A week ago I had the privilege to attend a lectureby the distinguished and inspirational Howard Marks of Oaktree Capital. The lecture was part of the CFA eminent speaker series. The room was packed – one of the highest turnouts the CFA have experienced for such an event.
Howard based his lecture on his 2014 memo “Getting Lucky”. His thesis is that his own success and that of most other successful people have been vastly influenced by being lucky – a combination of being born at the right time, in the right country, going to the right schools, getting the right jobs and making the right investment decisions.
So why would so many people turn out to hear someone claim they’d been lucky? The audience were interested in Howard’s assessment of the investment industry and what is likely to work and not work in the period ahead. Is it necessary to be lucky? If so, is it possible to improve the odds of being lucky?
Howard described how luck happens when preparation meets opportunity. Investment performance is what happens when events collide with an existing portfolio. The future is, of course, unknowable. We only know that we will be surprised by events. Several things need to happen for an investor to be right and to make money: the analysis has to be correct, the future has to develop as per the investors’ expectations and the timing has to be right too! Luck is required, and it plays a huge part in the outcomes.
But luck alone is not enough – successful investing requires both technical skill (to be able to find mis-priced assets) and the existence of inefficient markets – nobody can beat an efficient market, since the market is already pricing in all available information. Howard thinks that no market is perfectly efficient since that would require participants to be objective and unemotional – which they are not, due to being human beings.
His conclusion is that markets are “cyclically inefficient”. In March 2009, investors were so fearful that prices were pushed to levels that Howard has described (in his book “The Most Important Thing”) as the most attractive investment opportunities he’d ever seen in his working career (figure 1 shows the picture for global equity markets).
In more normal times, when pricing is closer to fundamentals, it’s almost impossible to make decent returns other than by luck. This is part of the reason that we believe that an emphasis on incremental alpha, churning out excess returns month by month, may not always be the best strategy. The focus of a sustainable investment strategy must be on understanding when and where the inefficiencies in markets arise.
Hearing Howard Marks speak was a timely reminder of several things. We need a combination of good analysis (to identify mispriced assets), that markets are not efficient, that patience is required (he mentions patient opportunism five times in the book) and that luck plays a significant role. There are not many investors who come close to thinking along similar lines to the Episode philosophy. “The Most Important Thing” and Howard Marks’ memos are close.