Howard Marks: 3 attributes of investors who will always outperform

One of the world’s most successful investors of recent decades, Howard Marks is a champion of contrarian investing. In his latest memo, the Oaktree Capital founder tries to define what it means to be a contrarian. This starts by casting way back to the early days of his career, which began in 1969. And it finishes with Marks' view - from mid-June 2022 - on where we are currently in the market cycle. 

To save you from having to read the entire 13-page document, I've outlined some of the main takeaways below. Though of course, you can read the full memo if you'd prefer, by clicking on the link at the end of this wire.

Key points

• The pedestal of popularity, or why no company is too big to fail
• 3 attributes of the perfect investor
• Contrarian investing explained
• Why active investing isn't for everyone
• Are we headed for a recession?

Recalling his experience of the oil crisis of 1973-1974, he reflects on what happened when several of the S&P 500’s “too big to fail” companies saw their share prices tumble. The index itself fell just under 50% during this period, and many of the Nifty Fifty that many regarded as good value at any price fell further still.

“Their devotees lost almost all of their money in the stocks of companies that ‘everyone knew’ were great. This was my first chance to see what can happen to assets that are on what I call ‘the pedestal of popularity,” Marks writes.

“If you hope to distinguish yourself in terms of performance, you have to depart from the pack. But, having departed, the difference will only be positive if your choice of strategies and tactics is correct and/or you’re able to execute better.”

The concept Marks is asked about most often

Second-level thinking is a key requirement for those hoping to beat the market, explains Marks.

“Being right may be a necessary condition for investment success but it won’t be sufficient. You have to be more right than others…which by definition means your thinking has to be different.”

What separates first-level and second-level thinkers? For the former, the only prerequisite is an opinion about the future. 

But second-level thinking is deep, complex, and convoluted, writes Marks. Among the long list of things such thinking includes are considerations about:

• The range of likely future outcomes
• The probability of being correct
• The consensus view
• How your expectations differ from the consensus
• How the current price of an asset compares with both the consensus view and your own
• Whether the sentiment (what Marks terms “consensus psychology”) incorporated in the price is either too bullish or bearish
• What will happen to the asset’s price if the consensus view is correct
• What will happen to the asset’s price if you’re correct.

Three attributes of the perfect investor

Marks also outlines three capabilities that distinguish investors who will always outperform the market. These are an ability to:

1. Better understand the significance of the published numbers
2. Better assess the qualitative aspects of the company, and
3. Better divine the future.

And this sums up just why investing is inherently risky. Because, as Marks points out: “None of these things can be determined with certainty, measured empirically, or processed using surefire formulas.”

“Unlike present-day quantitative information, there’s no source you can turn to for easy answers. They all come down to judgement or insight,” Marks writes.

What is contrarianism?

In Marks’ view, there are two different types of contrarianism - blind and intelligent.

Referencing his earlier comparison of first- and second-level thinking, Marks notes the former might believe contrarian investing is simply doing the opposite of what most people are doing - such as selling when the market rises and buying when it falls.

But he argues that an understanding of contrarianism itself needs to occur at a second level. Quoting his friend Joel Greenblatt of Gotham Asset Management, Marks writes: 

“…just because no one else will jump in front of a Mack truck barreling down the highway doesn’t mean that you should.”
“In other words, the mass of investors aren’t wrong all the time, or wrong so dependably that it’s always right to do the opposite of what they do,” Marks writes.

To be an effective contrarian investor, you must answer these questions:

• What is the herd doing?
• Why is it doing it?
• What’s wrong (if anything) with what it’s doing?
• What you should do about it?

“Good investment decisions made at the best opportunities - at the most overdone market extremes - invariably include an element of contrarian thinking,” Marks writes.

Why active investing isn’t for everyone

Contrarian investing, by its very nature, is a double-edged sword, as Marks admits. 

“Everything you do to depart from the consensus in pursuit of above-average returns has the potential to result in below-average returns if your departure turns out to be a mistake," he writes.

Marks identifies this greater risk of inferior performance as an additional cost of active investing, beyond the commissions and management fees of which we’re all aware. As he describes it, each investor must decide whether to prioritise superior returns at the risk of falling behind the pack, or to hug the consensus position and ensure average performance.

“Unconventional behaviour is the only road to superior investment results, but it isn’t for everyone. In addition to superior skill, successful investing requires the ability to look wrong for a while and survive some mistakes,” Marks writes.

“Each person has to assess whether he (or she) is temperamentally equipped to do these things and whether circumstances - in terms of employers, clients, and the impact of other people’s opinions - will allow it…when the chips are down and the early going makes him (or her) look wrong, as it invariably will.”

Are we headed for a recession? (And why the answer doesn't even matter)

Marks concludes his memo by reflecting on a presentation he gave in June 2022, during the London edition of Oaktree's biannual conference.

"I told attendees that I pay close attention to the questions people ask most often at any given point in time, as they tell me what's on people's minds. And the questions I'm asked these days overwhelmingly surround:

• The outlook for inflation
• The extent to which the Federal Reserve will raise interest rates to bring it under control, and
• Whether doing so will produce a soft-landing or a recession (and if the latter, how bad).

In short, his response is that everyone at Oaktree has opinions about such short-run phenomena, "we just don't bet heavily that they're right."

"My usual answer is that whenever we’re not in a recession, we’re heading toward one. The question is when,” writes Marks,

But he insists that shouldn’t change the way you invest. Why not? 

"Because the possibility - or even the fact - that a negative event lies ahead isn't itself a reason to reduce risk; investors should only do so if the event lies ahead and it isn't appropriately reflected in asset prices," he writes.

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