Tuesday, April 8, 2014

Howard Marks Memo: Dare to Be Great II

In September 2006, I wrote a memo entitled Dare to Be Great, with suggestions on how institutional investors might approach the goal of achieving superior investment results.  I’ve had some additional thoughts on the matter since then, meaning it’s time to return to it.  Since fewer people were reading my memos in those days, I’m going to start off repeating a bit of its content and go on from there. 
About a year ago, a sovereign wealth fund that’s an Oaktree client asked me to speak to their leadership group on the subject of what makes for a superior investing organization.  I welcomed the opportunity.  The first thing you have to do, I told them, is formulate an explicit investing creed.  What do you believe in?  What principles will underpin your process?  The investing team and the people who review their performance have to be in agreement on questions like these: 
  • Is the efficient market hypothesis relevant?  Do efficient markets exist?  Is it possible to “beat the market”?  Which markets?  To what extent?
  • Will you emphasize risk control or return maximization as the primary route to success (or do you think it’s possible to achieve both simultaneously)?
  • Will you put your faith in macro forecasts and adjust your portfolio based on what they say?
  • How do you think about risk?  Is it volatility or the probability of permanent loss?  Can it be predicted and quantified a priori?  What’s the best way to manage it?
  • How reliably do you believe a disciplined process will produce the desired results?  That is, how do you view the question of determinism versus randomness?
  • Most importantly for the purposes of this memo, how will you define success, and what risks will you take to achieve it?  In short, in trying to be right, are you willing to bear the inescapable risk of being wrong?
Passive investors, benchmark huggers and herd followers have a high probability of achieving average performance and little risk of falling far short.  But in exchange for safety from being much below average, they surrender their chance of being much above average. All investors have to decide whether that’s okay.  And, if not, what they’ll do about it. 
The more I think about it, the more angles I see in the title Dare to Be Great.  Who wouldn’t dare to be great?  No one.  Everyone would love to have outstanding performance.  The real question is whether you dare to do the things that are necessary in order to be great.  Are you willing to be different, and are you willing to be wrong?  In order to have a chance at great results, you have to be open to being both.