Learning from other’s mistakes is a better way to learn than hoping to make them all yourself and learn along the way. There’s far less pain involved – this typically involves big losses in investing – and you get a secondary lesson from other investors being humble. That second part you don’t see very often.
There are a few great investors who seem to bring it up mistakes all the time. Buffett does this annually in his letters. I came across two others – Seth Klarman and Howard Marks – discussing it in a transcript from the 2008 Graham and Dodd Symposium.
Seth Klarman played the role of moderator and panelist, asking and answering his own questions to the rest of panel. The other two panelists were Howard Marks and David Abrams. The panel was asked about the one or two biggest mistakes they made and the lessons they learned in the process.
Both Klarman and Marks tackle leverage in one their two lessons. Being 2008, it certainly seems appropriate. I pulled their full comments below.
Here’s Seth Klarman:
They’re really easy. One is stay away from bad people. When you’re with bad people if you fight them you end up wasting a huge amount of time, you’re not going to change them, and so there are a lot of cheap stocks that should be cheap because they think that your money is their money and they’re not going to change. So we’ve learned the hard way in a few situations many years ago, when it’s a really bad person just let it be somebody else’s problem.
The second is beware of leverage, not in your portfolio but in the underlying companies. The biggest mistakes we’ve made have been where we thought our value was covered easily but where we were not in the senior-most position and there was a lot of debt in front of us. Then, a relatively small change in the value greatly impacts those securities. I remember, I believe it was InterCo Bonds [phonetic] that were not the juniorest bonds but also below the senior and when the company failed to execute on a business plan, the economy got a little bit worse, the bonds that we had bought at 50 were trading in the 20s, and we were lucky to get out at that price, we felt. So be really careful, especially in this environment. Stock can look incredibly cheap but the leverage that they have won’t be leverage that they’ll be able to roll when it comes due. That’s become an obvious lesson now but it’s something, luckily we learned for small dollars a long time ago. And you can never imagine how little amount of actual debt can seem really large just when you have a big problem. That leverage is really an enemy of being able to take a long term perspective because you can drown in a pond that is only one foot deep on average. Leverage has that effect sometimes.
Here’s Howard Marks:
Well you know, at the end of ’07 I wrote out a list of what I thought were the lessons of ’07 and I thought that the most important one, the best one, was that investment survival has to be achieved in the short run, not on average in the long run. And that leads to your point about drowning in shallow water. But the upshot of that is that investors have to make it through the low points and because ensuring the ability to do so under adverse circumstances is incompatible with maximizing returns in good times, investors must choose between the two. And that’s really key to survival. And you know, incredible as it sounds, and we tend to lose track of this, survival is an essential component in success.
The other thing I’ll just mention in terms of a mistake we made, probably the biggest percentage loss we ever had in an investment was where we ignored the dictum of lasting assets. And we bought the debt of a technology company which had a very good technological position in the market but, you know, one of the cornerstones of distressed debt investing is for the most part not putting in more money. And we learned the hard way that if you have a technological advantage and you don’t feed it for a year then you don’t have it anymore. So you know, this is a very important kind of lesson to learn and hopefully with small dollars.
The Graham and Dodd Luncheon Symposium 2008