The Secret to Successful Investing: Insights from Howard Marks

how do you make money as an investor the people who don't know think the way you do it is by buying good

assets a good building stock in a good company or something like that that is not the secret for

Success the secret for success in investing is buying things for less than they're

worth as you know I wrote a book in uh 2011 called the most important thing and the reason it's has that title

is because I would find myself in my client's office and I would say you know the most important thing in investing is

controlling risk and then five minutes later I would say the most important thing is to buy at a low price and five

minutes later I would say the most important thing is to act as a contrarian and so back in

203 I believe I wrote a memo called the most important thing I listed 19 things Each of which was the most important

thing and then I used that I couldn't think of a better format for my book so I used the same format in uh 2011

interestingly some of the things are different and that you supposed to show you that that one's thinking should

still be alive and should still evolve and I know that s Rob and some of the other fellow went to see Charlie Munger

speak in Los Angeles this week at age 91 and uh I'm sure he's still evolving and uh and getting younger so I'm going to

try to do the same now I should tell you and I don't know if you know this but uh I ow I write memos to the clients and

I'll refer to a lot of memos in in this session probably and they're all available on oakry capital.com website

and the price is right they're all free and so uh you know I've been sending them out now 25 years I started in 1990

and I got a letter from a a guy in named Warren Buffett in 2009 or 10 and he said if you'll write a

book I'll give you quote for the jacket and so I had been planning on writing a book when I retired from work but

Buffett's promise uh caused me to accelerate uh my time frame and what the book is is who who here has read it okay

about half so what what the book is it's a recitation of my investment philosophy and as it says in the forward to the

philosophy which I took the forward you know I never I don't know about you I never read the forwards of books but I

took the forwards of Mind very seriously and what it says in there it's not the designed to to tell you how to make

money and it's not designed to tell you how easy investment is or to try to make it easy and in fact my highest goal is

probably to make it clear how hard it is investing is very difficult because it's it it's kind of

counterintuitive and it it kind of turns back on itself all the time and there are no formulas that work so what I

tried to do in the book book is teach people how to think and uh now the thoughts they should hold change from

time to time but how to think I think is uh valid in the long term um so and I it's my investment philosophy and I

wasn't born with an investment philosophy I was you you'll hear from a lot of people if you're interested in

investing who'll say well I started reading perspectives at age eight and I didn't uh or I you know at 13 I invested

my bar mitzvah money which I didn't do but and in fact when I was getting out of graduate school age

23 in 1969 so I know you can all do the math I didn't know what I wanted to do I had

studied uh Finance at Wharton and accounting at uh Chicago and I knew I wanted to do something in finance but I

had I wasn't very specific so I interviewed in five or six different fields uh large consulting firm small

consulting firm accounting firm corporate treasury Investment Management Investment Banking six

so uh you know I ended up in the investment business why because I had had a summer job in ' 68 at city in the

investment research Department I liked it had fun right that's a good reason so I went there and by the way

interestingly there was nothing magical about working in the investment business at that time it paid the same as all the

rest all six jobs that I was offered had the same pay between 125 and 14 a year not a month and and uh

and uh you know and there were no famous investors at the time investing was not a household word there were no

investment TV shows uh and uh so I just did it because I liked it I liked the people and I thought that the that the

investing was intellectually interesting um so I wasn't I didn't have a philosophy then when I started and that

I had some things I had learned in school but I think that your philosophy your philosophy as opposed to somebody

you know if you if studi decart or lock or somebody like that you learn his philosophy if you might learn a

philosophy by studying a religion but that's not your philosophy your philosophy will come from the

combination of what you have been taught by your teachers and parents and your experiences and what your experiences

tell you about the things you were taught and how they have to be modified so I developed uh My Philosophy over you

know I it might seem like I started writing the mamals a long time ago 25 years but I had been working already

over two decades at that time so I think that the integration of real life into philosophy is essential now my I

prepared a few slides for today and basically the slides are here to illustrate where the philosophy came

from talk to you about some of the foundations and Roots so I call it Origins and Inspirations and I hope

you'll find it interesting so first of all uh uh not in order chronologically but hopefully in order

to try to make something intelligible uh Fooled by Randomness by Nasim Nicholas TB now I who here has

read that all right more people than have read my book uh and uh I think it's very important I think it's a excellent

book uh with very very important ideas now don't tell nasm I tell I I said this but I tell all the people I speak to

that it is easy it is either the most important badly written book or the worst written very important book that

you'll ever read uh I I think it's not very clear and I think it's uh not uh well maybe there's no attempt to

make it clear uh but I think a lot of the ideas are very important and uh even profound in my opinion so among other

thing and and the basic theme is that in investing there's a lot of Random and if you look at

investing as a field without Randomness where everything where everything is determinative you'll get confused

because you will not draw the proper uh inferences from what you see for example just a brief example you see somebody

and they report a great return for the year the science the the scientist who thinks that the world that that the

investment world runs like the world of physics might think well great return that means the guy's a great investor

but in truth it it might be somebody who took a crazy shot and got lucky why because there's a lot of Randomness in

the world when I went to Warden 1963 the first book I remember learning was called decision making under

uncertainty by C Jackson Grayson who became as I recall America's First Energy are and uh I learned a couple of

important things from that book number one that you can't tell from an outcome

whether a decision was good or bad it's very important most people don't understand this totally totally

counterintuitive but the truth is in the real world where there's Randomness at work I mean if you build a bridge and it

falls down then you must assume that the engineer made a mistake that it was a bad decision to

build the bridge that way but in the in the real world of where where every where there's Randomness good decisions

fail to work all the time bad decisions work all the time the investment business is full of people who are quote

right for the wrong reason made this a bad decision it didn't work out the way they thought but they got lucky and they

were bailed out by events so this is very important and this is the the basic theme of uh of Fooled by Randomness tb's

first book since then he has written uh the Black Swan which became more famous but I don't think it's as good a book

and he's written a book called antifragile and uh uh that one didn't get famous um but I think that this book

is something everybody should read it if you have an interest in numbers investing and how the world works so

it's as I say the book is all about the role played by luck and uh basically uh even if you know what's most likely many

other things can happen instead this is very very important we talked uh earlier at lunch about what's the most important

lesson you can draw well of course I can't I'll never say most important to anything but one very important lesson

for for you to learn is that you should not act as if the things that should happen are the

things that will happen hey everyone I just wanted to jump in here real quick and say that if you're enjoying this

video you should download this completely free pdf at the link in the description because it contains 525

pages of Howard Mark's legendary investment memos I compiled these memos just for you as my thank you for

supporting the channel thank you for all that you do and now back to the video again in the world of the physical

sciences you can probably bet that that's true and the electrical engineer knows that if he turns on a light switch

over here the light will go on there every time because it's subject to physics not

in the world of investing and so uh for every possible phenomenon there is there is a a range

of things that can happen there may be one where it's possible to discern which one is the most like

and if we draw a probability distribution that may be the highest point on the distribution the most

likely single outcome but that doesn't mean it's going to happen and the reason we the reason we don't have many

probability distributions that look like this but rather that look like this is because a range of things can happen and

it's very very important to notice that number one there are lots of things that can happen so you have to allow for them

and number two the thing that is most likely to happen is is far from sure to happen and we and so uh that's that's

very that's very key there's a professor at the London Business School who put it succinctly he said risk means more

things can happen than will happen and uh this is again this is profound in my opinion

um in the economic world people generally make their decisions based on something called expected value which is

to say that you multiply every possible outcome first of all of course you don't think in terms of a single

outcome you think in terms of a range of outcomes so you take every if you could if you could iterate over so many you

take every possible outcome you multiply it by the likelihood that it will happen you sum the results and then you get

something called the expected value from that course of action and you choose your course of action based on the

highest expected value and that sounds like tot totally rational thing but what if the course of action that you're

considering has some outcomes that you absolutely can't withstand then you may not do it you may

not do the highest expected value course of action because it has some you can't live with you know who here is willing

to be uh you know uh the the sky diver who was right 98% of the time you know for example so you may elect to do bike

riding on the SCH campus rather than skydiving even though skydiving is more exhilarating uh 98% of the time anyway

so the point is uh it as I lived my life from Talking learning about Dimson learning about TB from learning from my

own experience I realized that should is does not equal will lots of things that should happen fail to happen and even if

they don't fail to happen they fail to happen on schedule ual so the thing that the that the economist or the finer

thinks should happen this year may happen in 3 years you got to live three years to see it happen one of my

favorite sayings is never forget the six- foot tall man who drowned crossing the stream that was 5 feet deep on

average we can't live by the averages we can't say well I'm I'm happy to survive on average we got to survive on the bad

days you got to survive and and if you're a decision maker you have to survive long enough for the

correctness of your decision to be become evidence and you can't count on it happening right away I always remind

people overpriced is not the same as going down tomorrow and if you bear that simple

truth in mind I think it helps so so to Leb and the role of luck very important then John Kenneth GTH John Kenneth GB

for those of you who are not familiar with ancient history was an economist American Economist uh died uh around 05

I think maybe a little after and uh at the age of about 98 and he was my one of my favorites he was he was uh a little

on on the left side uh he was you know somewhere between free enterprise and socialism but um he was what you what we

call the liberal in the days when when that word when it was okay to say that word um but he was he was very very

smart and he was not a he was not famous as an economist but he was a he played a lot of roles in government and he was a

diplomat but he wrote some very good books and one of them is called uh a short history of financial

Euphoria and uh I like thin books so and his is his is thin especially the ones he wrote in the last decade or two of

his life were very thin so I enjoyed those but but the short history is very good and I recommend that to you um and

one of the things he says is we have two classes of forecasters the ones who don't know and the ones who don't know

they don't know now I don't believe in forecasts uh macro forecasts people who forecast

interest rates performance of economies performance of stock markets and I don't think that my efforts to be a superior

investor and most other people's are aided by macro forecasts so am I saying that that the F forecaster is never

right no I'm not saying that the forecasters are often right last year GDP grew

2% many forecasters forecast that GDP will grow this year at 2% that's called

extrapolation and usually in economics extrapolation Works usually the future looks like the recent past so usually

the people who forecast a continuation of of the current are right the only problem is they don't make any money

because let's take let's take the economy most people forecast two something for this year a growth rate of

two something is cooked into the prices of Securities today if the growth rate turns out to be

to something everybody who forecasted that will be right but the secur but security prices will not change much

because that to something grow both was anticipated and discounted a year or two ago so uh all those people who are

right won't make any money our forecast so that's a that's a that's a correct so most forecasts most

extrapolation works all the time forecasts that are extrapolations work all the time but they don't make any

money logically am I saying that forecasting that forecasts never make any money no the forecasts that make

money are the forecasts of radical change if if I predict if everybody's predicting

2.4% growth for this year and if it turns out if I predict minus two and it turns out to be minus two or I predict

six and it turns out to be six I'll make a lot of money so forecasts which are not extrapolations forecasts which are

radically different from the recent past are potentially very valuable if they correct of course they're not of any

value if they're incorrect if they're incorrect they'll they'll cost you a lot of money if if everybody else thinks

it's going to be 2 four and you predict six and it turns out at 2 four you're probably going to have taken the wrong

Investments and lost a lot of money so deviant forecasts which turn out to be right are po potentially very valueable

but it's very hard to make them it's very hard to make them correctly it's very hard to make them

correctly consistently and uh uh somebody at lunch mentioned an early memo I wrote called the value of

forecasts and uh in one of there was the value of forecast and then there was value of forecasts two I think right and

in one of those I reviewed the history recent history of the Wall Street Journal poll every six months the Wall

Street Journal uh publishes the results of a poll of economists and uh on you know GDP growth CPI value of a dollar

price of oil whatever it might be a bunch of phenomena they do it consistently and they they ask like 30

people consistently over time and uh so it shows basically that most of the time when people get it right it's because

they predicted extrapolation and nothing changed once in a while something changes

radically and invariably somebody predicted it but the problem is if you look at

that person's other forecasts over the years you see that that person always made radical forecasts and never was

right any other time so of course if you if you're getting your information from a

forecaster the fact that he was right once doesn't tell you anything you you wouldn't the the views of that

forecaster would not be of any value to you unless he was right consistently and nobody's right consistently in making DV

in forecasts so uh so the bottom line for me is that forecasting is not valuable uh

and uh that's something that my experience has told me so we we don't know what's going to happen and

Randomness will play a big role in what happens and Randomness is by definition unpredictable number

three the losers game by Charlie Ellis this is very interesting uh anybody here know the

name of the company TRW few people TR W used to be a big conglomerate uh and now it's known

primarily for credit scores and uh there was a guy named Sao he was the r it was it was Thompson Ramo Woolridge and he

was the r in TRW and very smart and Sao wrote a book and uh it was about uh winning at tennis

who here plays tennis okay this is good because as I go around the world now very few people play tennis anymore

but what Deo said is that there are two kinds of winning tennis players if you look at Pete Sampras or Nadal or jokovic

how do they win the winning Champion tennis player wins by hitting winning shots he hits shots that the opponent

can't return they're either so well placed or so strategic or so fast and hard that the opponent can't return

and if Nadal hits a shot which is not a potential winner then his opponent can probably put it away because it doesn't

have enough difficulty on the ball so the the championship tennis player wins by hitting

winners you play tennis right how do you win do you win sometimes how do you win if I win it's by not hitting it out it's

that's right the amateur tennis player like him and me we win not by hitting winners but by avoiding hitting losers

and we believe that if we can just push it back 20 times and just get it over the net 20

times our opponent can only do it 19 we believe that that we'll out steady him Outlast him and eventually he'll hit

it into the net or off the court we'll win the point but we'll win the point without having hit a

winner so they're obviously two styles of tennis and so same is true for investing and uh so Charlie Ellis wrote

an article called The Losers game and he said he thought that in investing so championship tennis is a Winner's game

it's won by winners he thought amateur tennis is a losers game it's won by the people who avoid being losers he thought

that Charlie thinks or thought that investing is a loser game and so the best way to win at tennis is by at

investing is by not hitting losers now I believe also that it's a losers game not as much as Charlie believes and not for

the same reason Charlie believes that that investing is a losers game uh because the market is efficient and

securities are priced right I believe there are inefficiencies I just think it's hard to consistently take advantage

of them and you have to be an exceptional person to take advantage of them on a consistent basis and uh uh you

know the reason that the pro can go for winners is because he is so well schooled and practiced and steady and

talented that he knows that if he does this with his foot and this with his hip and this with his elbow and this with

his wrist that the bull will go where he wants he doesn't worry about miscues uh wind sun in his eyes uh

distraction he's so well schooled um and in fact you know in in in scoring tennis match match is they keep track of

something called unforced errors and the reason they keep track of them is because there are so few the pro doesn't

make a lot of unforced Errors we make unforced errors all the time and so we have in order to survive we have to

avoid them so the point is if you're going to be an investor you have to decide am I good enough to go for

winners or should I emphasize the avoidance of losers in my Approach and then the fourth input

uh oh so I I I say here that the difficulty of getting it right is what makes defensive investing so important

because it's just for us in investing especially because there's Randomness if we do the right thing with our foot and

hip and arm and elbow we're not going to get a winner every time and then the fourth uh uh origin that I wanted to

talk to you about today was my meeting with Mike milin in November 1978 so uh in 78 I got a call from my boss at City

Bank and he said there's some guy in California named Mike milin and he deals with something called high yield bonds

can you figure out what that means because one of our clients had asked for a high yield Bond portfolio and in that

day nobody knew about it it was it was unknown and uh so I I I uh I met with Mike in November of 1978 he came to see

me a city in New York he was looking for clients he was just starting off the in the high yield Bond industry and it was

a great meeting and he explained to me that uh if you buy AAA bonds there's only one way to go tripa bonds are bonds

that everybody thinks are great their companies are making a lot of money they have prudent balance sheets the Outlook

is good everything's perfect so if everything's perfect that means it can't get

better and if it can't get better that means it can only get worse it doesn't have to get worse

but if there is a change it's going to be for the worse and if you've bought a bond on the assumption that it's

perfect and it gets worse then you lose money so uh that's important on the other hand he said if you buy single B

bonds and they survive there's only one way for them to go which is upgrade now that's not

exactly true because they can default and go bankrupt but the ones that survive will go up will be upgraded

and the surprises are likely to be on the upside so this was very important again this is about trying to

hit winners avoid losers and if you're buying bonds that most people don't think much of it's hard to have a big

loser because such low expectations are Incorporated now let me digress for a minute because this is really important

how do you make money as an investor the people who don't know think the way you do it is by buying good

assets a good building stock in a good company or something like that that is not the secret for

Success the secret for success in investing is buying things for less than they're

worth so if you buy a high quality asset you know there's a I and I say in the book there's a guy in on the radio I I

used to when I lived in La I listened to NPR on the way to work and there was a guy who's and I heard him say it he said

well if go into a store and you like the product buy the stock couldn't be more wrong because

what determines the success of an investor is not what he buys but what he pays for it and if you buy a high

quality asset but you overpay for it you're in big trouble you can buy a very low quality asset but if you pay less

than it's worth chances are you're going to make money so the so the book says chapter three says the most important

thing is value figuring out what the value of an asset is but number chapter four says the most important thing is

the relationship between price and value so let's assume that you're able to figure out the value if you pay more

than that you're in trouble if you get it for Less the wind is at your back so um it was very very important then uh to

be in an area where the surprises were likely to be on the upside and if you buy the bonds of b-rated companies about

which there are such low expectations maybe it's easy for there to be a favorable surprise now how can I how can

I prove to you that the expectations were low the answer is that uh if you look in the Moody's guide to Bonds in

those years it what was the definition of a b-rated bond quote fails to possess the

characteristics of a desirable investment in other words it's a bad investment now I drove here from the

airport in my car and if I take you outside to look at my car and I offer to you for sale because I I don't need that

car anymore when I'm done here uh uh I'm not coming back if I say to you would you like to

buy my car what is the one question you must ask me before saying yes or no price you get an A you get an A

so in other words it's a good buy at a certain price it's a bad buy at another price Moody is now saying that b-rated

bonds are a bad buy without any reference to price so in other words there's no price

at which a company that has some credit risk uh is is worth investing in and by the way before I turned to high yield

bonds in 78 I was part of the bank's me Machinery to buy the bonds of uh the stocks of America's best companies and I

explained to lunch how if you bought the bonds of H packet Perkin Elma Texas Instruments Merc Lily Xerox IBM Kodak

Polaroid AIG Coca-Cola and Proctor and gam and if you bought them all in ' 68 and you held them until 73 you lost 90%

of your money why because they were overpriced the average stock since the postwar has traded at 16 times its next

year's earnings these were trading at 80 and 90 times why because they were so good everybody it's great companies

nothing can go wrong so it doesn't matter what price you pay and if you pay 80 or 90 times that's fine and uh so

here we are in my experience again experience as a teacher you invest in the best companies in

America you lose a lot of money then you go to the high yield Bond business you buy you invest in the worst

companies in America you make the most money so it's an instructive lesson if you have your eyes open and and and you

learn from experience uh which which I did um but the key words were and they survive right there's a little trap

there because you have to you have to catch those three words if you buy single B bonds that don't survive then

you're in trouble so it but it's obviously it's torically true that if if a company about which the expectations

are low uh survives it'll probably at minimum it'll pay off at maturity and maybe in the meantime it'll be upgraded

or taken over if they survive so what that convinced me when I was starting the

higho bond business and this conversation came at a great point in time is that my analyst should spend all

their time trying to weed out the ones that don't survive not finding the ones that will have favorable events but just

excluding the ones that have unfavorable events and that's what we did so now uh I'll tell you an interesting story

around 05 or 06 the the Bible of investing is a book called security analysis written by Graham and do and uh

they they wrote the first edition in 1934 Ben Ben Graham was Warren Buffett's teacher at Columbia and uh in many ways

the father of value investing um and uh he and David Dodd wrote this book in 34 and they updated it in 40 and then

several times after and uh the 40 Edition is is is considered to be a great Edition and so in ' 05 mcroy Hill

which owned the book said they want to update the book and uh they uh turned it over to uh Seth claran who's a great

dead investor at in Boston at bow poost and a professor uh can't remember his name right now

H that's right Bruce Greenwald at Columbia so you should be up here I'll sit down uh and uh they they turned it

over to Seth and and Bruce uh to to bring out this this revision and they in turn asked people to revise the sections

and they asked me to revise the section on debt um and so that meant I had to go and read the 1940 Edition in order to

update it and I came across something fascinating and it was and it verified what I had always thought it said that

Bond investing is a negative art what does that mean what it means is I don't know how

many of you know how bonds work but a bond is a promise to pay you give me $100 and I promise to give you 5%

interest every year and then pay give you bonding back in 20 years fixed income it's called because all the

events are fixed the contract is fixed the return is fixed assuming the promise is

kept so all 5% bonds that pay will pay 5% no will pay six none will pay four all the ones that pay will pay

5% what does that mean it means it doesn't of the ones that pay it doesn't matter which ones you buy I'm going to

like this one I like that one a lot that pays five I like that one that pays five it doesn't make any difference you're

not GNA be a hero by choosing among the bonds that pay the only thing that matters is to exclude the ones that

don't pay so if there are 100 bonds 90 will pay they'll all pay the same thing it doesn't matter which of the 90 you

choose the only thing that matters is excluding the 10 that don't pay negative art the the the greatness of your

performance comes not from what you buy but from what you exclude so I thought that was very

useful I should have that up here too but anyway so that that milin was my fourth uh input so to lab says that the

future consists of a range of possibilities with the outcome significantly influenced by

Randomness and galra says that forecasting is feudal and Ellis says that if the game

isn't controllable it's better to work to avoid losers than to try for winners and milin says that holding survivors

and avoiding defaults is the key in bond investing so if you put them all together that's how you get the

philosophy that's in the book these were my Origins so when we started oak tree

April the 10th of 1995 almost exactly 20 years ago we wrote down our investment philosophy and here it is we published

it we were a bunch of guys who had been working together for most of the previous 10 years at a at a different uh

employer and we left there as a group and we started oak tree and so for a philosophy so I believe in writing

things down and like like learning at the L says today write them down right so uh we wrote down our philosophy we

published it we' never changed a word since and the clients like knowing what our road map is so these were the six

tenants of the investment philosophy so the first one says that the the most important thing is risk control and we

tell the clients we think that for a for excellence in investing the most important thing is not be making a lot

of money it's not beating the market it's not being in the top cortile the most important thing is controlling risk

that's our job that's what we'll do for you and the clients come to us who want to invest in our asset classes with the

risks under control there are other people who who who put less emphasis on controlling risk and they have better

results in the good times and worse results in the bad times our clients want what we give them number two we

have an emphasis on consistency so we say we don't try for the moon at the danger of crashing you know uh the first

memo that I wrote in 1990 I'm sure you remembered that J uh talked about uh a guy who was head of an an asset manager

that had a terrible year and he said well it's very simple if you want to be in the top 5% of money managers you have

to be willing to be in the bottom I have no interest in being in the bottom 5% I don't care about being

in the top 5% I want to be above the middle on a consistent basis over the long term and there's a funny bit of

math this will confound the uh what do you call yourself data scientists this will confound the data scientists in the

room but the the so in that first memo I contrasted the comments from that uh that uh

uh uh money manager with uh a comment from one of my clients who told me right about the same time it was the ju Theos

that caused me to write that first memo he told me that for the previous 14 years his pension fund had never been

above the 27th percentile or below the 47th percentile so it was solidly in the second

quartile every year for 14 years so let's see 27 47 the average of that is 37 right what percentile do you think

that fund was in for the whole 14 years four four and it it if you think about it

it's really almost mysterious why why the fourth not the 37th and the answer is that when people blow up they really

blow up and so uh uh we said we want consistency we want to be a little bit above the middle all the time maybe

we'll pop up to the top in the years when the markets are terrible and our risk control is rewarded but we think

that over a long period of time we'll be uh very respectable that way and our clients will have an absence of bad

experiences which I think for them is very important so then macro forecasting is not critical to investing we do not

make our decisions based on macro forecast as I explained to you we all have opinions we all we our official

dictum is that it's okay to have an opinion you just shouldn't act as if it's right and and and I think this is

this is very important you know Mark Twain said it's not what you don't know that gets you into trouble it's what you

know for certain that just ain't true and and so uh we try to avoid holding strongly to those macro opinions and

finally we don't do a lot of Market timing which is very very hard to do we do long term investing in assets that we

think are underpriced so that's the oak tree philosophy you can see how the uh

Origins and Inspirations that I went through uh fed into that and in fact it's all distilled in our motto which

says that if we avoid the losers the winners to take care of themselves and if we avoid if we can make a large

number of investors and just weed out the problems then we'll have just think of

the bell-shaped curve we'll have a lot that do okay and an occasional one which is exceptional if we can read these out

so a lot of money managers go into the clients and say we will get you in the top cortile into the great rightand tail

I think it's hard to do on a consistent basis and if you aim for the right hand tail and you miss you end up in the left

hand tail what we say is we'll just Lop off the left hand tail and if we can do that successfully

and we pretty much have then what will you have okay good very good great terrific but no terrible the average

will be very good and that's basically what we've had so lastly I'll just leave you with

what I consider my three greatest adages not mine but the ones I've encountered over my career and that have been the

most helpful um and they're all used in the book first of all what the wise man does in the beginning the fool does in

the end in every Trend in invest testing it eventually becomes overdone if you find an asset which is cheap and buy it

that's great if everybody else figures that out that it's cheap then it'll go up every then people see that it's

rising and more people jump on the bandw and goes up up up and the last person to buy it is a is a fool and the first

person to do do it buy it is a wise man it's the same asset just at different prices and and as as people

say first the the innovator then the imitator then the idiot so that's another way to look at

this adage number two never forget the six foot tall man who drowned crossing the stream that was 5T deep on average

kind of like that sky diver who's right 98% of the time it's not

sufficient depending on how you want to live your life to survive on average we have to survive on the bad days so we

have to be able to survive the low spots in the stream your portfolio has to be set up to survive on the bad days so you

won't be shaken out uh of of your Investments and then finally being too far ahead of your time is

indistinguishable from being wrong and yet that's a great challenge because as I said before the things that are

supposed to happen will not necessarily happen and they absolutely will not happen on time so you have to be able to

live until the wisdom of your decisions is proved if at all so all of these things I think say

something about modesty and humility of belief rather than shess which I think is the greatest risk so with that

s Rob I'll stop talking and we have a little time left and I'd love to take your questions that's what I'm here for

thank you Howard this was fascinating so we are open for questions please raise your hand and I'll bring the mic to you

um the thing you said about uh what the wise man does in the beginning the fool does in the end can can come you can

come up from a single stock and you can think about your whole philosophy that way so you've been focusing here on

avoiding losers and maybe humans are kind of generally focus on trying to find Winners maybe that's why we'll

always do wrong but if everybody in the world was trying to avoid losers maybe the wise investor now Shoots for the

winners do you know what I mean it's sort of self balancing sure well number one I don't think I don't think that we

have to worry about everybody becoming too prudent or too wise because we're talk because we're talking about human

nature Charlie Monger the boys went to see Charlie merer this week one of the one of the great quotes that Charlie

gave me was from the philosopher deines who said for that which a man wishes that he will

believe what do most people want more than anything else they want to get rich very few people think that the future

that that the that the that the uh the secret to their happiness comes from prudence and caution most people think

it comes from that stroke of Genius which will put him on Easy Street uh so but you're you're absolutely right and

there are times when most people are behave in a prudent and cautious manner when is it it's in a

crash when security prices are down here right that's the time to turn aggressive and buy so Buffett says the less

Prudence with which others conduct their Affairs the greater the Prudence with which we must conduct our own Affairs

and there are times when we should turn aggressive and that's when everything's being given away um so you said that you

do not predict you do not make any Micro Focus right but actually the macros can affect companies in a lot of ways like I

mean if you have interest rate like 30% I mean 99% of the companies will be gone or something like that right so how

do you even make an investment okay so now now I know I'm not coming back to Google anymore because the people are

too intelligent because this is one of the great traps I say that we don't invest on the basis of macro forecast

but you have to have a an economic framework in mind when you predict the fortunes of individual

companies um and uh what I would say is what we try to do is we you know it's one thing to say that oil is at 50 and

we're going to invest in this company because it will do fine if oil's at 50 survive if it goes to 30 and Thrive if

it goes to 70 but it's another thing to say oil is 50 I think it's going 110 10 I'm going to invest in this company

which is going to be great if if it goes to 110 but bankrupt if it stays at 50 so the question is how radical are your

forecasts and we try to anticipate a future that looks pretty much like the

norm and make allowance for the thing that that things other than the norm can happen and I can't really uh

be much more concrete than that it's all you know all this by the way all this stuff is Judgment you know there are no

rules there are no algorithms there are no there are no formulas that always work none of this is any good unless the

person making the decision has Superior judgment and you know the first chapter of the book says the most important

thing is second level thinking most people think on the first level to be a superior investor you must think on the

second level you have to think different from everybody else but in being different you have to be better you know

so the the first the first level thinker is naive he says this is a great company let's buy the stock the second level

thinker says it's a great company but it's not as great as everybody thinks it is we better sell the stock that's the

difference between being an average person and a person with Superior Insight by the by the way uh most people

are not above average yes sir do you think Diversified index funds adequately protect the

amateur investor from losers well this is a great this is a great question the role of the index fund

um a lot of people say I'm going to take a lowrisk approach I'm going to invest in an index

fund and they are confused what an index fund does is it guarantees you performance in line with

the index so the point is

because of the operation of What's called the efficient market not many people can beat the market it's true

most mutual funds do not beat the market most mutual fund investors would would be better off just to be in an index

fund and in in and in fact most active investment schemes impose fees that they don't earn and that is one of the major

reasons that most active investment schemes perform below average so the index fund which is

called passive investing yes it does reduce the eliminates the likelihood that you fail to keep up with the index

it also of course eliminates the possibility that you outperform the index so you trade away the two sides of

the probability distribution for shity that you get index results so but it doesn't eliminate the

risk of the investment it eliminates the risk of deviating from the index what you have to to keep in mind is that the

index fund investor loses money every time the index goes down why because there's no value added

to to keep it above so uh and it by the way index investing is a fine thing for the average amateur investor because the

average amateur investor number one can't beat the market number two can't find anybody or hire anybody who can

beat the market but the only thing is he shouldn't think that it's a riskless

trade it's you you you uh eliminate what we call Benchmark risk but you retain the risk of the underlying

assets sorry um so you've been through one or two of these business Cycles I guess and uh with the availability of

information and uh with the number of books being written about this subject about value and proper investing and how

many managers don't beat the market do you think the average investor is doing anything different than they were 20

years ago well look I think I think there's a minor movement toward

indexation it's not a a a ground swell there's still lots of money in actively managed uh mutual funds where the where

there's 2% a year of fees and costs or one and a half uh uh but but I think there's more in indexation every year

and that's probably appropriate but here's an I'll just turn it around I'll leave you with a

question why can't people beat the market because the Market's pretty efficient and market prices most things

right and most people can't find and identify and act on the times when the market prices things wrong that's why

most people can't beat the market that's what I learned at University of Chicago and I think it's pretty

true so the reason for the inability to beat the market is the Market's efficiency the Market's

efficiency comes from the concerted efforts of thousands of investors who are trying to find the bargains what

happens when they stop trying so when when when the interest in P in active investment declines because

people give up on it and turn to passive investing and all the analysts quit studying the companies then prices

resume their deviation from intrinsic value then it becomes uh uh possible to beat the market again

so it's really paradoxical and I would say counterintuitive but I don't think we we're close to that day but in theory

there comes a day when so little attention is being paid to active investing that active investing starts

working again yes sir thanks our for coming for the talk uh so you talk about the difference in value and the price uh

the other dimension is time so how do you estimate the time taken to that preach to close you never do you never

know see what he's saying I mean again it's a very good question and and what we want to do is we want to find things

where the intrinsic value is here and the price is here and so his question is how do we estimate the time that it's

going to take for The Gap to close and the answer is there's no way to say uh on occasion there are what we call

catalysts and um one Catalyst would be uh the maturity the pending maturity of a bond if a bond

is going to mature in 2012 and it's selling at 60 because most people think it's going to go bankrupt but it's but

we think it's going to pay off and and uh at maturity then the date of that the existence of a maturity date is going to

force the convergence of price to Value uh another uh Catalyst today is all these um um activist investors they find

the company it's selling they think the intrinsic value is here it's selling here because the management is subpar

and they're not doing the right strategy so they go in they F in trouble they try to get a board seat they try to force

the management to do the right thing to course to to cause the price to converge with the value so there are a few

catalysts in the world but generally speaking you buy a stock you hope you think it's worth here the price is here

you hope it'll converge but there's no way to estimate the time and that's the reason why

being too far ahead of your time is industrial from being wrong because it can take a long time so would you always

look for presence of catalyst when you find a gap there aren't enough I mean it happens you know most of what we do is

in the fixed income world and there are more catalysts in the fixed income world than in the equity world you find a

stock you know the how many how many stocks you think the the the activist investors go after a year 10 20 5050 100

no more there are thousands of stocks so most stocks are never going to get catalyzed curious if you could tell us

what uh it was like when you were out raising money for oak tree in the early days I I I would imagine that I would

imagine that today some clients are are skeptical uh but I would imagine that it was was it a lot different for you back

then and well by the time we started oak tree it wasn't that hard because we had a reputation but when we but but but you

know when I started raising money for our strategies 1978 junk bonds 90% of investment organizations like Google had

a rule a concrete rule against any bond investing below triple below a or below investment grade which is Triple B and

of course Moody said it's an improving investment so that was very very hard to overcome but you have what you have to

do is you have to find a few people you see you have to find a few people you have to go say him to him you should do

this because nobody else is because nobody else is doing it it's languishing cheap you make no money doing the things

that everybody wants to do you make money by doing the things that nobody wants to do who then turn out to have

value and if you say that message to a 100 investors in the beginning maybe 10 jump on

board after it works for a while then the rest come on like the screen says but but uh hopefully not too extreme but

the point is it was very hard in the beginning and uh you know in certain foreign countries it was even harder

because in certain foreign countries where the thinking is a little more narrow than American

thinking I always thought that if I go into somebody's office I say you should do this because nobody else is they'd

call the man in a white coat to take me away they don't they don't understand that you know I think that Americans

semi intuitively understand the value of contrarianism and of being a Maverick but in many countries they they they

just don't get it so that's an example high yield now in but then we started Oak Tree in oh no no that was a city in

85 I switched from City to trust compy the West TCW and in 88 we we brought out the first distress debt fund now now

we're not investing in companies that have a risk of default we're investing in bonds that are either in the fault or

sure to be and people would say well how can can you possibly make moneyy investing in

the bonds of bankrupt companies and we had to explain to them that that if a if a if a creditor of a

company doesn't get paid the interest in Principle as promised they have a claim against the value of the company and

they exert that claim in a process called bankruptcy and in bankruptcy to oversimplify and overgeneralize the old

owners are wiped out and the old creditors become the new owners and if you bought an ownership stake through

the debt for what for less than it's worth then you make money and the you know we've made about 23% a year for 28

years uh investing in distress debt before fees uh without any leverage so that's pretty astronomical

uh why because from time to time in distress debt you get to buy things for less than they're worth and in fact

because other people are fleeing from the bankruptcy maybe you get them to buy get

them to buy them for a lot less than they're worth so you know it was very challenging but uh you know if you can

like and you can't convince everybody but if you can explain the merits and and and tell the story clearly and

concisely and persuasively then you get some clients and then if you get good results then you get more

clients thank you a for for your talk uh one question uh Buffett uh in 99 said that if he was running very small

amounts of money he would be able to find lots of Bargains and beat the market by 50% and he would use the word

guaranteed uh I presume he meant that there are a lot of inefficiencies in the small um capitalization stocks one thing

that kind of surprises me is if uh someone an analyst willing to work hard on his own not in an institution the

world of distress debt investing is kind of shut out even for the value investor filled with lot of technicalities and

seems like the big institution has a lot of Advantage there are there such inefficiencies that are kind of shut out

to the institutions but the small investor willing to work hard can find inefficiencies in the debt World well I

think that uh I I think that I think that this the small guy can even be active in distress debt uh he he can't

get enough bonds to get a seat at the creditors committee table or have a voice but he can still uh find Superior

values um you know so what I was saying in answer to your question is that if you have good if you get some accounts

and you have good performance you'll get more accounts so that that goes a little further because what I really say is

that if you have good performance you'll get more money and eventually if you let that process become unchecked if you get

more money you'll have bad performance and this is one of the conundrums in our in our business and so

you have to hold that but the truth of the matter is that the little guy has an

advantage as long as he's willing to stay small many people are not because the in

the short run the more money you manage when you get fees the you know there's a it's a great lure to take on more money

but you have to stop it at a point where it's before it starts ruining your performance now uh for the data

scientists Among Us I always like to point out that if if if I worked at uh uh you know Firestone Tires and I

developed a new tire and I wanted to know how far it would go I would put it on a car and run it until it blew up

right that's called destructive testing but as an investor with clients and a fiduciary responsibility I don't

have the luxury of doing destructive testing so I can't add more people always say to me well what's the limit

on how much money you can invest well and I can't find out by running into the wall I have

to stop this side of the wall one of the interesting lessons is that if you stop this side of the wall then you never

find out where the wall really is but that's what we have to do and uh uh so but uh so you have to stop and I

believe that the person who has uh a big brain and a little money and a lot of time and uh exceptional Insight can find

great bar bargain uh but you know that's that's a pretty daunting list and I don't think

that Buffett's guarantee uh necessarily extends to everybody in this [Laughter]

room do you see any unhealthy Trends in valuation in the market today the same way Tech or housing was valued in the

past yes I do um because uh to the the market extends the the menu extends the what we call the

Capital Market line extends from What's called the risk-free rate the risk-free rate is the rate generally speaking on

the 30-day treasury bill and of course if you can get 3% on the risk-free rate then you in order to tie up your money

for five years in a 5-year treasury you want four and to get it years you want five and if you can get 10 years on a

government security uh 5% then in order to go into a corporate security which has some credit risk you would demand

six and to go into a high yield Bond you demand 12 and so forth so there's a there's a kind of a process called

equilibration uh which makes things line up in terms of relative risk and return but always tied pegged from the

risk-free rate today the risk free rate is zero so everything that I just named this Capital Market Market line

has had a parallel downward shift and so it's it before the crisis I had you know uh

sirab mentioned about the fact that I turned bearish all my money was in was in treasuries uh all the money that I

had outside of oak tree was in treasuries and I was getting six and a half% for 1 two 3 four 5 six year

maturities I was getting income and safety today you have a choice income or safety because the things today that are

highly safe pay no income you know and if you go to Fidelity conduct an experiment go to Fidelity or Vanguard or

big mutual fund firm and go online and look at their menu of offerings and what is the current yield on current net

yield after fees and expenses and for you'll see that for money market and short-term treasuries and maybe

intermediate treasury the yield is zero so just think the guy is watching the Super Bowl in his undershirt he gets

a statement from Fidelity he opens it up and it says the yield on your fund is now

zero he grabs the phone he calls the 800 number he says get me out of that fund that yields zero and put me in the one

that yields six and he becomes a high yield Bond investor he has no idea why he doesn't

know what a high yield bond is he doesn't understand what the dangers are he doesn't understand how to pick a high

Bond manager but he seduced by that 6% versus zero and all around the investment world today people are

chasing return they don't like the low returns that are available on safe instruments they're going for the for

the Gusto they're going for riskier instruments and they're doing it mindlessly and uh I promise you I'd

mentioned some memos I thought forgot to do that but if you go back that I wrote One in March of ' 07 called the race to

the bottom and I talked about the fact that when people are number one eager to invest

and number two not sufficiently risk conscious they do risky things and when people do risky things the market

becomes a risky place and that's why Buffett says the less Prudence with which others conduct their Affairs the

greater the Prudence with which we must conduct our own Affairs and that is going on now to some extent because

people can't get a good return from safe instruments they're going into the risky ones and they're bidding you know so

there's a there's a race to the bottom it's like an auction now if you want to buy a painting at sbe's there's an

auction and the painting goes to the person who pays the highest price but in the investment world it's a reverse

auction well sometimes you pay highest price but sometimes you you bid in lowest return so there's a there's a uh

there's a bond that's going to be issued by a company I say I demand 7% interest and this fell says no I'll take take six

and that guy says I'll take five I say I want protective Covenant to make sure that the company can't do

things that that ruins its own creditworthiness he says I'll do it with less covenants and that guy says I'll

take I'll do it with no covenants what happens the bond is issued at 5% with no covenants and that's the race to the

bottom and anybody who participates in that Bond probably you know could be making a mistake and that's going on now

not to the same terrible extent that it was in ' 06 and 07 but you got to be be careful today Oak

tre's motto for the last three and a half years has been moved forward but with caution caution has to be a very

important component of everybody's actions today well thank you very much for being

with me and I hope you enjoyed it and uh uh when I think of more stuff I'll come back thank you so much