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The Most Important Thing Illuminated
by Howard Marks
January 8, 2014
My MBA is finally coming to an end. So I can get back to more books. Trailing behind the Intelligent Investor, these two books have the most profound influence over my investment strategy. Must read. The most important thing illuminated is a list of 20 items. Here, I jotted down some of my notes.
1. Second-level thinking.
2. Market Efficiency. We should use "rebuttable presumption" on EMT. Assume EMT hold until proven otherwise. Inefficiency is necessary to achieve superior performance. Being too far ahead of your timing is indistinguishable from being wrong.
3. Value
4. Price and value
5. Understand Risk. Define risk as "the likelihood of losing money" as oppose to volatility, as defined in textbook. Risk is subjective, hidden, and unquantifiable.
6. Recognize Risk. Investment risk comes primarily from too-high price
7. Controlling Risk.
8. Being attentive to cycles. Rule1. Most things will prove to be cyclical. Rule 2. Some of the greatest opportunities for gain and loss come when other people forget about rule 1. The best loans are made at the best of times. When cost of capital is greater than return on capital, it creates capital destruction, and follows by market downturns. Cheap money cause overexpansion which lead to dramatic loss.
9. Awareness of pendulum. 2 main risks in investing are 1). Risk of losing money 2) risk of missing opportunities. It is possible to eliminate either one risk but not both.
10. Combating Negative Influence. These are 1) greed 2)fear 3)tendency to dismiss logic 4) tendency to conform to world view 5) envy 6) ego 7)capitulation
11. Contrarianism. Buffett “The less prudence with which other conduct their affairs, the greater the prudence which we should conduct over our own affairs.” It is our job as contrarians to catch falling knives.
12. Finding Bargains. Failure to distinguish between good assets and good buys set most investor into trouble
13. Patient Opportunism. Waiting for bargain is often your best strategy. Mujo, from Japanese early culture, the turning of the wheel of the law. Cycule will rise and fall, thus we must recognize, accept, cope and respond.
14. Knowing What You Do Not Know.
15. Having a sense for Where We Stand. The riskiest is when too much money chasing too few deals. Low interest leads to price are bid up, leads to return shrinks, leads to risk go up.
16. Appreciate the Role of Luck. First thing Howard learned at Wharton is that "the quality of decision is not determined by its outcome."
17. Investing Defensively
18. Avoid Pitfalls. You must avoid outliers. Psychological errs includes1)succumbing to negative influence. 2)Error of not noticing . 3)Error of omission .ie. fail to sell when its overvalued. We can watch for pitfall by learning from the past.
19. Add Value. Assess in term of beta and alpha. Risk-adjusted return holds the key, even though – since risk other than volatility cannot be quantified – I feel it is best assessed judgmentally, not calculated scientifically.
20. Reasonable Expectations
21. Pulling it all together. This offers an re-cap of the book.
11 lessons learned from crisis:
1) Too much capital availability makes money flow to wrong places.
2). When capital goes when it should not, bad things happen.
3)when capital is oversupplied, investor compete for deals by accepting low returns and a slender margin of safety.
4). Widespread disregard for risks creates greater risk.
5)Inadequate due diligence leads to investment losses.
6)In heady times, capital is devoted to innovative investment, many of which fail test of time.
7)Hidden fault lines running through portfolio can make the price of seemingly unrelated assets more in tandem.
8) Psychological and technical factors can swamp fundamentals.
9)Market changes invalidating models.
10)Leverage magnifies outcome but does not add value.
11)Excess correct. “when there is nothing clever to do, the potential pitfall lies insisting on being clever.”