Oaktree's Howard Marks Explains The Difference Between Volatility And Risk

Tyler Durden's picture

Volatility is the academic's choice for defining and measuring risk; but Oaktree Capital's Howard Marks warns Bloomberg TV's Stephanie Ruhle that "while volatility is quantifiable and machinable... it falls far short as 'the' definition of investment risk." In fact, he berates, "I don't think most investors fear volatility. In fact, I've never heard anyone say, 'The prospective return isn't high enough to warrant bearing all that volatility.' What they fear is the possibility of permanent loss." With $91 billion under management, perhaps it's worth listening to (and reading) his perspective: "In brief, if riskier investments could be counted on to produce higher returns, they wouldn’t be riskier. Misplaced reliance on the benefits of risk bearing has led investors to some very unpleasant surprises."

Bloomberg TV interview:

Selected excerpts:

STEPHANIE RUHLE: Surely you've heard this line before. If you want to make more money investing, take more risk. Fine. Great even, if you understand what risk actually means. Howard Marks says most people don't, and he should know. He's the chairman of Oaktree Capital and one of the greatest investors in distressed debt. Howard, welcome back. Your newest letter is out. Tell us, what don't people understand?


HOWARD MARKS, CHAIRMAN, OAKTREE CAPITAL MANAGEMENT: The main thing people don't understand is that it's wrong to say if you want to make more money, take more risk. This is what people say. Higher -- riskier -- riskier investments have higher returns. So if you want to make more money, take more risk. It can't be right, Stephanie.




MARKS: Because if riskier could be counted on to produce higher returns, they wouldn’t be riskier. It's at simple as that. There's got to be something wrong with that formation. What we should say is that investments that appear riskier have to appear to offer higher returns or nobody will make them. But that doesn't mean it has to come true. And lots of things other -- lots of things can happen other than what you hope will happen.


ERIK SCHATZKER: Is it also true that investing in riskier instruments increases your chances of higher returns but also of higher losses?


MARKS: Exactly, exactly. That's -- that's the thing that people have to understand. Yes, when you take on more risk you expect a higher return, but you should also understand --


SCHATZKER: Hope for a higher return.


MARKS: You hope, yes, but you should also understand that the range of possible outcomes becomes wider. With T-bills there's no uncertainty. With the five-year there's a little uncertainty. With corporates there's a bunch. With stocks there's more. The more risk you take, the more uncertain the outcome is, and the worse the bad ones are.

*  *  *

MARKS: You shouldn't think you know what's going to happen.


SCHATZKER: But so many people do.


MARKS: Well, but they're wrong.


SCHATZKER: They're professional prognosticators.


MARKS: Exactly. That's an oxymoron. Mark Twain said it ain't what you don't know that gets you into travel. It's what you know for certain that just ain't true.


RUHLE: One more time?


MARKS: 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. If you think you know something and act in certitude and turn out to be wrong, that's how you lose a lot of money. If you say I'm really not sure what's going to happen, I'm going to hedge my bets and diversify my portfolio, you're less likely to get into trouble.

*  *  *

MARKS: I think that every investor faces two risks. Now if I say to you, Erik, what are the two risks, you'd get an A if you say the main one is the risk of losing money. But if you want to get an A plus you have to say the second one, and that is the risk of missing opportunity.


RUHLE: Fear of missing out.


MARKS: Now -- now the problem is we have the risk of losing money and the risk of missing opportunity, and you can eliminate either one.

*  *  *

From Marks' memo below:

Key point number one in this memo is that the future should be viewed not as a fixed outcome that’s destined to happen and capable of being predicted, but as a range of possibilities and, hopefully on the basis of insight into their respective likelihoods, as a probability distribution.


In other words, in order to achieve superior results, an investor must be able – with some regularity – to find asymmetries: instances when the upside potential exceeds the downside risk. That’s what successful investing is all about.


That leads me to my second key point, as expressed by Elroy Dimson, a professor at the London Business School: “Risk means more things can happen than will happen.” This brief, pithy sentence contains a great deal of wisdom.


This uncertainty as to which of the possibilities will occur is the source of risk in investing.


Key point number three: Knowing the probabilities doesn’t mean you know what’s going to happen.


Bruce Newberg says, “There’s a big difference between probability and outcome.” Unlikely things happen – and likely things fail to happen – all the time. Probabilities are likelihoods and very far from certainties.


It’s true with dice, and it’s true in investing . . . and not a bad start toward conveying the essence of risk. Think again about the quote above from Elroy Dimson: “Risk means more things can happen than will happen.” I find it particularly helpful to invert Dimson’s observation for key point number four: Even though many things can happen, only one will.


In brief, if riskier investments could be counted on to produce higher returns, they wouldn’t be riskier. Misplaced reliance on the benefits of risk bearing has led investors to some very unpleasant surprises.

To move to the biggest of big pictures, I want to make a few over-arching comments about risk.

The first is that risk is counterintuitive.

The riskiest thing in the world is the widespread belief that there’s no risk.


Fear that the market is risky (and the prudent investor behavior that results) can render it quite safe.


As an asset declines in price, making people view it as riskier, it becomes less risky (all else being equal).


As an asset appreciates, causing people to think more highly of it, it becomes riskier.


Holding only “safe” assets of one type can render a portfolio under-diversified and make it vulnerable to a single shock.


Adding a few “risky” assets to a portfolio of safe assets can make it safer by increasing its diversification. Pointing this out was one of Professor William Sharpe’s great contributions.

The second is that risk aversion is the thing that keeps markets safe and sane.

When investors are risk-conscious, they will demand generous risk premiums to compensate them for bearing risk. Thus the risk/return line will have a steep slope (the unit increase in prospective return per unit increase in perceived risk will be large) and the market should reward risk-bearing as theory asserts.


But when people forget to be risk-conscious and fail to require compensation for bearing risk, they’ll make risky investments even if risk premiums are skimpy. The slope of the line will be gradual, and risk taking is likely to eventually be penalized, not rewarded.


When risk aversion is running high, investors will perform extensive due diligence, make conservative assumptions, apply skepticism and deny capital to risky schemes.


But when risk tolerance is widespread instead, these things will fall by the wayside and deals will be done that set the scene for subsequent losses.


Simply put, risk is low when risk aversion and risk consciousness are high, and high when they’re low.

The third is that risk is often hidden and thus deceptive.

Loss occurs when risk – the possibility of loss – collides with negative events. Thus the riskiness of an investment becomes apparent only when it is tested in a negative environment. It can be risky but not show losses as long as the environment remains salutary. The fact that an investment is susceptible to a serious negative development that will occur only infrequently – what I call “the improbable disaster” – can make it appear safer than it really is. Thus after several years of a benign environment, a risky investment can easily pass for safe. That’s why Warren Buffett famously said, “. . . you only find out who’s swimming naked when the tide goes out.”

*  *  *

Full Oaktree letter to investors:

Oaktree Risk Revisited

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Bloppy's picture

Um, there is no risk anymore, remember?

Also: Twitter users spoof Obama's Stonehenge visit with caption-fest:


IANAE's picture

Kudos to Oaktree and Marks for attempting to broadcast to (more of) the masses what the risk/hedge folks have known all along.

If more people had those critical reasoning skills...

That said, one can reasonably expect the uninitiated listeners to practically pass out before the half-way point..."Mark Twain said what?!?!"

Cognitive Dissonance's picture

"MARKS: You shouldn't think you know what's going to happen.

SCHATZKER: But so many people do.

MARKS: Well, but they're wrong.

SCHATZKER: They're professional prognosticators.

MARKS: Exactly. That's an oxymoron. Mark Twain said it ain't what you don't know that gets you into trouble. It's what you know for certain that just ain't true."

The more certain I am about something the higher the likelihood I am wrong.....simply because I no longer am looking for anything other than confirmation that I am correct. Thus I never see the bus coming that runs me over.

IANAE's picture

...no doubt, he is preaching to the choir... it was like watching uncertainty's greatest hits.

cdm's picture


... and he sounded quite certain about his "bell-shaped curves".


good luck with that, Mr. Marks.


if you need me, i will be over here exploring

some curves of a more physical nature.





buzzsaw99's picture

risk has been abolished by the frauderal preserve

Xibalba's picture

In the Valley of the Blind the One-Eyed are kings. 

Kirk2NCC1701's picture

Here's how a teenager would explain it to his buddy...

Volatility is like "Waxing your carrot", and Risk is like "getting caught".

[looks around] Are we on the Air?

ebworthen's picture

Reminds me of that scene from "Fast Times at Ridgemont High" when Brad (Judge Reinhold) gets busted fantasizing about Linda (Phoebe Cates).


ebworthen's picture

"Risk is for the little people" sayeth Wall Street.

RaceToTheBottom's picture

The longer the FED plays, the bigger the probability tails become, until the distribution becomes all tails.

cart00ner's picture

Howard Marks is someone who can tell you to go f**k yourself in such a way that you will actualy look forward to it.

Tinky's picture

Taleb on Risk:


  • Consider that the turkey's experience may have, rather than no value, a negative value. It learned from observation, as we are all advised to do (hey, after all, this is what is believed to be the scientific method). Its confidence increased as the number of friendly feedings grew, and it felt increasingly safe even though the slaughter was more and more imminent. Consider that the feeling of safety reached its maximum when the risk was at the highest!
  • Much of the research into humans' risk-avoidance machinery shows that it is antiquated and unfit for the modern world; it is made to counter repeatable attacks and learn from specifics. If someone narrowly escapes being eaten by a tiger in a certain cave, then he learns to avoid that cave.
  • It does not matter how frequently something succeeds if failure is too costly to bear.
  • Under opacity and in the newfound complexity of the world, people can hide risks and hurt others, with the law incapable of catching them. Iatrogenics has both delayed and invisible consequences. It is hard to see causal links, to fully understand what’s going on. Under such epistemic limitations, skin in the game is the only true mitigator of fragility.
teslaberry's picture

hahah, he calls 2008 " a little trouble" yea, that's what kramer was saying in 2008. after he told everyone to buy the things that got into a little trouble. 


this is called REWRITING HISTORY. the past is over , high crimes and misdemeanors will be forgotten in the morass of history. 

disabledvet's picture

A simpler way to express risk is by looking at the law, namely "why did you your great grandmother's entire portfolio in Yahoo stock...back in 2008?"

Great investors...indeed the greatest like Buffet..."age well." They actually aren't afraid to go all in "in spite of what the number by the name says."

In short they know that professional money managers exist and they're paid to generate alpha, especially when they're young. Buffet is a case study in taking truly stupendous bets on single companies. (American Express, Coke, etc.)

This is not normative...and has generated excess returns beyond belief for ye olde Oracle o Omaha. If you'd done the same with say...GE however...well, you get my meaning.

This is why investing in companies like Tesla, Amazon, Netflix, et al are really hard to figure. "By definition you're throwing money away"...yet what you can be certain is that it's not "stale" money. There is a business model...sometimes it makes more sense to the managers than the owner actually. (Tesla is a classic case in my view.). But seriously...there is no way to "value" growth such as this. The best that can be said is "I know it when I don't see it"...for example Wal Mart.

And of course then there are companies that simply get no love period...although in this particular moonshot (number 4?) that has been pretty hard to find. Wisconsin Energy was my favorite company as a result of the "Greenspan Call" and to so they've overachieved is like calling Charlie Chaplin an okay actor.

So what "truly" is the risk then? In my view right now it's purely in execution...there is no shortage of folks throwing money at this thing..."but can the team deliver?" And simply put "this is unknowable"...or what philosophers call "epistemological risk."

This is also true in many other fields and endeavors...for example "geo politics." How is one to know whether an "Operation Trident" is actually an invasion of a foreign nation? And the answer is of course "only on the execution of said training exercise can we find out."

Mario55's picture

Howard Marks does not change: a lot  of patronizing blah blah to say nothing subtantial.

Catullus's picture

This was dumb. This person has $91 bn under management?

Risk is quantifiable. Uncertainty is not. That the future is uncertain is given. You don't have knowledge of the future. These words are not interchangeable.

There's also the difference between case and class probability. Case probability is the likelihood of certain events occurring. Class probability is the likelihood that certain cohort of a set will have something occur (like 4 people of this set of 300,000 will die in car accident next month. I don't know which ones, but you know it will occur)

So there are risks that you can evaluate for any investment that are specific to the thing you're investing in or are part of large secular movements of money in or out of the investment class. It's unlikely that the government will default on specific bonds, but it could default on the shorter term bonds which would effect the entire class of treasuries.

Hungarian Pengos's picture

Marks is probably the only Wall Street guy I like.  He's a singles and doubles hitter.  Sometimes he connects while trying to hit a single and blasts a HR, but that wasn't the intent.

One thing I've learned over many years is that "risk" = "crap investment".

Chief Wonder Bread's picture

   There’s far too much randomness at work in the world for future events to be predictable. As 2014 began, forecasters were sure the U.S. economy was gaining steam, but they were confounded when record cold weather caused GDP to fall 2.9% in the first quarter.


That's funny.