaign automation: An AI-based Intel system automates how partners deploy and optimize campaigns to maximize return on investment (ROI). At the same time, it recommends the most relevant personalized quests to users to raise participation. - Strong community building: The layered staking model differentiates rewards based on actual contribution rather than simple capital size, fostering a power-user community that contributes most to platform growth and tightly aligning long-term incentives with them. In conclusion, Layer3 already has a market-proven economic model, clear expansion potential into the mainstream, and the technical infrastructure delivered through v3. All of these elements interlock toward a single vision: becoming Web3’s gateway—“discover like Google and learn like Duolingo.” 5. Layer3: The Layer of Discovery and Learning for Mass Adoption Layer3 is becoming a successful example of directly tackling two long-standing problems in the Web3 ecosystem: the “chaos of discovery” and the “barrier to learning.” Rather than merely listing projects, it provides an integrated experience in which users discover and learn for themselves, creating a new way to convert temporary attention into persistent on-chain identity. Layer3’s direction has been realized on technical foundations such as narrative-driven quests, on-chain credential CUBEs, and omnichain infrastructure. In addition, a sophisticated tokenomics model built around the L3 token and partnerships with mainstream companies like Robinhood have helped Layer3 move beyond an experiment and establish market viability and sustainability. Together, these elements have played a decisive role in positioning Layer3 as a distinctive leader in the Web3 user onboarding and engagement market. However, Layer3’s path ahead will not always be smooth. The biggest challenge is continually proving the “authenticity of participation.” Layer3’s structure effectively filters out airdrop hunters who chase only short-term rewards, but as long as rewards exist, skilled mining-like behavior that masquerades as learning will inevitably become more sophisticated. Ultimately, the platform must solve the problem of distinguishing whether on-chain reputation via CUBEs reflects users’ real understanding and loyalty, or merely optimized behavior to maximize rewards. If that trust wavers, the value of the ecosystem built on it may also be shaken. Even so, Layer3’s positive impact on Web3 as a whole is clear. Where the prevailing approach used to be to attract broad, indiscriminate attention through large token rewards, Layer3 has shifted this to education-based onboarding. Bringing in users who have experienced and understood a project’s value can steer the broader ecosystem toward a healthier, more sustainable direction—projects gain more authentic users, and users receive more meaningful experiences. Looking ahead, Layer3 is signaling an expansion beyond an onboarding platform into an “on-chain super app.” Users’ quest histories and CUBEs could function not only as proof of activity but also as an “on-chain credit score.” With this, Layer3 could recommend tailored DeFi products to verified users, or build new SocialFi or InfoFi ecosystems that connect users with similar interests. In other words, beyond discovering and learning, the experiences of investing and connecting could take place within a single Layer3 platform. In particular, connectivity to stablecoins—drawing global attention—could become a key driver of Layer3’s growth. As major fintech companies such as PayPal and Stripe adopt stablecoins and new forms of stablecoins emerge, the market for “user education and early adoption” is expanding rapidly. Layer3 is well positioned to capture this market. New stablecoin projects can explain their mechanisms and acquire early users through Layer3, and if stablecoins such as $USDC are integrated as rewards and payment rails, platform usage becomes more convenient, potentially lowering the final barrier to Web3 mass adoption. Ultimately, Layer3’s greatest potential lies in becoming a decisive bridge between Web3 and the mainstream. As shown in multiple cases including Robinhood, Layer3’s ability to abstract complex Web3 structures into user-friendly experiences is difficult to replace with any other protocol at this stage. As many Web2 companies enter the blockchain market, it appears clear that Layer3 will be one of the first onboarding and education infrastructure partners they seek. Accordingly, Layer3’s success is not just the achievement of one platform, but an important barometer for whether Web3 as a whole can expand into the mainstream. Four Pillars is a global blockchain specialist research firm. Experts with years of hands-on experience have come together to provide research services to global clients. Since its establishment in 2023, it has conducted a wide range of research with more than 100 protocols and companies across areas such as stablecoins, decentralized finance, infrastructure, and tokenomics, aiming to reduce information asymmetry across the industry and support the practical adoption and growth of blockchain. Disclaimer This article was written based on the author’s independent research sponsored by Stable. It is intended for general informational purposes only and does not provide legal, business, investment, or tax advice. You should not make investment decisions based on this article, nor use it as accounting, legal, or tax guidance. Any reference to a specific asset or security is for informational purposes only and is not an investment recommendation. The views expressed in this article are the author’s personal opinions and may not reflect the views of any related institution, organization, or individual. The opinions reflected herein are subject to change without prior notice. This report is independent of the publication’s editorial direction, and all responsibility lies with the information provider.

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Test

No. 6–10

5

4

3

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1

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Yes — you can compile a list like the one below of Japan-born figures/channels that are influential or gaining attention in the crypto and blockchain ecosystem. That said, given the nature of Japan’s market, it tends to mix traditional finance/government/regulatory and exchange-centric figures with SNS/community-centric figures. 🔹 1. Industry/Company-Centric Figures 🎯 Yuzo Kano — Co-founder of bitFlyer Co-founder and CEO of Japan’s largest cryptocurrency exchange, bitFlyer. Founded in 2014, bitFlyer has established itself as one of Japan’s leading exchanges and has also pursued global expansion. He is also a prominent voice in domestic regulatory discussions, including the establishment of self-regulatory bodies (JVCEA/JBA). 👉 He is widely seen as one of the most influential leaders in Japan’s crypto industry from the perspective of regulation and industry development. 🔹 2. Social Media/Community Influencers 💡 Yuta Misaki / Aojiru Prince Regarded as one of Japan’s most well-known crypto YouTubers/influencers. Operating under the nickname Aojiru Prince, he delivers content on Bitcoin and altcoin market analysis and investment strategy. He runs an influential channel with hundreds of thousands to nearly a million subscribers. 🇯🇵 Other Japanese crypto YouTube/community channels Below are influential Japan-based token/blockchain channels highlighted by various outlets (covering a range of focuses such as investing, NFTs, and market news): Coin Exploration Club – centered on project and trend analysis CoinSensei JP – educational/basic lecture-style content PudgyPenguins JP – NFT/Web3-focused Tsubasa Yozawa, Kamio TV, Ninja DAO, etc. – subscriber-driven crypto content creators 📌 Most of these are less “professional investors” and more akin to "crypto culture and information disseminators." 🔹 3. Historical/Cultural Influences 🤫 Satoshi Nakamoto While the Bitcoin creator’s name is Japanese-style, the true identity remains uncertain. Within Japan’s crypto community, the name is often referenced as a kind of symbolic figure. Virtual Currency Girls A crypto-themed girl group that once drew attention in Japan, contributing culturally to the crypto boom.

"You have to live up to expectations, right?" Dohyeon relocates—under a false registration—into Daechi-dong, Seoul, the country’s top education district, driven by his mother Okja’s zeal and his own innate greed. Despite being wealthy enough to get around in a Mercedes, he loses even the chance to become an exchange student to a friend who had been exploiting disability benefits; from the moment he learns that friend was not actually disabled, he begins to see the loopholes in government subsidies. Together with Jiwoo, a classmate he meets in a university entrepreneurship club, he exploits extra points tied to youth, women and disability status to collect youth start-up grants. Concluding that “start-up grants are blind money from the state meant to let you fail,” he deliberately bounces from intentional defaults to shutdowns. Dohyeon then launches a cryptocurrency venture backed with nine-figure won support from investor Kevin; driven by ambition, he develops the 'MOMMY' coin and delivers record-high results, but scrutiny from financial institutions follows over its algorithm and flawed interest-income model…