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Book Review:
The Most Important Thing
by Howard Marks
With only a few weeks left in my MBA career, I am now fully aware that being astudent again offers some very valuable perks. Through my fellowship on UCLAAnderson’s Student Investment Fund I have had access to a number of greatinvestors. But, by far my biggest break was having the opportunity to meet withHoward Marks, the founder of Oaktree Capital Management and author of so manymemorable investment memos. Like many of you who unfailingly read Marks’smemos right when they are released on Oaktree’s website, I was thrilled when Iheard that Marks was going to publish a new book on investing. However, I neveranticipated that I would be lucky enough to receive an advance copy from Howardhimself or have the opportunity to review it for my blog. But, as I said, being astudent again is not too bad. So, in an attempt to revive the book-reviewing skillsthat have been lying dormant since middle school, the following is my commentaryon Howard Marks’s soon-to-be-released book,
The Most Important Thing.
Oddly enough, I think it is important to start off with a disclaimer.
The Most Important Thing
is not a how-to book about investing. Marks doesn’t provide a JoelGreenblatt-esque magic formula or any shortcuts to becoming a great investor. Infact, on the very first page of chapter one Marks reminds us that no investing rulealways works. The book also does not separate out specific investment techniquesfor different asset classes. Instead, in the tradition of Ben Graham’s
The Intelligent
Investor and Seth Klarman’s
Margin of Safety,
it is a book on how to
think
aboutinvesting. In reality, Marks builds on the ideas of the most famous value investorsby adding his own insights and anecdotes. For people who are devoted valueinvestors, the philosophy he articulates will sound familiar and certainly will notdrastically alter the way you invest. However, what is both unique and strikingabout this book is the way he breaks down the important aspects of his investmentapproach into very approachable and wisdom-filled sections. When the reader hasfinished the book, the lasting impression is that Marks was able to provide acomprehensive and detailed overview of his investment approach in less than 200pages.In his thoughtful and didactic way, Marks aims to help the reader develop themental tools and investment framework that are required for success in this verydifficult and treacherous domain. Specifically, using his four decades of experienceas a basis, Marks introduces the reader to his investment philosophy with acombination of new material and a brilliant integration of passages from previousmemos. The transitions between the original and previously articulated ideas are soseamless that Marks comes off like a wise grandfather who always has a perfectlypoignant story to tell, no matter what the context. For example, even in theintroduction, the reader gets the sense that Marks has been able to leverage hisvast experience in way that gives him an investment edge:
The Inoculated Investorhttp://inoculatedinvestor.blogspot.com/
Importantly, a philosophy like mine comes from going through life with your eyes wide open. You must be aware of what’s taking place in the world and what results those events lead to. Only in this way can you put the lessons towork when similar circumstances materialize again. Failing to do this—morethan anything else—is what dooms most investors to being victimized repeatedly by cycles of booms and bust.
I chose to highlight the above passage because I think it is very emblematic of twoof the major themes that run throughout the book. The first is the idea of viewingand thinking about the world in the most open manner possible. Marks introducesthe reader to the difference between first-level and second-level thinkers andsuggests that we all work to become the latter if we want to survive in theinvestment wilderness. First-level thinkers are people who look at the worldsimplistically and superficially and who don’t take the time to reflect on themeaning of the events they witness. On the other hand, second-level thinkers arecontrarians who cogitate about probabilities, risk and whether or not they actuallyhave an investing edge. These are people who are constantly questioning their ownassumptions and those of their peers in an attempt to be what Marks calls
“different and better”
than the rest of the crowd. Not surprisingly, Marks firmlybelieves that being a second-level thinker is a necessary condition for achievingconsistently superior returns. The next theme embodied in the above passage and discussed throughout the bookis that of the cyclical nature of financial markets. Chapters eight and nine are allabout paying attention to cycles and being mindful of the swings in the pendulumbetween greed and fear. In many instances, Marks clearly stresses that those whoforget history are doomed to repeat it. In fact, he starts off the chapter on cycleswith what looks to be a play on one of Buffett’s most famous quotes:
Rule number one: most things will prove to be cyclical.Rule number two: some of the greatest opportunities for gain and loss comewhen other people forget rule number one.
The point is that through experience, investors can gain an advantage overnewcomers to the business or those who forget that financial markets areinherently cyclical and that boom and busts are inevitable. What is required then isan understanding of the historical parallels with current events that only comesfrom an ability to step back from periods of euphoria and excessive pessimism.While Marks may not say it directly in this section, the implication is that thedevelopment of a particular type of even temperament is paramount if a personwants to avoid being caught in the herd during a painful turn in the cycle. (He doessay later in the book that the
“biggest investing errors come not from factors that are informational or analytical, but from those that are psychological.”)
The Inoculated Investorhttp://inoculatedinvestor.blogspot.com/It is in that context that Marks expands on Ben Graham’s assertion that marketpsychology moves wildly between greed and fear by likening those fluctuations tothe swing of a pendulum. While the underlying concept will be very familiar to valueinvestors, I think the simple way he articulates his understanding of marketpsychology is very compelling and memorable:
Like a pendulum, the swing of investor psychology toward an extreme causesenergy to build up that eventually will contribute to the swing back in theother direction. Sometimes, the pent-up energy is itself the cause of theswing back—that is, the pendulum’s swing toward and extreme corrects of itsvery weight.
************************************************************************************ The next prevalent theme in the book is that of risk. It will not be surprising tofrequent readers of Marks’s memos that he devotes three full chapters to riskassessment and management. The first time I was exposed to Marks was at aWharton Hedge Fund Network event in New York. I have been fortunate enough tomeet and learn from a number of wonderful investors in my life, but somethingMarks said at that event still sticks with me to this day. What he said was that
themain job of a steward of other people’s assets is to manage risk and protect capital
.It was such a simple statement but the implications are so powerful, especiallyconsidering that most of the people in the investment business seem to believe thattheir primary responsibility is to make themselves rich.In any case, Marks begins by discussing how to measure risk. You will not beshocked to learn that there is no discussion of beta, value at risk or price volatilityas measures of risk. Instead, he humbly suggests that there is no viable standardthat can be used to quantify risk and that risk and return estimates cannot bereliably turned over to a computer. Therefore, risk lies in the very subjective eye of the beholder:
Where does that leave us? If the risk of loss can’t be measured, quantified or even observed—and if it’s consigned to subjectivity—how can it be dealt with? Skillful investors can get a sense for the risk present in a givensituation. They make that judgment primarily based on (a) the stability and dependability of value and (b) the relationship between price and value.
In other words, risk has to do what price you pay and the relationship of that priceto the intrinsic value of the asset. For anyone who does not recognize this idea, it isvery much the same as the margin of safety concept espoused by Graham andKlarman. Believers in the merits of value investing when it comes to equity securityselection should take comfort in the fact that one of the best debt investors in theworld uses the same risk framework to find avoid overpriced fixed income assets:
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Book Review- The Most Important Thing by Howard Marks
The following is my review of the new book from Oaktree Capital's Howard Marks entitled The Most Important Thing. I highly recommend the book to anyone interested in investing.
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