Supported by Greenhaven Road Capital, finding value off the beaten path.
This post will use quotes from Howard Marks’s fall 2018 interviews with Barry Ritholtz, Tim Ferriss, and the The Investor’s Podcast as well as an August 2018 talk at Wharton.
You can listen; iTunes, Overcast, or Soundcloud.
Or read; ePub.
Howard Marks’ advice is for people to think like Nassim Taleb’s dentist. Not his dentist, but the one introduced in Fooled by Randomness. Dentists in New York earn (on average) $163,000 annually. Ones in North Carolina $120,000. It’s a stable and normal distribution that one can arrive at with almost all skill and zero luck. Marks’ periodontist probabilistic philosophy makes sense.
In the terms of Michael Mauboussin’s Success Equation, dentists find “history a useful teacher.” Mauboussin introduced three questions to ask to determine if something shades towards skill or luck.
1/ Are cause and effect easily identifiable?
2/ How steep is the mean reversion curve?
3/ How predictable is it?
Careers cleaning canines and incisors is an easy example. But, dentists rarely give podcast interviews and Marks has learned some helpful lessons in the field of investing. If you want a stable career, go into dentistry. If you want a more stable career, listen to Marks.
We’ll use Matryoshka – little matron in Russian – Dolls as our model. Also, if Oaktree ever needs to raise another round, Marks Matryoshkas might be a nice bonus. It’s not unprecedented.
Marks’ Matryoshka is three versions; himself, his firm, and his situation. Good choices at one level sit within good choices at another. And it takes all three levels to have good results. Marks told Tim Ferriss, “I began each chapter ‘the most important thing’ because there are twenty-one most important things.” The capstone chapter is even titled, “Pulling it all together.”
It’s combinations that matter. Michael Ovitz told Ben Horowitz that CAA succeeded as a composite. Individually this was hard to see, but if someone looked at the whole they would get the picture.
Owen Slot saw this too after he documented the British Summer Olympic team overhaul. Slot wrote, “It’s not just your ten-thousand hours, or your leadership, or your environment, or your talent – it’s all these things….but that doesn’t give you the opportunity to put one simple answer on the book.” Hence Marks’ titling tack.
Interacting elements also removes one-size-fits-all solutions from our list of options. Tim Brown warned that designers can’t be “exported universally” to solve problems. Margit Wennmachers warned that PR isn’t like a fireman, swooping in to limit the damage. Pat Dorsey said discount cash flow is “not a magic bullet.”
But, what Brown, Wennmachers, and Dorsey do say is that lots of hard work will pay off. If someone were to read Marks’ books, tinker with the lessons, and apply them to their lives – then you’ll have great returns. He told Ritholtz, “I never want to give people the impression that this is easy, but it can be done.”
Marks wants people to find valuable things but never pay too much for them. What’s valuable? That’s a good question. He told Ritholtz, “A good investor has to be skeptical, the great investor has to figure out the truth as opposed to the story.”
Stories are to the truth like butter is to popcorn, it makes it tasty. Story, Robert McKee wrote, “is the metaphor for life.” McKee also quotes Plato who disdained storytellers, “Writers deal with ideas, but not in the open, rational manner of philosophers. Instead, they conceal their ideas inside the seductive emotions of art.”
Our challenge is to figure out what parts of stories, metaphors, maps, and models are true. There’s never a 1:1 to map. There’s never a model that always works.
Marks told Ritholtz, “The fact that things have gone down is not a sell signal.” Good businesses may look ugly and bad businesses may look good. Buffett said that airlines are “sexy for some reasons.” Scott Galloway told FT it’s the boring businesses that are creating shareholder value. Patrick O’Shaughnessy told Meb Faber, that “the more boring, stodgier portfolio is probably going to do better.” David Chang told us that just because a restaurant is busy doesn’t mean it’s also profitable. Pixar made great commercials and special effects but their business strategy was going to Steve Jobs, hat-in-hand, at the end of each month and asking him to cover the difference. Chris Douvos uses this formula; opportunity = value – perception.
How might someone listen critically and shift the odds? Here’s how Marks has done it.
Himself
Marks has what Mike Lombardi calls the management of self, as Lombardi told Shane Parrish, “When you make a mistake or when you do something that’s not effective, you have to be able and honest to say, ‘You know what? I made a mistake here. I need to correct that.'”
“One of the keys to successful investing,” Marks said, “is to be unemotional or – at a minimum – act like you are.” How do you do this? It’s not easy. Marks said, “In basketball, they say, ‘You can’t coach height.’”
What we can do is manage our hubris and humility. “We should never say ‘never’ ‘always’ ‘has to’ ’can’t’ – these expressions are far too absolute to be winners in a world beset by uncertainty and randomness. When you use those words you tend to get into big trouble.”
We need to see the world as flexible and ourselves as sometimes wrong. Marks uses writing as a form of thinking. He told Ritholtz, “Writing makes you tighten up your thinking.” In another interview Marks said, “One of the reasons I love to write is because I tend to think of new things as I write that I hadn’t thought of before.”
Other investors like Morgan Housel, Bob Seawright, and Eddy Elfenbein do this kind of thinking too. Author and ‘academian’ Adam Grant said, “I often find I have to write a longer summary of a study before I really start to distill why I care about it.”
Thinking, writing, and investing all take time to compound. Tyler Cowen said he’s able to read so quickly because he’s read for forty years. He has compounded returns. Marks wrote for ten years and “After ten-years I became an overnight success.”
In addition to reducing emotional outbreaks and sharpening his thinking via his pencil, Marks uses an alternative history mental model. “We need to think of the world as a probability distribution…The things that reasonably could have happened but didn’t.”
Peter Thiel could have followed the supreme court path. Charles Lindbergh could have fallen sick and we’d celebrate someone else. Even the horse, wrote Stephen Jay Gould, is only one possible outcome of many. Bill Simmons said to think of the alternative histories of a football season.
What trips us up is ourselves. Marks said, “The element that causes the problems in investing is psychology. If we knew that positive news would result in good price-performance life would be very easy.”
This applies to the professionals too. “Institutions don’t make investments, people make investments for institutions.” Sure, Marks admitted to Ritholtz, professionals may have more education, more experience, and more capital, but there’s one thing working against the professional – career risk. “The mom and pop investor has the advantage that they can’t get fired. The institutional investor has to worry about getting fired and that makes it hard to do the right thing at the extremes.”
Go back to 2008, Marks said, “Personal concerns make it very hard, even for the professionals.” Ritholtz added, “Career risk is present all the time.”
Career risk is like a crosswind in sports. Sometimes it gusts, sometimes it doesn’t. It’s a variable to consider. Pat Dorsey uses the axiom, no one gets fired for buying IBM as a way to find businesses with moats. Rory Sutherland noted how some decisions are more important for signaling something rather than being right.
Bill Belichick is brilliant. David Swensen is smart. Scott Malpass is magnificent. These things are true, but each of them also has a unique situation. They have less career risk which lets them make more interesting decisions.
Which brings us to the second vessel, his firm.
His Firm
Marks succeeds because he’s in an environment to succeed. Conditions matter. A simple example is sports. Steve Nash said about Kevin Durant, “the more he plays like a point guard the more brilliant he is.” The trouble with Durant’s previous team, Nash explained, was too much offense where he might “face five guys, put the ball on the deck and take a tough pull up.” In another episode about basketball, Bill Simmons said, “It’s a long list of people that miss Brad Stevens,” implying that the conditions on the Celtics let the players overachieve.
Like pieces of furniture in the office, there are three areas Marks has arranged.
1/ Career risk.
2/ Communication with clients.
3/ Combative and kind arguments.
Marks has little career risk, but Warren Buffett has less. “There’s a book out called The Warren Buffett Way and I was asked to write the forward for the latest edition and I wrote something called ‘what makes Warren Buffett Warren Buffett and I listed the things that characterize him; extremely high IQ, unemotional, great analysis, understands what’s important, looks at the things that are important, ignores the things that are unimportant, and on and on. The last one was one of the most important; he’s not afraid of getting fired. He doesn’t have to worry about the interim consequences of error. Most people do.”
Part-of-what allows this is clear communication with clients. Ritholtz asked about pushback and Marks said there wasn’t much. Oaktree’s clients invested their dollars and bought into the approach. Ritholtz’s firm is good at this too.
Astros GM Jeff Luhnow said this is a big part of his job, ” I think it’s important in our position we spend the requisite amount of time managing the stakeholders; the fans, the media, the influencers in the organization, the ownership – all of those stakeholders.”
And clients are only one stakeholder we all have.
Lastly, Marks and the Oaktree staff argue well. In interviews, Marks praises his partner Bruce Karsh. A good business partner is like a good tennis partner.
“The person should bring skills you don’t bring and operate in ways you don’t.” They should also have “shared values and complementary skills.” We saw this with Pixar’s story. Steve Jobs worked well with Ed Catmull and Lawrence Levy while he butted heads with Michael Eisner.
What makes Marks’ relationship with Karsh so good is that they’ve never had an argument. “Intellectual disagreements but never an emotional argument. The key is respect. Even when we disagree, we respect each other.”
And Marks warned, “Don’t equate winning an argument with success. If you’re in a business situation that proves to be a mistake, your success in winning the argument will lead to a failure. Don’t confuse winning an argument with coming to the best decision.” Sometimes your arguments wrote Ed Catmull, won’t even end in an answer. That’s okay too.
Good arguments only work with good people. “Who did you get in a partnership with. You have to share values. You shouldn’t be partners with someone you don’t like spending time with and be able to work with constructively when the stuff hits the fan. Solving most personal problems starts at the beginning, with the hiring.”
Any single advice for this? “Try to limit the testosterone.”
In his podcast with Ritholtz, John Montgomery articulated this balancing act:
“We all know that you don’t want to hire a bunch of yes people – but there is tremendous psychological pressure to hire people that look and feel and think just like you.
“You want to associate with people you trust. Who do you trust? People that look just like you. That’s a formula for disaster.
“We’re trying to intentionally hire people that don’t agree with us. People who have a different view into things.
“Some people will say, ‘Do you know that this other team member doesn’t agree with you on XYZ?’ I’m like, ‘Yes, and that’s a good thing.'”
Ben Horowitz said, “If you’re too friendly you never ask hard questions to the other one – which you need to grow.” It’s like picking fruit. Too gentle and you’ll harvest nothing, too rough and you’ll have a mess on your hands.
Our Situation
Our final Matryoshka is the situation. Marks is publishing his book as we run through a (long, longest?, TBD) bull market. It’s probably good timing. He brings this up in the interviews. Marks told Ritholtz, “My approach is that we never know where we’re going but we should know where we are,” and “The easy money had been made.” At Wharton he told undergraduates they’ll have to work a lot harder than he did.
While the self is easier to control and the people we work with manageable too, our overall situation is difficult. Which brings us back to where we started; getting the odds in our favor. For example, might this time be different?
Maybe it’s a new economy. What if modern monopolies are the new norm? What if there are two economies? What about network effects? Do these things change the calculus?
We should know where we are.
Our world isn’t designed so much as compiled. Many individuals pile into a composite. But, Marks reminded Ritholtz, “There is no market, only a bunch of people. The collective decision of the market is not better than the decisions of the individuals and they are riven with psychology.”
When to trust the wisdom of crowds and when not to? This question has been around a long time:
“According to Aristotle, ‘it is possible that the many, though not individually good men, yet when they come together may be better, not individually but collectively, than those who are so, just as public dinners to which many contribute are better than those supplied at one man’s cost’.”
But crowds are only wise when they are diverse, intelligent, and can communicate but not overly influential. But, Charlan Nemeth told Russ Roberts, “majorities can be correct but aren’t necessarily correct.” Fear of judgment, fear of looking stupid, fear of dissent can also create unwise crowds.
…
Getting the odds in your favor is like not hitting line shots in tennis. “Look in the mirror, do you see Pete Sampras?” wrote Brad Gilbert. “Unforced errors determine results more than spectacular shots.” That’s kinda what Oaktree has done. Marks said that five of the firm’s thirty years account for more than their share of returns.
“So it’s not an investment question, it’s a management question. How do you keep an organization going when its business goes out of favor sixty percent of the time? First, you have to hire people that are long-termed oriented, that don’t need instantaneous gratification every year.”
Matryoshka doll #2.
Marks has also been lucky. “When my mother came back from every parent-teacher conference she said, ‘Your teachers all say you are an underachiever,’ and I didn’t know what that meant or why it was a problem.”
But he helped the tennis coach who was kind enough to write him a letter for Wharton. Then he got to Chicago right as they were teaching the new stuff. Then some guy named Milken called and he wanted help with something called ‘junk bonds.’ Marks had the ability, skill, drive, enthusiasm, curiosity, etc to turn luck into serendipity.
Matryoshka doll #3.
When asked at Wharton what separated Bruce and Marks from others he said, Why do people buy high and sell low? “I think we can lump the explanation under the heading of emotion.”
Matryoshka doll #1.
The worst thing someone could do is try and copy Marks. It’s a fools errand. It can’t be done. What someone could do is think about making better decisions, and getting the odds in their favor.
Thanks for reading.
In 2015, Tim Ferriss spoke with Ed Catmull, the computer scientist who leads Pixar and author of 
The Waiter's Pad 