Interview with Howard Marks: Masters in Business (Audio)

Dear Lord, this was a master class in everything from investing to valuation two cycles to managing your own emotions. This is one of those podcasts that I guarantee you will listen to two or three or four times. My job was to just push Howard a little bit in one direction and then stay the hell out of his way. He is so experienced, knowledgeable, smart, insightful, full of wisdom, charming and and he also has a bit of a devilish sense of humor, which I don't know if you'll

hear it. But the things we discussed um off camera, so to speak. I just find his his insights and his perspective delightful. I I could go on at great length of all the things we discussed. I won't. I'm just gonna say, with no further ado, my ninety minutes with Howard Marks. This is Masters in Business with Barry Ridholtz on Boomberg Radio. My special guest today is Howard Marks. He is the co founder and chairman, co chairman, co chairman of oak Tree Capital Management, and he has a

long and storied history on Wall Street. Rather than go through all of the details, will discuss it as we as we get to it. I am compelled to mention that oak Trees seventeen distress debt funds have averaged after fees for the past twenty two years, far outpacing it's their peers. That's about as much of an intro as I think we really need. Let's jump right into this. I find your history really fascinating. You minored in Japanese studies.

Ever plan on doing something besides finance? I never did. I was a Wharton kid. But at those days, in the mid sixties, you were required to have a non business minor and also to have one semester of the literature of a foreign country. Most people took English or

French for some reason. I have no recollection of I took Japanese and I loved it, and so I turned that into my minor, and I took fifteen credits in the You would uh what was then called the Oriental Studies Department, and and you had always wanted to go into finance, and I think that's reflected you ended up graduating from Wharton with a major in finance an MBA from University of Chicago, and then you move over as an equity analyst at City Corps. Eventually you become the

director of research there. Before you find your way to the Trust Company of the West and there you end up focusing on distress that high yield bonds and convertible securities, before you became their c i O for fixed income. How do you transition from equity analysts to fixed income analysts? It was a real life story, not a dream story. Um, as you say, I was director of research for equities from seventy five seventy eight. The bank was what was

called the nifty fifty investor. We've invested in the fifty best and fastest growing companies in America. And it was a disaster because the official dictum was it didn't matter what price you paid. The prices paid were highly excessive. That corrected in the seventies. The the investor in these great companies probably lost eight of his money, haven't Haven't we heard that expression it doesn't matter what price you pay,

you just have to own this. Well, we do hear that, And of course that's exactly the wrong thing to say. What I say is there no such thing as a good idea or a bad idea in the investment world without reference to price. It's not what you buy, it's what you pay. And finally, investing is not a matter of buying good things. It's a matter of buying things well and meaning at at the appropriate value. And people or less, and people who don't know the difference shouldn't

be in the business. Well that that seems to be an issue that comes up anyway. The bank faltered with this fifty fifty. They thought it would be great if they had somebody other than me as director of research. Uh and Uh. I asked my boss, uh, Peter Vermilier, Uh, What's what's next? He said, I'd like you to start a convertible bond fund. So I moved over to the bond department in May of seventy eight, started the fund in August, and in August I got the phone call

to change my life. My The head of the bond department said, there's some guy named Milken or something in California and he deals with something called high yield bonds and can you figure out what that is? A client had had come in and asked for Ohio bond fund and they asked me to be the manager and that that put me in the right place at the right time. So it was a pure luck, just serendipity. You he hasn't invest you in this client, and I'd come in

with that is my only contribution. Barriers that I was smart enough to say, yes, I'm gonna I'm gonna challenge you on that a little later. So that leads to an interesting question, how did your experience with both being an equity analyst and the obvious problems with buy it at any price in the how did that affect your approach to either high yield or subsequently distressed assets. Well, what I would say is number one, you learn nothing

from success. You only learned from failure. You learn from experience. Experience is what you got when you didn't get what you wanted. And so so the experience of buying top quality assets and losing was very instructive, and it, as I say, it convinced me that the key is the price you pay. Any there's no asset which is so good that it can't be overpriced. There are few assets

which are so bad that they can't be underpriced. So when I switched into the HYO bond field that everybody thought was disreputable and unseemly and non fiduciary, and they called the junk you know, and I said, well, maybe maybe if it's so disparaged, maybe you can find a bargain.

And in fact that was the case. The common thread between working in equities and working in high yield bonds or distress is that in most of the fixed income world, high grade fixed income treasuries and that kind of thing, the only thing that matters is the direction of interest rates. Interest rates up, price down, because everybody assumes there's no credit risk. When you get down into hyel bonds and

distress debt, there is credit risk. I describe it as fixed income where what the company does matters, so you had better be able to judge the future of the company, just like you do as an equity analyst. So it was really the right skill set applied to the right asset class. I'm still taken by the phrase experience is what you get when you don't get what you want. Do do we credit you for that? Or or has that been around longer than you? Well, I'm too old

to remember where I got it, so you may. I'm Barry rid Hilts. You're listening to Masters in Business on Bloomberg Radio. My special guest today really needs no introduction. He is Howard Marks. He is the co chairman and co founder of oak Tree Capital, which is now a publicly traded company and has done extremely well for its long term clients. Let's talk about what you're probably best known for, the Chairman Chairman's Men memos, which you put

out every quarter. And I will quote no lesser an authority than Warren Buffett who said, when I see memos from Howard Marks in my mail that the first thing I opened and read I always learned something new. But but that's today, and when you first began these a few decades ago, that really wasn't what the response was like. Tell us about what happened in the early When did the memos begin? I started in I'm not again, I don't exactly remember why, um, but I remember the events.

I went to the Midwest. I met with the head of pension funds of General Mills, and he explained to me that over the fourteen years he had run the fund, he was never above the seven percentile or below the forty seven percentile, and as a result solidly in the

second quartile for fourteen years. The funny math about it in our business is if he can do that for fourteen years, you end up in the fourth percentile for the entire fourteen year period, because most people who do well for a while shoot themselves into foot ten or bottom tent exactly. So I was very impressed by that. And then I came home and h some famous value management firm had had a really tough time because they were heavy in the banks, and the banks suffered terribly.

And the president comes out and he says, well, you know, of course, if you want to be in the top five percent of money managers, you have to be willing to be in the bottom five percent. And I said, how wrong can you be? I I my clients don't care for him in the top five, and they're absolutely unwilling to be in the bottom five. I like the other approach, where you're to lead just above the middle, and that puts you at the top for the long run.

Second quartile over long periods of time leads to top five percent if you never have that terrible year to pull you down. So so I published the first memo called the Route to Performance. The Road to Perform its the route to the route and the interesting question what kept me going because as you say, I had, the response was thundering. I never had a response. For the first ten years, I never had one response. I never nobody ever said, good memo, and nobody said I got it,

and I wrapped the fish in it. I have to I have to stop here and emphasize this. This is pre Twitter, pre Facebook, pre email. You were literally spending time running a memo, printing them out, folding them, addressing envelope, stamping them, inserting paper into envelopes, and taking him to the They used to have this thing called the mail um the post office, and you could mail envelopes that way. So you're doing this for a decade and I might as well have thrown them in the drain because I

never heard back nothing. But of course to hear back, somebody would have had to either write me a letter and put a stamp on it and put it in that thing called the post office, or pick up the phone, and nobody did. So it's a solid So the question that that naturally leads to is you have to be very self motivated to express your views if you're sending this out to deafening silence. And I I was writing about stuff I believed in, and this was it was quarterly.

Then is that right? No? No, there was only one in ninety and one in ninety one, and and uh, then it started to pick up a little bit. I don't remember. I never did it with the regularity in mind. And by the way, during the crisis, I probably did ten a year because there was so much to write about. Sure, so that that's amazing you kept going and then something changed into thousand. On the first day of two thousand, I wrote a memo called bubble dot com about the

possible fragility of the tech bubble. Uh, and that had two virtues. Number one, it was right, and number two it was right quick. It was timely. So because if you're right, but it takes three years to happen, they don't remember you. You know, there there's there's there's saying in our business. Well, that's right if it was saying in our business that being too far ahead of your time is indistinguishable from being wrong. But this was right quickly.

And so I say, I think I said in the introduction to my book that that made me after ten years, I became an overnight success. And I remember that memo. Barrens picked it up in the Wall Street Journal picked it. It made the rounds, and it was suddenly that that's exactly right, just like Playboy magazine at Summer Camp. Right, it made the rounds, to say the least. So so you don't recall what motivated you to start it. And aside from that dot com memo, what the bubble dot com?

What other ones really are memorable and stay with you? I think two indicate the process for taking advantage of extremes of the cycle, and which is very important to me. And in March of oh seven, I wrote a memo called the Race to the Bottom, which you talked about the fact that when investments are in short supply and people are in heat to make them, they will bid to an extent that that makes them bad investments. And

then in of course, then we had the crisis. And then in mid October eight, which was the depths of the crisis, I wrote one called Current Developments um and and another, well maybe the better one called the Limits to Negativism, in which I said, you know, everybody knows that investing requires skepticism. And most of the time skepticism consists of saying no, no, no, that's too good to be true. But in the depths of a crisis, skepticism requires you to say no, that's too bad to be true.

And people were telling such horror stories and nobody could imagine any assumption which could not be exceeded on the downside. And I said, hey, people are just being too pessimistics. We actually heard people say stocks are going to zero well and and the financial world is going to melt down. And and you know, most of my I don't think these things up in my head, Barry, most of these

things stem from some experien experience. And so I had a meeting with the pension manager was trying to talk that pension fund into investing in a levered loan fund of fund of loans that was had leverage and the levered return on the fund. Seeing loans was in the twenties, and he well, not only that, but he said, well what about if they are defaults? And every default scenario that I assumed, the c I oh said well what if it's worse than that? What if it's worse? What

if it's worse? No, and I and and eventually I ended up saying, do you have any equities in your pencrofun And the c IO said yes. I said, well, then you better run out and sell them, because the the environment you're pushing me to assume everything is valueless. And so I ran back to my office and I wrote this memo, The Limits to Negativism, which says, sometimes you've got to say no, it can't be that bad. I'm Barry rit Hults. You're listening to Master's in Business

on Bloomberg Radio. My special guest today is Howard Marks. He is the founder and co chairman, co founder really of oak Tree Capital Management, which is now a publicly traded company specializing in distress debt, convertible securities, a whole run of different fixed income related investment. And let's talk a little bit about distress debt. I look at the high yield market rates now, and there's low as they've been since, which is kind of surprising. What is that?

What should we take from that? Well, Barry, people ask me, are we in a high yield bubble? And my answer is no, we're in a bond bubble, generally speaking, across the board. Does on the board, the central banks have pulled the interest rates so low that you know, all the the yields on all fixed income instruments are calibrated relative to each other. That's why we have what's called the yield curve. So if the maturity is longer, the yield is higher. If the quality is lower, the yield

is higher. If the liquidity is lower, the yield is higher. But they all start from the base rate. And the central banks said back in twenty nine or ten, let's make the base rate zero to get this economy going. And so the the incremental turn you get for taking time risk, credit risk, a liquidity risk is still about the same as history. But you were starting from such a low rate. So the yield on all bonds is extremely low, including high yield bonds. So you reference the

Fed taking rates to zero. Should they not have done that? Should there have been a fiscal policy instead of a monetary policy, what what options presented at that time. I think it would have been good to have. Well, in fact, we we did have some fiscal also, but not much. It would have been good to have some of that, you know, the uh we had, you know, deficit spending, the famous shovel ready projects and that kind of thing, uh, you know, would have been a good idea, were a

good idea. But I think that the the the monetary was essential. And I think that you know, basically, you can't quibble with with results. We went through the worst financial crisis in eighty years, and we pulled out of it very quickly, and here we are in and I would say for most people it is a distant memory, that's true. And especially when you look around the world, if it's if you don't like this economy, well don't look overseas, because we're by far the cleanest shirt in

the hamper. So people, that's a good one. So people say to me, you know, how do you grade Geitner and Banankee and Poulson and company on their handling of the crisis? And I said, you know, I don't know if I give him an A, but if you mark them on a curve, they get an A plus because clearly far they did far the best job in the world, and we are out of the crisis we had. We

have had a modest recovery. But you know, there are a lot of bad things that could have happened that didn't to to money market funds, to commercial paper and so forth. And here we are, uh in a very healthy environment. So I don't quibble with the people who pull us out of the crisis, and in fact, I think they did a hell of a good job. I would not have liked to have had that job at

that time. I'll quibble a little bit and saying you can give Paulson the A plus, Bernanking Geythner, we're part of the team that helped create the crisis, so I have to dock them a few points. But but but it certainly is Paulson who gets unmitigated credit to say the least's let's let's get back to um distress, Debton and and the issue you you raise here um about us doing fairly well. I noticed that credit spreads are the favorite weapon of the perma bear when they when

they get too tight. The answer as well, investors are so complacent and as soon as they start to widen. It's okay, here comes the next disaster. What is going on with credit spreads? And and why is it used as that double edged sword? Well, credit spreads are to some extent that indicator of psychology. Uh um. But you know, I don't believe in taking uh my instructions from the market.

I put out a memo about a year ago um as a result of a conversation I hear had here at Bloomberg where people were you remember, the markets got off to a terrible startlaship and everybody was bugging me. You know, isn't that a cell signal? If the market is holding into a cell signals? Right? So I ran back to my office again, and this time I wrote a memo entitled what does the market now? And I think it doesn't know much? But I but I do think. I do think that the that the credit spread is

an indicator of the values that are available. And when when credit spreads are wide, that means, for the benefit of your listeners, that the interest on low grade bonds is much higher than it is on high grade bonds, then I think you have substantial uh incentive to invest in low grade instruments. It also is an indicator of fear. That's why spreads are wide. When spreads narrow, it means

that people are less afraid. As you say, more complacent, I would say more risk tolerant, and that the reward for bearing incremental risk is on the decline, which is not a good thing. I'm Barry Ri Hults. You're listening to Masters in Business on Bloomberg Radio. My special guest today is Howard Marks of oak Tree Capital. Let's talk

a little bit about volatility and uncertainty. You have a number of delightful quotes about the future, and one of my favorite is investing concerns exactly one thing dealing with the future. Yet it's clearly impossible to know anything about the future. You can't predict, you can only prepare. Discuss that well, everybody who wants to engage in investing has to reach your conclusion as to whether the future is predictable or not. If you believe that is, you'll behave

one way. You will uh can reach a conclusion about what the future holds and put together the perfect portfolio for that eventuality. If you don't believe it, you will think about different possibilities and you'll put to together a portfolio that will suboptimize, that will do well under many of them, and not badly. And that's that's a difference of approach. I don't believe the future is predictable, you know. I I'm from the believers in what John Kenneth Golbreys said.

He said, we have two kinds of forecasters, the ones who don't know and the ones who don't know. They don't know. Well, I know, I don't know, and so I try to put together portfolios that will do well in a variety of environments, but without trying to make a prediction about here's what's gonna happen interesting exactly, here's

what's gonna do, Here's where's the recession exactly. So you can have a portfolio which is prepared for a variety of eventualities without uh insisting that any one of them is going to be the case. And that leads to another quote of yours. We can make excellent investment decisions on the basis of present observations with no need to make guesses about the future. Essentially what you just said.

That's right, you know. Let me make clear one thing, Barry, it would be great if we knew what the future held. It's not like I don't care. We would be great investors if we knew what the market was going to do tomorrow in which stocks would do best. But if you reach the conclusion that you can't know, then you look for another avenue to deal with the future. And I'm in that category, and that's figuring out what's happening today and adjusting it. So so I do something I

call take the temperature of the market. Okay, how does one take the temperature of the market. In fact, when we look at the market today, let's talk about stocks, the vix is pretty much as low as it gets for any extended period of time. Um, what does that tell about market risks? What does that tell us about the temperature of the market. Well, you you want to know what kind of thinking is being incorporated in investment decisions. If I was considering an investment, I could know only

one fact. I'd like to know how much optimism is incorporated in the price Because if there's a lot of optimism, then there's a lot of possibility of disappointment and if and if the if, if the truth turns out to be less good than the expectations, then the price will fall.

If there's no optimism, as there was back in October of oh eight at the depths of financial crisis, then I know we can buy risky assets aggressively because there's no possibility of disappointment or the the assumptions that are factored into the price are as negative as possible, or war. And so you know, oak Tree invested extremely aggressively between UM September fift oh eight, which was the day Lehman

went under, and the end of the year. We invested over half a billion dollars a week over that period, and that turned out to be mostly fixed income or was in a mix. Well, most of what we do is what we call credit, you know, non government fixed income,

and and most of it was distressed at UM. So the point is, uh, the temperature of the market was frigid, which meant there was no enthusiasm and we could buy you know, Buffett says, the less prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own affairs, which means if other people are unworried, we should be terrified. If other people are terrified, we should be aggressive. So you've talked a lot about

second degree thinking. I think a lot of people if I were to ask them if I could share with you one aspect of a stock or a market, they would say, tell me valuation. You're taking that a step further and saying tell me sentiment, and what is already reflected in valuation? So let's talk about second degree thinking. It's a phrase you've referred to repeatedly. Well, I actually call it second level second level right, Um, I think in terms of degrees because it's been so called out.

But what is second level thinking? Well, you you agreed with me earlier when I said, if you think like everybody else, you'll take the same actions as everybody else. If you take take the same actions as everybody else, you'll have the same results of everybody else. So, and by the way, it seems mathematically unarguable, Well, if that's true, then in order to be a superior investor, you have think different from everybody else. And that about different is

not enough. He has to be different and right. So to some degree, this is Keynes's famous beauty contest. Yes, this is absolutely Can's hypothesized a beauty contest in which the newspaper ran the pictures of twenty young women. It was a very Chopin's time, and and he offered a prize or the newspaper offered a prize to the reader whose entry ranking the girls in terms of prettiness was

closest to the average entry. The first level thinker says, I'm going to figure out which girls are the prettiest. The second level thinker says, I'm going to figure out which girls the average reader will say are the prettiest. That's how you win the contest. Now, don't you run into the next digression, which is the next person thinking, I'm going to think how the second level thinkers? At what point do investors start to outsmart themselves? Can you

take that thinking too far? Yeah, well you can go to third level and fourth level, but I think second level is good enough. You know, I mean you when you get into the question of trying to figure out which girls the average reader is going to conclude, the average reader is going to say that is the produced He gets very complex. And so with with the niceties, you have to kind of factor in the realities of can you do it? So if you can merely come up with a better sense of value and write price

than others on a consistent basis. I think that's good enough without going to third and fourth levels. I like the way that sounds. Let's let's talk a little bit about the opposite of um trying to guess how other people are going to guess and bypass it, and talk a little bit about the shift towards passive investing. In indexing.

Some people have said, we don't want to try and guess what's the best stock is, or what other people are gonna think what the best stock is, just by the whole thing and not worry about it well, and in fact, Barry, some people are observing that most people who try to do that don't do it well, and that the average UH mutual fund doesn't add value. Well, it's obvious that on average, the average investor does average before fees and below average after fees and trading impact.

So now there's a ground swell toward what's called passive investing or indexation. You're buy an index fund, you buy a fund. Ad bused a little bit of everything. By the way, this theory was advanced fifty years ago when I started at the University of Chicago, So it's nothing new. It's a sign of how thinking goes. That it took fifty years for it to take hold. But the point is John Vogel at Vanguard and to the Index Fund, I don't know, probably okay, forty years ago and and

it's been creeping up. But the movement toward passive has become a ground swell in the last year or two because a lot of people are throwing in the towel.

And basically the stems from University's Chicago work on something called the efficient market hypothesis, which said that so many people are out there trying to make money in the market, and they're all intelligent, computer literate, with access to databases, highly motivated, objective, and clinical, and that that their efforts to find bargains and over pricings cause prices to converge with something called intrinsic value, so that there are no bargains.

And if there are no bargains to be found or over pricings to be avoided, then you can't beat the market. That's the theory we've been speaking with Howard Marks. He is the co founder, co chairman and co c I oh are you still co cee? Dishwasher Code Dishwasher of Oak Tree Capital Management. Be sure and stick around where we keep the digital tape rolling and continue to talk about all things valuation. Uh. Be sure to check out my daily column on Bloomberg dot com or follow me

on Twitter at rid Halts. We love your comments, feedback and suggestions right to us at m IB podcast at Bloomberg dot net. I would be remiss if I did not say you can find all of Howard's really delightful and and beautifully written memos at oak Tree Capitol dot com or his book. We didn't even get to the only thing that matters his book. Uh. The only thing

that most, the most important thing. The only thing that matters is the book, which is the most important thing, and you can find that at Amazon or at fine bookstores near you. I'm Barry Rihults. You're listening to Masters and Nous on Bloomberg Radio. If you're having a business dispute, the process can be slow and drawn out, especially if you rely on litigation in the courts. You can wait for years before your case is resolved, and the longer

your case proceeds, the more your case can cost. Not with the American Arbitration Association, arbitration or mediation with the American Arbitration Association is faster. In fact, nearly fifty of our cases settled prior to hearings. A d r dot org resolve faster. Welcome to the podcast. I don't know why I do this every time, Howard, Thank you so much for doing this. I always find it delightful and

instructional anytime we get to sit down. Someone said to me the other day we were just in Toronto, I guess before winter, at at a c f A events and someone said to me, you know, I've either listened to or seeing you interview Howard multiple times. You've become the Howard Marks whisperer and I'm My response was, I'm pretty sure he doesn't need a whisperer. He's pretty uh

articulate on his own. UM, so let's keep talking about the market, because there's so much stuff we didn't get to and so many things we were last speaking about UM indexing, Bill Miller had a really fascinating quote. He said, the problem with active management is an active management. The problem with active management is most of those managers are essentially high cost closet indexers. UM. What do you think

of something like that? Well, I do think that most people ken for maybe career purposes, to hug the benchmark and to have a portfolio which is not very different from the benchmark, in which case you're wasting your money by paying him or her fees. You can get the benchmark for probably six basis six basis points as six hundreds of a percent, and active managers probably get close to a percent on average. I think those numbers are

about right. Okay, So that means the average manager is charging uh eight four ninety four basis points more, which is a straight subtraction from the performance of their funds. And if they don't add at least ninety four basis points uh to the return per year, you might as well go into an index. And that was his point. He said, if you want to do active, then really do active. Don't waste your time with Well, that's well, that goes to what I mentioned before my memo, dare

to be great, dare to be great. In order to outperform, you have to dare to be different from the index, which means you have to be dare to be wrong. You have to be willing to either accept a draw down or a significant under performance in any given year. Exactly there is no The interesting thing about investing is that there is no approach which is guaranteed to work. There can't be, given the nature of markets. Nature's markets

abhor certainty. Right, And I'm so glad you said that because this has been a peeve of mind forever, because you I want to repeat what you said, markets abhor certainty every time I flicked on the TV. Some clueless pondit is saying markets hate uncertainty. And if you think back, the only time there's certainty is at extreme tops or

extreme bottoms two thousand. When you did the dot com bubble in in January two thou markets were sure, they were certain, valuations didn't matter, Trees go to the sky, everybody loves it. And back in oh nine March oh nine, markets are going to zero. There is no value that is cheap enough. It's all terrible. So I like your quote better markets abhor certainty. Well, you know, maybe Barry should rephrase No, No, I'm I'm You're stuck with that one.

I'm keeping it. How would you want to rephrase that? Because that's pithy. I think that investors like certainty, it's just that it's usually wrong and wrongest at the extremes. That's a that's a good it's less of a sound bite. It's less of a sound bite, but it explains exactly

markets a poor certainty because investors listen. If you're comfortable, then it's probably not a lot about performance because to get to that point, you have to do something that is intuitively uncomfortable and and countervailing to what the crowd is doing. Well. Dave Swenson, who runs the Endowminant Yeah, which is been a performing endowment for decades for He's been doing it for thirty years and he has great,

great results. He said in his book Pioneering Portfolio Management that that investment management requires the maintenance of uncomfortably idiosyncratic positions, which, in the light of so called common sense or conventional wisdom, appear uh irrational. In other words, what everybody believes, common sense, common wisdom is is factored into the price of the stock. If you're going to find a bargain, you have to find the times when consensus is wrong. You have to

diverge from consensus, which can can only be uncomfortable. Makes sense, Yeah, you have to be idiosyncratic, and people will look at you and you say, who is that not selling out of his tech stocks in the first quarter of two thousands, which raises the question You're not just in an ivory tower penning notes and sending them out and not caring if people responding. Your oak tree is now running forty hundred d hundred billions. In two thousand, you guys were

still running billions of dollars. So you have real clients with real assets at risk, real money at risk, and their jobs on the line. Because your clients are primarily institutional, How do you handle when something looks idiosyncratic? People say how it has finally gone off the deep end this time? And the phone start lining up in the office, Hey, what are you guys doing? How do you manage that? As as a as a company? How does the organization handle well? I think one of the money manager's most

important jobs is client education. And hopefully we've convinced our clients by now that you have to be contrarian, and you have to look wrong for a while, and and and so forth, um and and it's our job to hold their hands when we do extreme things. You know. I wrote this memo current Developments back October the eighth of eight, probably the low point of credit. And I mentioned that I was talking to a reporter at that time. He said, what are you doing? I said, we're buying.

He said to me, you are like that with an exclamation point. Well, everybody else he spoke to a selling, right, and and uh. And so when everybody, if there are a hundred money managers in are selling, what do you want to do? You want to buy or sell? You want to be the Well, actually the answer is most of the time the crowd is right. It's at those extremes where I want to be on the opposite side. But only at the extremes. Are ninety nine out of

a hundred selling, that's right? And and if a hundred selling, then there must be no optimism in prices. Prices cannot be high relative to intrinsic value. You can't lose by buying. So what about the process. We've seen this happen over and over again with especially with value stops. I assume it's similar with distressed assets or anything credit related, which is just because something is cheap doesn't mean it's not

going to get cheaper. There's there's a famous quote, um David Einhorn said, a stock that's down is a stock that was down before it got got in half. So how do you know? I love that line. How do you know when you're early? You're not. You're not necessarily gonna take the bottom. You're prepared to buy something and keep buying it as it continues to fall out of bed. You never know when you're at the bottom. It is logically impossible because what is the bottom. The bottom is

the price below which things never went. You went. That's a past tense work. You can only assess the bottom in the past tense. So if you can't find the bottom, what can you do? You can buy that that smile at the bottom of what I would say. You can buy when it's cheap. That's all you can do, even if it's quote unquote early, even if it's early, because you don't know if you're early or not. But if you're if you're really no value, then you know when

things are cheap. So the debt, by the way, and you have to bear in mind everybody wants to be a successful investor has to bear in mind the cheap and going up tomorrow are not synonymous. And so if you buy because it's cheap, it goes down, you buy more it's still cheap, you keep buying. No, it's cheaper, it goes down more, you buy more. If you liked it at nine, you're gonna love it at eight and at seven. And then you run out of money and you raise more money and you keep doing it. But

eventually you have to be proved. Right, So what at what point does um At what point do you say to yourselves, I'm out of money, I need more capital, and you go back to the client base. What what do they say in response to that? Well, sometimes they say, you know, we have faith in you, here some more money. And sometimes they say, you know, you're obviously a moron.

They actually say that too, Well, not that word, but I mean they're like I described that that experience in October eight when I went out to get people to invest in a levered You raised a lot of money for that fund, didn't well, not the levered loan fund. We reached a point where on the levered loan fund where we we needed money and we couldn't get the

clients to put it up anymore. We had a shortfall. Uh. The irony is I felt that it was my responsibility and I put it up myself, your own cash because the clients did the last dollars. It would have been unfair if I would have stepped in front of them and put my money into in place of them, but if they refused, I put it in. It was one of the great investments I ever made. What were the returns of that from eight Well, certainly more than really yeah,

not too bad, not too bad. But but the point is um the degree of faith in you that your clients have tells you how long they'll stick with you when things go tough. But every client is probably going to reach a point where he says, I'm out of money, I'm fatigued. I love you, but you know, maybe you're not right. M you. I recall you were raising one of the distressed funds. I don't remember it was in the housing bust in oh six, o seven or lift,

but it was a substantial, substantial funds. Uh that did really well. Which which fund am I thinking? Well? Uh? On the we had a we had a very big fund in No. One oh two which did very well because we were able to invest in the telecom meltdown and the scandals of and Run and Delphian World Colm. Uh. The market snapped back in oh three, we raised more funds than OH four, oh five and no fund to No. Six. On the first day of oh seven, we went out.

We said the clients, you know, we think we can use three billion three And within a month we had eight oh real And we said to the clients, so you really have trained your clients well educated and and uh and we said to him, we can't use eight. We will take three and a half. We closed that fund. We said, but we'd like to have the rest of your interest in a standby fund. So the first fund three and a half billion was seven and we said we'd like to have money for seven b and we started.

We had the first close of that in marcho seven. We had the last close in March o eight, and by that time it was eleven billion UM. And we told people it's a standby fund. We're not going to spend it on the time is right. We're not going to charge any fees until we're into the investment process. So from March oh seven until Juno eight, we didn't charge any fees. Juno eight we started to spend the money very gradually. Uh, that's fairly early in that's right.

And and Lehman went bankrupt. On September we were twelve percent called. By the end of the year, we were called so fully invested, so we called of eleven billion, which is six and a billion over fifteen weeks. That's all you had to do, you know, all you had to do to make money in the crisis in retrospect was have money to spend and the nerve to spend it. You didn't need caution, conservatism, risk control, patients, selectivity, discipline,

any of those things. All you needed was money and nerve, money and nerve, and money and nerve, capital and and but not all the time, because sometime money and nerve will get you killed. And and one of most of the time, well and money. And so one of the keys in investing is to know which is which. That that's really that's really fascinating. Um, there's another quote of yours that's relevant to exactly what you just said. I have to bring up rule number one. Most things will

prove to be cyclical. Rule number two. Some of the greatest opportunities for gain and loss come when other people forget rule number one. Why is it that people do not understand that this too shall pass, that it's most cyclical because of the rule of emotion rather than logic. Emotion is a great enemy of all investors. Back in nineteen seventy five, probably forty two years ago, I learned one of the greatest lessons. Somebody said to me there

are three stages to a bull market. The first age, when a few bright people believed that there could be improvement, the second stage, when most people understand that things are actually getting better, and the third stage, when every idiot believes that things can only get better forever. So so where are we today. It's it's February, you know, Barry. I don't believe that most people are thinking very optimistically. I think most people have reservations. Most people understand that

economic growth is uncertain. Most people understand that we don't know how the central bank experiment with zero rates is going to end up, or how it gets reversed. And of course most people are concerned about the geopolitical developments in the world today. So I believe that enthusiasm is not unrestrained, it's tempered. I believe it's tempered. On the other hand, people maybe maybe thinking in not a bullish way,

but I think they're acting in a bullish way. What accounts for the difference rates near zero, and when you live in a low return world, you have to take risk to get returned. People are willing to take risk because my late father in law would call them handcuffed volunteers, people who do things not because they want to, but because they have to have choice there isn't and so people are taking more risk than they used to take to get the returns they used to get at one

point in time. Um I recall in the early two thousand's the rule of thumb for for foundations and endowments and any charity to maintain their tax deferred status is they're giving out five percent a year and that's a pretty easy bogey to hit most of the time. But when you have you know, rates uh rising rapidly in stocks not doing especially well, that becomes a real challenge to hit. We saw that in the in the early

to mid two thousands. How much of what takes place in direct reference to what you were just saying, comes from foundations having no alternative comes from endowments, charities, all the big nonprofits having to hit that five percent bogey because they're so loath to go into the corpus of of their trust. How much of that handcuffed um volunteers comes from that segment of the investing world. Well, I think of a good bit, although foundations and endowments are

not a large proportion of the money. Uh. But the same is true of pension funds. You know, the management of a company puts in an amount of money, and then that amount of money is supposed to be invested in grown so that by the end or by the in the future, there will be enough money to pay pensions. And the connection between today's dollars and the number and the dollars you need in the future to pay pensions is called the actuarial assumption, the rate you need to

make the math work. And for a long time that was eight and say now most in the interests of conservatism, most pension funds have switched to seven and a half. But if you think about it, that that that the five year T bill treasury note used to pay six and alf p So how hard is it to make eight at that point and today it pays one and

a half? And stocks used to stocks return in the nineties, and it was assumed that they would return at least eleven forever, and today it's assumed that they'll pay, they'll make five or six. So if if the prospective returns have come down so drastically and the expectations of institutional investors have not, then I think that they all have

a real challenge. So I don't know if you can really talk about state pension funds, but they seem to be somewhat underfunded and wed to these high return expectations. What does this tell us about the future obligations that taxpayers may find themselves on note, for that's really one of the great questions today, Barry that very few people

are talking about. But the pension, the the the state or municipality puts in a certain amount of money and then it assumes a rate of return which will enable it to pay. But I've noticed if you assume a high rate of return, you have less money today, but more money down the road, and appreciably more. What that assumption should be, and what I think it used to be is what we can make. Now I think more

often it's what we need. But that's not right. It should be what they can make, and what you can make in this low return environment has come down quite a bit, regardless of the assumed rates being too high. Lots of funds are underfunded anyway, regardless no's and and uh on others. If you ratchet down your return expectations,

then you're even even more undertunded. I think that most public funds are woefully underfunded, and many of them are working with their unions to renegotiate the pensions so that the that that the UH funds can be returned to viability. In some cases you can't do it, like in Illinois, where the pension fund is a right that's guaranteed in the constitution and you can't play with pens. So it's

unnoable how these funds will deal with the future. You look at Illinois, it just doesn't seem that it's possible for insolvency to be avoided really for the for the state or for the individual for the fun you know that, Well, it requires the state on the hook to make makeup the short it is because because the constitutional right. So if that's the case, does the state is the state looking at either a renegotiation or a default. Well, it

may do. We've had some small municipal bankruptcies around the country. Yes, Stockton for good memory, um, but you know, nobody wants to experience these things until they have to. Nobody says, you know, if we go on this track, we're going to be broken ten years. So that's X y Z unless they have to. What's the famous Hemingway quote. It was very gradual and until it was very sudden that the may I don't know that, I take your word for it. How did he go bankrupt? It was very gradual.

But you know, but there is no provision for state bankruptcies in the Bankruptcy Code. What about uh, A territory like Puerto Rico, there was no provision for bankruptcy. That was one of the challenges in resolving that issue, and it had to be done consensually. But but I think that uh, you know, if you look at the math, you look at the funding status, and you look at the assumed returns, a lot of public pension funds are

going to have big problems down the road. And I'm not talking about the twenty second century, uh, And you mean a decade or so from from here. I'm not an expert on the numbers, but I believe that it's more imminent than infinite. And I I just don't think that, uh, that the average citizen, uh understands the risk. And you know what's let's say that we did begin to have states going under with the federal government bail amount It

depends on who's running the government, that's right. And by the way, if you look at the stay which are uh most troubled, you'll find out that that that the Illinois who else is on that that shortlist? Well, I don't, I don't, I shouldn't really go into that where where above my depth. California has seemed to get its fiscal house in order. Well, I think they're on the way.

They've taken some steps. But the point is I think that that uh, you know, the the expectation that that the states will be bailed out by the federal government, which which means transferring money. I mean, the federal government has no money. It is not a money making organization. It is only an intermediary. It collects money and it gives it out and print prints a little on the side of prince a little. But I mean, but it

doesn't earn any money. It's not like you and me going to work in the morning and and so so. The the the federal government redistributes money amongst the states. It's it's hard to see a massive trend of taking money from the states that have been uh pro economical and prudent and giving it out to the ones that

have been profigate, So that complicates matters. And UM, I just think that the precarious state of public pension funds is an issue that has received very little attention, but will get more in the future in the coming years. I want to jump to my favorite questions, but before I do, I have to reference something you described, um I believe was at the c f A event in Toronto, which, for lack of a better phrases, is called organizational alpha.

You were describing the way your firm more than assets selection, the way your firm processes information and create some mechanism for identifying opportunities for investment. So so let's talk a little bit about that. You referenced some of your colleagues your reference Bruce Covener, Cars, Bruce carsh Bruce Kovener, different person um the other gentleman, Sheldon Stone, Sheldon and and

who else are running different portfolios in the office. John Brady runs the real estate and Matt Wilson and Jordan Crews run the control funds, the Klee Kramer runs the European control funds. Uh. You know, we have a lot of strategies. We have a lot of great guys running them, and even some women and so you um which is which is relatively rare these days in in institutional asset management, but that's starting to change. Um So you are co chairman, co c I O. Is that correct? No, I'm co

chairman and co founder, co founder. You were ce I O for never I misremembering that. Edit that out. We'll we'll leave that in. Um So, how so, where I'm where I'm getting to with this is how is the decision making process about where to allocate capital, how aggressively to portion? How are those decisions actually made? Sure? Well, Number one, for the most part, Barry, we don't allocate capital clients. Institutional clients don't go to a firm like

oak Tree and say here's a hundred million dollars. Do what you think is right to a specific going to a fist specific fund or strategy. So we don't have the allocation decision. Our job is to manage the money within the assignment. Um. When you use the term organizational alpha, which I think is a good one. Alpha means perfect personal skill, the the ability to add value above what the market gives in any given niche Where does it come from? And the answer I think is it's it's

personal or its organizational. Personal means hiring great people, and of course we try to do that, but organizationally, I think that you can be constructive or destructive. We have a very explicit investment philosophy which tells everybody who works at oak Tree what our game plan is and how we're going to go about adding value for the clients.

An emphasis on risk control and on consistency, not on top, that's how bottom this u and insistence that we will only be active in inefficient markets, and a desire for a high degree of specialization. We don't have a general research pool. We have research teams assigned to every strategy.

We have a refusal to base investment decisions on macro forecasts, which shouldn't come as a surprise to you, and a reluctant to raise and lower cash to time the markets, which we think is very difficult to do most of the time. So everybody knows the game plan. We think it's an effective um game plan, especially that everybody knows that the way to succeed at oak Tree is not by being some cowboy and swinging for the fences, but rather to to control the risk and drive out the

negative surprises. Um So the investment philosophy gives everybody a creed to live by and a way to pull together, and we don't have. You know, I've seen investment organizations torn apart by by battles between the cowboys and the chickens. You know, in in the good markets, the cowboys say, the chickens are put holding us back, and in the bad markets, the chickens say, the cowboys are getting us killed. And it's very bad. Uh it's also bad for the clients.

Our clients want to know what kind of an order aization they're hiring, and then they want to get what they came for, and an explicit creed like we have enables that to be the case. So I think that that the the the common creed the investment philosophy is extremely important. Then the other thing is that at oak Tree we have a structure which is designed to encourage team behavior, not individual behavior. Uh So nobody at oak Tree, you know, we don't have the philosophy that that exists

in some places. You eat what you kill. Uh. You know, everybody gets paid on their own performance, and you can quantify it down to the basis point. Uh. We get paid at oak Tree on how the team did, how the firm did, how the team did, what we believe of your contribution and your potential. We don't keep records of who gave which recommendation and how much money did

it make us or lose it. We don't pay people based on their quantitative results in the prior year, because quantification is in everything, and the prior year is everything. You know, uh m Albert Einstein said, not everything that counts can be counted, and not everything that can be counted counts. There is so much more in assessing the contribution of an individual to the performance of the team and the organization than just whether his recommendations worked last year.

Uh that we uh insist on uh an organization that functions as a team for the benefit of the clients, and it sounds like it's certainly been working over the years. Let's let's jump to some of our favorite questions while I while I still have you, you mentioned some folks who influenced you at city Who who are some of your early mentors. I don't really have the mentors to talk about. My uh philosophy was shaped mostly about reading. So so wh who affected you well? I mentioned John

Kenneth galbray Thrower, and I think he was terrific. And he talked about the fact that forecast on work, and he talked about um, the fact that people in the financial world have very short memories and that's why cycles tend to repeat. Has a great book called A Short History of Financial Euphoria which talked about the extremes of cycles, and that was very impactful on me. I read that one a long time ago. What other books have you

read that have been very influential to your philosophy? Fooled by Randomness by Nassa Nicholas to Leb talks about the fact that the future is indeterminate and that events are unpret aredictable in large part because the world is subject to randomness. And in a world of random this, you can't have events that are predictable and and and I think he makes very very sound arguments on that subject.

So there's any other example against the Gods by Peter Bernstein on the subject of of of probability and risk, um and and so forth. I UM, not too long ago had Meyer Stateman in here, and he said in one of his early advisers was Peter Bernstein, demanding guy, but he said whatever he worked with on him was

so much better when it was done. And you know, I so I wrote a memo called risk in OH six and updated it Risk revisited in fourteen, and then in fifteen I found a memo from Bernstein on my desk and oh seven, memo from Bernstein who had passed away in O nine, and it was entitled can risk be reduced to a number? He didn't think so? I don't think so. I don't think that risk can be quantified. I think it's just a matter of subjective judgment and and and it had a profound influence on me, as

he did in general. His his writing was just so dense with thought and so clearly structured, and his prose was I find any time I sit down, UM, I have his book on gold on my desk, and I'm I'm looking forward to diving into any of the books you want to mention you You previously mentioned Graham and Dodd. Is there anything else you want to reference. Uh, what what are you reading now? I'm reading Tim Geithner's autobiogramys

really Stress Test and how is It's very interesting. It's it's not h exciting reading, it's not fun reading, but it's very very illuminating. Oh, you get a lot of in said as to what was going on behind the scenes. I have not read either Bernanke or Paulson's um autobiographies, but they are sitting on my shelf, and I'm just one of these days I feel obligated to get to the well. I think we should because if we don't study crises, then we are bound to repeat them quicker.

If we study them, it will take longer. Of course, they'll always but you know, it was Santayana who said, those are those who are ignorant of history are bound to repeat it, and and reading the books of people like Paulson will help us, uh to delay their repetition. What do you what do you do outside of the office to relax? What do you do for fun? Well? I read, okay, and I play some tennis, and I uh like houses and architecture. You like architecture, I had

no idea about that. What do you do? How does that express itself. Do you go on architectural tours. I'm assuming you've been to oak Brook and done the whole I do, right, I do visit uh stand out examples of architecture, you know. And the great thing about is that when you go on a business trip, right, you can find the best one or two examples and you can go visit them. It doesn't take very long. You're kind of bi coastal. You're in l a part of the year, so you have plenty of Frank Gary buildings

and other such stuff. Your references are too modern. I didn't say modern. Okay, that is my bias coming out. I actually prefer classical architecture, Okay, such such as well. Uh, I mentioned Frank. When you when you go to in you should visit potsdown Potsdam has great examples of eighteenth century architecture, and and UH, you know when you go to UH, when you're down south, you should go to

Mount Vernon and Manticello and so forth. Um. And it's really a highlight to be able to take a little bit out of your day to go see a great building that's fascinating. I had no idea. UM. You you occasionally bump into a millennial or a recent college grad. What sort of advice do you give to a young person just starting their career if they said, hey, I'm interested in finance, UH, what advice would you give them?

I think the most important thing, Barry, is that you know, when I got out of grad school, I applied for six different jobs and sift six different fields of finance. I didn't know what I wanted to do. Uh, And I went into investment management primarily because I had had a good summer job at City Bank in nineteen and I enjoyed it. Uh. And all those jobs offered about the same pay. They all offered between twelve and four dollars,

and that was a year, not a month. And then sometime in the eighties God looked down and he said, I'm going to let those people who manage money make more than everybody else. And so there's a tendency for people to go into investment management hedge fund management in particular, because they want to get rich. It's not a good reason. And what I always counseled young people is that they

should try to find something that they will enjoy. And if you're doing something every day for your life, which is hopefully a long time and you're not enjoying it, then you're wasting your life and doing that the pile up money that you'll have left at the end. It seems so uh futile. So uh, you know, Christopher Morley, you're a great one for quotes. Christopher Morley, the English writer said my favorite one. He said, there's only one success, to be able to live your life your own way.

And so what that means is number one. Two, follow the convention of society into whatever all the cool kids think is great at a given point in time is an obvious mistake. You should not let society set your goals. And number two, the challenge is really, in my opinion, to figure out what will make you happy and then to pursue it. Uh. But that's what I tell people. Try to do something you'll love. Uh. There's nothing like spending your day uh doing something you love. You know.

I always say to people that investment management is great. I would do it for nothing if I if I had to. Fortunately I don't have to. My wife says I'm gainfully unemployed, which which is pretty much exactly what you're saying. Well, there's you know, we only get one life. You get to be my age. You're getting there one of these days, but you realize that it's not finite. My wife says, none of us is getting out of this alive. So the only thing that makes sense is

to try to maximize our satisfaction with our lives. You get to be seventy nine years old, you look back, you say, damn, I should have X y Z. It's unfixable. That's what you must think about. What will I how will I feel about my life at the end? And you have to behave in accordance to not having regret at the end. And and from what I'm told, very few people will say I should have spent more time at the office. Very few. Um and our final question, what is it that you know about investing in any

of its? Guys? Is that you wish you knew when you began low back in the nineteen sixties nine seventies. Well, I think that that. You know, I've learned a lot of lessons through experience. As we discussed getting what you didn't want, it's right and and uh, you know, those are the things that have shaped my philosophy to be what it is today. The the futility of trying to guess the future, the importance of understanding cycles, the essential character of value, that it's not what you buy, it's

what you pay. Um, the essential character of value. Yes, I mean the relationship between price and value determines your success. Not buying high quality assets, not shunning low quality assets, but buying assets of of any quality when they're available cheaper than they should be. Uh. So, I think that these are the kinds of the importance of controlling emotion, the importance of contrarianism. In fact, I got great news, Marry.

My book, The Most Important Thing, has twenty chapters, and each chapter says the most important thing is, and then it's a different thing. And I've tried to distill the important lessons of my career into that book. And uh and I'm satisfied with the job I have done, and as have everybody who's read the book. I can't recommend it enough. Um. The blurb on the cover is Warren Buffett, who is essentially the person who you tell a lovely story about him, saying, why don't you write a book? Howard?

I tried, he he wrote me. I always figured that when I retired, I would pull the memos to other into a coherent uh book and uh in. I got a an email from Warren and he said, if you'll write a book, I'll give you a blurb for the jacket. And that was all the motivation I needed to get going. And and the book came out a year later. And by the way, I love the fact that Warren Buffett says, you know who, I'd like to read a book from

that Howard Marks guy. Send him an email telling him I'll give him a blurb, and a year later I'll get a book from him. Well, I mean, the amazing thing is the amazing thing is that somebody like Warren, despite the respect he enjoys and the success he has enjoyed, is still reading. He's a a vociferous read. And by the way, he doesn't read his own writing. He reads from other people and and and and and glean's what is to be gotten? And you know, he's eighty seven.

I think he's not done learning. He he just said, if you've seen the HBO document to me on him, it's fascinating. He describes himself as he goes, I'm just a cigar, but there's nothing left anymore. But he still goes to the office him and Charlie Manger. Manger is ninety something and they read three or four hours a day. That's just astonishing. Howard, thank you so much for being so generous with your time. It's always a delight uh an instructional one chatting with you. We've been speaking with

Howard Marks of oak Tree Capital. Be sure to go to oak Tree Capital dot com. You can see the entire collection of chairman's memos. Each one is a lesson in itself, the most important thing at Amazon and fine bookstores near you. If you have enjoyed this conversation, be sure and look up an inch or down an inch on Apple iTunes and you can see any of the other I want to say, we're coming up on a

hundred and forty such conversations. I would be remiss if I did not thank Medina A recording engineer Taylor Riggs or booker Michael Batnick, our head of research. We love your comments, feedback and suggestions right to us at m IB podcast at Bloomberg dot net. I'm Barry Rihults. You've been listening to Masters in Business on Bloomberg Radio. Masters in Business is brought to you by the American Arbitration Association.

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