Howard Marks, Legends of Wall Street Presentation @ SF State Downtown Campus – June 27, 2012 “In theory there is no difference

between theory and practice, but in practice there is.” – Yogi Berra On the human side of investing: Markets are made up of people, and people make mistakes -> Take advantage of those mistakes Risk premiums must be demanded Too often forgotten during boom years Pendulum as analogy for market In constant motion between fear & greed, pessimism & optimism, risk aversion & risk tolerance Although the statistical mean is in the middle, this medium is rarely seen in markets Always ask, “Where are we now?” Memory must fail for extremes to be reached Having a good memory = prudence Being pro-cyclical = biggest mistake “What a wise man does in the beginning, the fool does in the end.” “When you find you are on the same side as the majority, it is time to reform.” - Mark Twain 3 stages of bull market: 1. Few realize improvement will come 2. Most recognize improvement is underway 3. Everyone thinks it will keep getting better forever (ideal time to sell) 3 stages of bear market: 1. Few realize markets are overpriced 2. Most recognize correction is underway 3. Everyone thinks will fall forever (ideal time to buy) On understanding what you don’t know: “There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.” – John Kenneth Galbraith It is okay to say “I don’t know” Oaktree’s investing philosophy falls under the “I don’t know” camp: I don’t know I know Hedged Positioned for one outcome only Diversified Concentrated Avoids leverage Levered up Seeks to avoid losses Seeks to maximize gains Investing is a loser’s game: “Avoid the losers, and the winners take care of themselves.” Analogy: Amateur tennis. When playing with your friends, as long as you get the ball over the net onto their side of the court, they will eventually hit a bad shot. You don’t need to focus on hitting amazing shots, just get the ball over the net and wait for them to make a mistake.

timing. you don’t need the third. bad decisions can work o Over long term. better to bet on good decisions 3 ingredients for successful investing: Aggressiveness. Yale University Institutional investors often seek only to avoid embarrassment/keep their jobs so they over-diversify Other mistakes include investing only in funds with: Obvious appeal Easy to understand Popular leads to high prices and limited returns Have been performing well On Meeting Michael Milken in 1978: There is no upside surprise on a AAA bond. but in 2005 when they were up 100%. They do not tell anything about ability to perform over the long run It takes a full cycle to have sufficient data Example: Amaranth’s blow up in 2006 (down 100%)…The problems didn’t start in 2006.On Risk: We are taught that risk is standard deviation." . but if a B rated bond survives. and can be result of combination of sheer aggressiveness and luck/timing. you get upside surprise The big money comes from upside surprises It’s a negative art .David Swensen. which frequently appear downright imprudent in the eyes of conventional wisdom. You must also examine risk adjusted returns On Institutional Investors: “Establishing and maintaining an unconventional investment profile requires acceptance of uncomfortably idiosyncratic portfolios. skill If you have the first two. Also focus on decisions and processes. not only on outcomes Being right for the wrong reasons is the same as being wrong Good decisions can not work. impossible to do the right thing at the right time” Twin impostors: Short term over and underperformance. o Going up or down 100% can be two sides of the same coin. this is not true Risk means “more things can happen than expected” Most people ignore black swans Lesson of crisis: Pay attention to “alternative histories”. But that’s unlikely “It’s hard to do right things.

You can read about it and listen to experts. but the problem is that you can’t eat relative returns. Most people are concerned about keeping their jobs so they don’t take the right risks. Q: How do you combat the institutional imperative? A: The problem is that if you take risk and it doesn’t work out. but at the end of the day it’s judgment. The best time to do this is during the up years. If you ask for an opinion and act on it then you are a nut Solution is to move forward but with caution.e. Explain to them what you are trying to do. Probability distributions are also all about judgment. you may get fired. It cannot be turned in an algo. At any point in time the best you can do is pick the best relative option. Anyone who finds it easy is stupid” – Charlie Munger . It takes expertise. In order to take on risk to produce outsized returns. experience. What’s your take on this spread? A: High yield is relatively more attractive now than it was in 2007 despite the similarly low yields as the spreads are generous right now versus the treasuries. “It’s not supposed to be easy. Q: How do you quantify risk. and insight. you must educate your clients. Let them know that it will not work all the time. some high-yields are in 7-8% range. Nobody knows. always ask “Who doesn’t know that already?” Three Greatest Investment Adages: “What the wise man does in the beginning. but there are no old.Smart Investing: Not necessarily buying good things. Q: 10Yr Treasury is yielding 1. but buying things well It takes an expert to know the right price “There are old investors and there are bold investors. and please comment on future probability distributions (i. bold investors” Additonal Oaktree Philosophy: Risk management Consistency Inefficiency Specialization No forecasting No market timing Knowing things that other’s don’t (Information edge) When presented with an investment idea. the fool does in the end” “Never forget the 6ft man who drowned crossing the river that was 5ft deep on average” “Being too far ahead of your time is indistinguishable from being wrong” Q&A Q: What do you see happening in Europe? A: I don’t know.6%. “New normal”/fat tails) A: Assessing risk comes down to judgment.

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