Howard Marks once describes his investment philosophy like this:
My philosophy of investing was built primarily on experiences but also on things I read: John Kenneth Galbraith’s ideas about cycles, the importance of contrarianism and being a countercyclical, and the importance of not being a forecaster, and Charlie Ellis’s article on “The Loser’s Game” — the desirability of just keeping the ball in play rather than trying to hit home runs.
Strategies that swing for the fences can experience random catastrophic strikeouts that ruin a game. Marks wants to stay in the game as long as possible, so he’ll forgo home runs for singles, doubles, and even walks. It’s like a small ball approach to investing, to continue the baseball analogy.
The point is, Marks wants to avoid as many mistakes as possible and not lose. To do that, he follows a process he learned from Ben Graham called the negative art. Here’s how he described it:
What you describe is what Graham and Dodd called a “negative art” in their book Security Analysis. They said fixed income investing — they called it fixed-interest investing — is a negative art, which means you improve the performance of your portfolio not by what you put in but by what you take out, by taking out the ones that do badly.
Now, that’s true for straight fixed-income investments. In other words, if you buy a hundred 7-percent bonds, all of the ones that pay are going to pay 7 percent. The only way to improve the return is by excluding the ones that don’t pay, because it doesn’t matter which of the ones that pay you hold. But when you get away from straight fixed-income investments, simply avoiding the losers is not enough. You also have to find some winners. We have a lot of strategies that are not really fixed income strategies — convertibles, distressed debt, real estate, private equity, power infrastructure. In the area of distressed debt, we have achieved a gross return of about 23 percent a year for twenty-seven years without using any leverage. You can’t do that without finding winners.
Oaktree’s motto is, “If we avoid the losers, the winners take care of themselves.” That’s a mindset; it’s not a roadmap. Whenever we consider an investment, we think just as much or more about what can go wrong as about what can go right, and we put the avoidance of losses on a high pedestal. That’s not the only thing we consider, but we put it first…
But the point is to consider risk control, loss avoidance, at least as important as return.
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For reference, here’s Graham referring to negative art:
Our primary conception of the bond as a commitment with limited return leads us to another important viewpoint toward bond investment. Since the chief emphasis must be placed on avoidance of loss, bond selection is primarily a negative art. It is a process of exclusion and rejection, rather than of search and acceptance. In this respect the contrast with common-stock selection is fundamental in character. The prospective buyer of a given common stock is influenced more or less equally by the desire to avoid loss and the desire to make a profit. The penalty for mistakenly rejecting the issue may conceivably be as great as that for mistakenly accepting it. But an investor may reject any number of good bonds with virtually no penalty at all, provided he does not eventually accept an unsound issue. Hence, broadly
speaking, there is no such thing as being unduly captious or exacting in the purchase of fixed-value investments. The observation that Walter Bagehot addressed to commercial bankers is equally applicable to the selection of investment bonds. “If there is a difficulty or a doubt the security should be declined.”
This post was originally published on August 2, 2019.
Sources:
Capturing Inefficiencies: The Rare Insight of Howard Marks
Security Analysis
Last Call
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