As the title will tell you, this memo is about the risk that H. Marks argued to be present in the 1994 markets. The risk H. Marks argue are related to two powerful trends. The first being the decline in interest rates to a thirty year low and the second being the “fabulous performance” by almost all securities during the 1991-1993 period. In conclusion, H. Marks argues that the markets at that point are predominated by greed. Reading this memo I can’t stop to think about the resemblance to the market environment that we are currently in. In other words, I believe one should read this memo with the M. Twain quote echoing in one’s head:
History doesn’t repeat itself, but it does rhyme. – M. Twain
Please comment if you have read the memo and what you thought of it. Also, if you have found a worldly wisdom in the memo that you think I should have included please comment on that as well. I’m very interested in what caught your eye while reading and why.
Worldly wisdom’s from Risk in Today’s Markets – 1994
“I think it’s important to remember, though, the symmetrical nature of most investments: almost every sword is two-edged, and he who lives by a risky strategy may die by it. Investments which will make you a great deal of money when things go well but not lose you a lot when things go poorly are very rare, and their existence must presuppose extremely inefficient markets.”
My thoughts: Or as W. Buffett likes to say; “Only when the tide goes out do you discover who’s been swimming naked.“.
“Comparison against low interest rates makes low earnings yields and dividend yields seem tolerable. Likewise, low rates increase the discounted present value of companies’ future earnings as calculated by valuation models. For these reasons and others, many valuation indicators are at levels today which have proved dangerous and unsustainable in the past. Just as today’s low interest rates are pushing investors toward riskier securities all along the “food chain” described above, however, this sword can also cut the other way.”
My thoughts: H. Marks explains in a simple way the “consequences” of a market environment with low interest rates. I would argue that we see the exact same thing happening in todays markets, i.e. interest rates are pushing investors toward riskier securities.
“Another adage I’m fond of is, “What the wise man does in the beginning, the fool does in the end.” No course of investment action is either wise or foolish in and of itself. It all depends on the point in time at which it is undertaken, the price that is paid, and how others are conducting themselves at that moment.
When everyone shrinks from a security because it’s “too risky,” the few who will buy it can do so with confidence, secure in the knowledge that the price has not been bid up, and in the likelihood that others will eventually outgrow their fear and jump on the bandwagon. Today, many prices have been bid up, and the bandwagon is already crowded with wild-eyed investors.”
My thoughts: What I would like to highlight in the extract above is the “how other are conducting themselves at the moment” part. You don’t have to know where the bandwagon is going, just make sure that the bandwagon isn’t already “crowded with wild-eyed investors” and force yourself onto it. It’s perfectly okay to stand on the sidelines when all the seats are taken.
“We do not preach risk-avoidance. In fact, the knowing acceptance of risk for profit is at the core of much of what we do, and we feel there is an important role today for investing which is creative and adaptable. But we would take this opportunity to exhort you to review most critically the risk associated with your current and contemplated investments, and not to be among those who uncritically joined the trend toward risk. Whatever investment opportunities you decide on, we would encourage you to stress thorough appraisal of the risks entailed and cautious implementation.”
My thoughts: With so much emphasis on risk-control in the earlier memos it is easy to confuse H. Marks/Oaktree philosophy as being “risk-avoidant“. However, they are far from the same thing as H. Marks points out above.
“Exploitation of opportunities in inefficient markets; insistence on preserving capital; refusal to pursue maximum return at the cost of maximum risk; specialization rather than dabbling; heavy emphasis on careful analysis; use of less-risky senior securities — these themes have been the cornerstones of our approach over the years. They remain highly relevant and should continue to be pursued by all of us, especially at this point in the cycle.“
My thoughts: With the exception of “use of less-risky senior securities” I aim and hope to establish the same cornerstones in my approach to investing.