Howard Marks' First Memo and the Significance of "Avoiding Losers":

  • In 1990, Howard Marks published his first memo titled "The Route to Performance" which discussed the phrase "if we avoid the losers, the winners will take care of themselves."
  • The phrase emphasizes the importance of risk management and avoiding investments that have a high chance of failure.
  • Marks shares an anecdote about a value investment firm that had a terrible year due to heavy exposure in banks. The head of the firm claimed that in order to be in the top 5% of money managers, one must be willing to be in the bottom 5%. However, Marks disagreed with this approach as it doesn't align with client expectations or his own.
  • He also mentions another experience where he learned from Dave Van Benskoten, who ran the General Mills pension fund. Despite consistently being in the second quartile every year for 14 years, their overall performance placed them in the fourth percentile. This highlights how even one or more terrible years can significantly impact long-term performance.
  • Marks explains his approach to investing by using an analogy with straight bonds. If you invest in non-convertible bonds expecting an 8% yield to maturity, your goal should be to avoid defaults rather than searching for future winners. By holding a highly diversified portfolio without any defaults, investors can achieve their promised yield.

Risk Control vs Risk Avoidance:

  • Marks discusses the difference between risk control and risk avoidance when it comes to investing.
  • He emphasizes that investing is about intelligently bearing risk for profit while acknowledging that there are uncertainties regarding future events.
  • Risk control involves managing risk intelligently and understanding that higher returns often come with higher risks. It's about taking calculated risks and making informed decisions based on analysis and research.
  • On the other hand, risk avoidance means completely shying away from taking risks. While it may reduce potential losses, it also limits the potential for higher returns.
  • Marks highlights that investors should aim to bear risk intelligently rather than avoiding it altogether. Avoiding risk may lead to missed opportunities and lower returns.

Tennis Analogy: Winner's Game vs Loser's Game:

  • Marks uses tennis as a metaphor to explain the choice between focusing on winners or avoiding losers in investing.
  • He references an article by Charlie Ellis that distinguishes between two types of tennis games: winner's game and loser's game.
  • In a winner's game, skilled players focus on hitting shots that their opponents can't handle, aiming for winners. They have control over their shots and can take risks without worrying about external factors.
  • In contrast, amateur or club-level players play a loser's game where they aim to keep the ball in play until their opponent makes a mistake. The goal is not to hit winners but to avoid errors and let the opponent lose points.
  • Marks emphasizes that both approaches have their merits, but investors need to assess their skill level, return aspirations, and tolerance for volatility before deciding which strategy suits them best.

Balancing Winners and Losers:

  • Marks discusses the risk associated with focusing too much on winners or not taking enough risk.
  • While there is a temptation to go for more winners in investing, especially when trying to beat market indices, it requires specific skills such as accurately predicting future events or timing market movements.
  • However, even if one successfully hits more winners, excessive risk-taking can lead to greater volatility and potential losses.
  • On the other hand, avoiding losers may result in missing out on potential gains. It is important to find a balance between offense (seeking winners) and defense (avoiding losers) based on individual skill levels and risk tolerance.

The Impact of Alpha:

  • Marks mentions the importance of alpha in investment strategies when discussing his graph depicting risk-return trade-offs.
  • Alpha refers to the ability of exceptional investors to produce asymmetrical outcomes, where their good outcomes outweigh the bad ones.
  • By generating alpha, investors can achieve better returns without necessarily taking on higher levels of risk. It allows them to outperform market averages and beat competitors.
  • However, Marks acknowledges that most investors do not have alpha-generating abilities and should opt for safer investments like index funds or high-grade bonds.

The Importance of Holding Investments:

  • Marks emphasizes the significance of staying invested in the market rather than constantly buying and selling based on short-term fluctuations.
  • He highlights how holding a diversified portfolio over the long run has historically yielded positive returns, with the S&P 500 averaging over 10% annually for a century.
  • Trying to time the market or actively manage investments often leads to subpar performance compared to simply being invested and avoiding mistakes.