Howard Marks, Investing In A Low Return World

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Value investors are contrarian by nature. They want to buy when everyone else is cashing out, and sell when sentiment is driving asset prices ever higher. So when dyed-in-the-wool value investor and founder of Oaktree Capital Management Howard Marks spoke at the Morgan Stanley Financials Conference earlier today you might have expected him to warn people against being too optimistic, but you would only be half right.

“Today’s markets call for caution, not aggressiveness, and my mantra for Oaktree for the last almost three years now has been move forward, but with caution,” said Howard Marks, Thomson Reuters reported. “I don’t think that prices are so high or the outlook is so bad that you shouldn’t move forward and invest. But I think that prices are not so low and the outlook is not so good that you should not include a very, very healthy dose of caution.”

Howard Marks more optimistic than many value investors, but remains ever cautious

Howard Marks identifies a number of challenging issues that are well beyond a portfolio manager’s control but have a significant impact on the investment environment. The decision to stimulate the economy by running deficits; inequality both within developed markets and between developed and emerging markets; ‘less than constructive politics’; job growth in DM that simply don’t need as much labor as they used to; and policy rates that skew capital allocations.

“I believe that free markets do a great job of allocating capital. And clearly there is no free market in money today. Borrowers are being subsidized, lenders and savers are being penalized by today’s low rates,” said Howard Marks.

This shows up in asset pricing, which Howard Marks describes as ‘on the high side of fair’. He argues that equity valuations and yield spreads are both reasonable right now, but that the base interest rate is so low that people have to move out on the curve to get decent returns.

None of that is controversial, but Howard Marks is more optimistic than many other value investors, saying that if his assessment of the economy is wrong he expects it to be wrong to the upside: he thinks it’s more likely that growth will exceed his expectations than they are to disappoint him.

Howard Marks looks for opportunities where retail can’t reach

One of Howard Marks strategies that is unfortunately not very helpful to individual investors is to look for asset classes that retail has difficulty accessing such as private debt and bank credit. Aside from avoiding the valuation swings that retail investors can cause, credit has the advantage of being less dependent on interest rates for solid returns.

“In credit, we don’t care that much about rates. Because the most important element in our equation is whether or not we will get paid,” said Howard Marks. “We are lending to people who have some risk about their credit and usually sell at elevated yields based on that, and the question is, ‘can we get it more right than the consensus of the market?’”

Oaktree is also investing in real estate, but it isn’t interested in ‘A buildings’ or ‘A cities’, instead focusing on the cities and properties that are being underutilized by their current owners and can be bought at a discount.

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