Echoing Charlie Munger, Oaktree's Howard Marks warns today's institutional and retail investors that "everything that’s important in investing is counterintuitive, and everything that’s obvious is wrong." These words seem critically important at a time when the world and his pet rabbit is a self-proclaimed stock-picking export. Be "uncomfortably idiosyncratic," Marks advises, noting thaty most great investments begin in discomfort as "non-conformists don’t enjoy the warmth that comes with being at the center of the herd." Dare to be different is his message, "dare to be wrong," or as Charlie Munger told him, "it’s not supposed to be easy. Anyone who finds it easy is stupid." While Marks philosophically adds that "being too far ahead of your time is indistinguishable from being wrong," he warns the lulled masses that "you can’t take the same actions as everyone else and expect to outperform."
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.
Dare to Look Wrong
This is really the bottom-line: not whether you dare to be different or to be wrong, but whether you dare to look wrong.
Most people understand and accept that in their effort to make correct investment decisions, they have to accept the risk of making mistakes. Few people expect to find a lot of sure things or achieve a perfect batting average.
While they accept the intellectual proposition that attempting to be a superior investor has to entail the risk of loss, many institutional investors – and especially those operating in a political or public arena – can find it unacceptable to look significantly wrong. Compensation cuts and even job loss can befall the institutional employee who’s associated with too many mistakes.
As Pensions & Investments said on March 17 regarding a big West Coast bond manager currently in the news, whom I’ll leave nameless:
. . asset owners are concerned that doing business with the firm could bring unwanted attention, possibly creating headline risk and/or job risk for them...
One [executive] at a large public pension fund said his fund recently allocated $100 million for emerging markets, its first allocation to the firm. He said he wouldn’t do that today, given the current situation, because it could lead to second-guessing by his board and the local press.
"If it doesn’t work out, it looks like you don’t know what you are doing,” he said.
As an aside, let me say I find it perfectly logical that people should feel this way. Most “agents” – those who invest the money of others – will benefit little from bold decisions that work but will suffer greatly from bold decisions that fail. The possibility of receiving an “attaboy” for a few winners can’t balance out the risk of being fired after a string of losers. Only someone who’s irrational would conclude that the incentives favor boldness under these circumstances. Similarly, members of a non-profit organization’s investment committee can reasonably conclude that bearing the risk of embarrassment in front of their peers that accompanies bold but unsuccessful decisions is unwarranted given their volunteer positions.
I’m convinced that for many institutional investment organizations the operative rule – intentional or unconscious – is this: “We would never buy so much of something that if it doesn’t work, we’ll look bad.” For many agents and their organizations, the realities of life mandate such a rule. But people who follow this rule must understand that by definition it will keep them from buying enough of something that works for it to make much of a difference for the better.
In 1936, the economist John Maynard Keynes wrote in The General Theory of Employment, Interest and Money, “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally” [italics added]. For people who measure success in terms of dollars and cents, risk taking can pay off when gains on winners are netted out against losses on losers. But if reputation or job retention is what counts, losers may be all that matter, since winners may be incapable of outweighing them. In that case, success may hinge entirely on the avoidance of unconventional behavior that’s unsuccessful.
Often the best way to choose between alternative courses of action is by figuring out which has the highest “expected value”: the total value arrived at by multiplying each possible outcome by its probability of occurring and summing the results. As I learned from my first textbook at Wharton fifty years ago (Decisions Under Uncertainty by C. Jackson Grayson, Jr.), if one act has a higher expected value than another and “. . . if the decision maker is willing to regard the consequences of each act-event in purely monetary terms, then this would be the logical act to choose. Keeping in mind, however, that only one event and its consequence will occur (not the weighted average consequence),” agents may not be able to choose on the basis of expected value or the weighted average of all possible consequences. If a given action has potential bad consequences that are absolutely unacceptable, the expected value of all of its consequences – both good and bad – can be irrelevant.
Given the typical agent’s asymmetrical payoff table, the rule for institutional investors underlined above is far from nonsensical. But if it is adopted, this should be done with awareness of the likely result: over-diversification. This goes all the way back to the beginning of this memo, and each organization’s need to establish its creed. In this case, the following questions must be answered:
- In trying to achieve superior investment results, to what extent will we concentrate on investments, strategies and managers we think are outstanding? Will we do this despite the potential of our decisions to be wrong and bring embarrassment?
- Or will fear of error, embarrassment, criticism and unpleasant headlines make us diversify highly, emulate the benchmark portfolio and trade boldness for safety? Will we opt for low-cost, low-aspiration passive strategies?
Fear of looking bad can be particularly debilitating to an investor, client or manager.
Charlie Munger was right about it not being easy. I’m convinced that everything that’s important in investing is counterintuitive, and everything that’s obvious is wrong. Staying with counterintuitive, idiosyncratic positions can be extremely difficult for anyone, especially if they look wrong at first. So-called “institutional considerations” can make it doubly hard.
Investors who aspire to superior performance have to live with this reality. Unconventional behavior is the only road to superior investment results, but it isn’t for everyone. In addition to superior skill, successful investing requires the ability to look wrong for a while and survive some mistakes. Thus each person has to assess whether he’s temperamentally equipped to do these things and whether his circumstances – in terms of employers, clients and the impact of other people’s opinions – will allow it . . . when the chips are down and the early going makes him look wrong, as it invariably will. Not everyone can answer these questions in the affirmative. It’s those who believe they can that should take a chance on being great.
Full Oaktree Capital letter below...