Thursday, August 7, 2008

Oaktree - Howard Marks: Letter to Clients

Of the two things I think are most wrong about American business, the worst is short-termism. (The other is the ability of executives to thrive while their companies do poorly.) Companies are rewarded for short-term success and penalized for short-term failure, whereas few people ask about the long term. The only thing that matters is “What have you done for me lately?” A lot of this emanates from stockholders.

In a memo several years ago, I listed a few phrases that have sunk into obscurity over the course of my career. They included “fiduciary duty,” “preservation of capital” and “dividend yield.” Another is “long-term investor.”

Most investment managers are measured against a benchmark every quarter and expected to add value. Some clients have their fingers on the trigger, ready to axe a manager who underperforms for a year or two. For this reason, managers sit with their own fingers on the trigger, ready to dump a stock or bond whose short-term performance lags. And company CEOs whose securities are laggards are likewise on the hot-seat, with boards that rarely support executives who disappoint Wall Street.

Too many people think of the long run as nothing but a series of short runs. The way to have the best five-year investment record, they think, is by sequentially assembling the twenty portfolios that will produce the best performance in each of the next twenty quarters. No one wants to invest in a company that may lag until long-term investments pay off down the road. They’ll just sell its stock today, assuming they’ll be able to buy it back later.

Understanding this, companies face great pressure to emphasize short-term results. What might they do in response?

• Maximize revenues (perhaps by stuffing pipelines and offering discounts that accelerate future sales into the present).
• Minimize expenses in slow-to-bloom areas like research and development.
• Borrow to buy back stock, because debt capital is cheap and equity is expensive (despite the fact that equity provides safety and leverage amplifies risk).

Do you want your companies doing these things? Probably not. But do the collective external pressures force companies in these directions? Absolutely. The things that maximize profits in the short run often serve to decrease profits and increase risk in the long run, but they can be mandatory these days.