Howard Marks is one of the most successful and well-known investors in the world. He co-founded Oaktree Capital, the largest distressed securities investor in the world, managing over $120 Billion. Marks himself is worth $2.1 Billion and his ideas expressed through his memos have been endorsed by Warren Buffett himself. He has also written two best-sellers on investing: “The Most Important Thing” and “Mastering the Market Cycle.” Howard spoke to students in the Amador Valley Investment Club on May 2nd, 2019.
H/T Dataroma
Howard Marks: Managing The Risk Of Unfavorable Outcomes
Q1 hedge fund letters, conference, scoops etc
Transcript
So in your 2015 memo risk revisited again you mentioned more than 20 types of risks investors face. I think the number was 24.
How does an investor manage all those risks well some are more important than others and even some of the ones I included were tongue in cheek but I think you know like anything else in life. If we have to deal with multiple factors we have to prioritize. So the main risk I've kind of evolved my my way of thinking or my way of talking about it because I think in that memo I said that the main risk is that is the probability of losing money permanent capital loss. And now what I would say is that the main risk is the risk of unfavorable outcomes. Which is slightly different. Usually losses are the most unfavorable outcome but there are other unfavorable outcomes. And an example is that you know an insurance company has to make 7 percent on its portfolio so making 5 would be an unfavorable outcome. And it's obviously not a loss but it's falling short. Equally you know if you're a professional money manager in let's say the tech space and Apple stock goes up 30 percent and you don't have it that's it unfavorable outcome. It's a risk to you in your profession. It's not a capital loss but it's it's unfavorable. So I think the best way to think about risk is the probability of unfavorable outcomes that's the one we worry about now for obviously some of that as I indicate some of this is subjective and for some people some things that represent unfavorable outcomes for some people are not unfavorable for others. There is a matter of subjectivity to it. But but I would say that it's a matter of prioritizing the things you have to worry about it and then worrying like crazy OK.
All right. So we got Matthew who's going to ask our first question Hi masculine. So what have you my nose and reach the bottom. You mentioned about overpriced markets. What red flags and metrics should investors look for that indicate an overpriced market and or a bubble. And how should investors deal with them across assets?
Well there are two categories of things to look at. Usually they're connected. One is quantitative. One is qualitative the quantitative is valuation. So for stocks PE ratio for bonds yields and yields spreads for real estate capitalization rate that is to say the net income as a percentage of the of the cost and a number and in private equity its enterprise value. It's the price being paid as a ratio of the companies EBITDA or cash flow.
So all of those are quantitative and all of those are indicators of risk of whether the market is elevated now you can look at them relative to the history for that parameter or relative to the history for that that parameter for that company or or stock and you can look at it relative to other stocks but.
But so nothing there's nothing that can be used as an automatic signal. Everything is subject to interpretation but you want to look at the quantitative valuations and then there's the qualitative Matthew which is what I call taking the temperature of the market and you want to assess the emotion that is prevalent in the marketplace.
For example when optimism is high assets will tend to sell high relative to their intrinsic value. When investors are driven by greed to make money and not too conscious of fear of losing money. You have to assume that prices may be high relative to intrinsic values. When people are. I was discussing the different types of risk when people are more afraid of formal the fear of missing out then they are afraid of losing money. Then you have to assume that maybe prices will be high relative to intrinsic value.
