RWH063: Avoid Disaster w/ Howard Marks

27:58That's one of your favorite quotes from him that comes, I think, from Pioneering Portfolio Management, which I'll read because it's very related to this ability to take idiosyncratic positions. And he said, active management strategies demand uninstitutional behavior from institutions, creating a paradox that few can unravel. Establishing and maintaining an unconventional investment profile requires acceptance of uncomfortably idiosyncratic portfolios, which frequently appear downright imprudent in the eyes of conventional wisdom. And I'm curious how you've managed to create an institution that even as it grew huge, never became bureaucratic or ruled by consensus or overly conventional and hidebound.

28:41Because I think that's actually part of the success of Oak Tree is that somehow you and Bruce Karsh and Sheldon and the like, you've managed to maintain this kind of willingness to be idiosyncratic and unconventional, even as you've become kind of much more institutionalized and more globally important. Well, I don't think we have become institutionalized. I think we just become bigger. But my dad used to say that marriage is a wonderful institution for people who like living in institutions. And I don't. And I learned, the best lessons we learn are learned early. And my first job was at Citibank and I was there 16 years.

29:24And I learned that I don't like institutional living. And at the bank, if you would say, well, let's try to do this, or let's pay this person this, or let's vote that person that. They would say, you know what, listen, we can't because there are institutional constraints. And this word institutional is a hell of a word. By the way, when I was a boy, they said, oh, he lives in an institution. That meant an insane asylum. But anyway, I try like crazy to avoid bureaucratic tendencies. And I wrote a memo in the early days, it must've been around 05 or so, called Dare to Be Great. And it was mostly a rant against bureaucracy and committees.

30:05Because when I was 29 and the tender age of 29, I became the director of research at Citibank. They put me on five committees. And as I recall, they would meet for a minimum of 16 hours a week. And I almost shot myself. I have a short attention span and I don't talk that much. And I don't like to listen to other people that much. And I found that those meetings went as long as the person who wanted them to go the longest let it go. And if you think about it, if you come up with some brilliant insight, what David called idiosyncratic, and you give it a shot. By the way, it's idiosyncratic. Why?

30:42Because everybody else is doing the opposite. That's what makes it great. And you want to do it because you think you have some insight about why they're all wrong and their actions have made it wrong in the market, can you imagine trying to convince a committee of 10 people to get the majority of them to support it? Well, how the hell can you do that? Because there's a reason why most people in the market aren't taking that approach because it's hard to see. So if most people are doing A, how can you convince the majority of a committee to do B? If you have idiosyncratic insight, if you have a young Warren Buffett working for you, you better just let him do his thing rather than say, well, you're Warren, you can't make any trades until you convince the majority of the committee.

31:31And so this is one of the most important things in investing. And bureaucracy and great investing are counterindicated, as the doctors would say. When Lehman Brothers went bankrupt in mid-September of 08, we had raised the biggest distressed debt fund in history by a factor of about three. We had$10 billion sitting on the shelf. Lehman goes under. Most people think the financial world is going to melt down. Question is, where do you spend the money? And people say, well, why don't you just analyze the future? There is no such thing as analyzing the future, especially when you have unprecedented events taking place.

32:07And so Bruce and I figured out that we should spend the money. And he ran the fund in question and he bravely invested an average of$450 million a week for the next 15 weeks. That's$7 billion in one quarter. But I don't think we could have convinced the committee. The good news is we had pre-raised the money, so we didn't have to convince the clients. The best time to invest is during a crisis. You can't raise any money during the crisis because people are frozen into inaction. So it was certainly idiosyncratic. I talked to a friend of mine who wrote for one of the newspapers. He said, what are you doing?

32:44I said, oh, we're buying. He says, you are? Like we were insane. It was certainly idiosyncratic, and it was certainly uncomfortable. We certainly weren't sure we were right, but it seemed like the right thing to do. So you do it and you have to overcome your discomfort. I wouldn't try to convince 20 people that I was right. And what is it, Howard, that makes Bruce so extraordinary as an investor? Because clearly, I've never really heard him talk much. And then I was listening a couple of days ago to a conversation that you'd had on your podcast, the Oaktree podcast, where you and he and Sheldon talked about the early days of the firm.

33:25And I was surprised that he just came across this really affable, decent, smart guy with a tremendous focus on family and decency and building an enduring institution. Tell us what he's like, because he's so clearly been a key figure in Oak Tree's success. Yeah. Well, I mean, he approached me. I was at TCW, he approached me in 87. He was a lawyer. He had done some investing for Eli Broad, who was the biggest leader in LA. and he had this idea of forming a distressed debt fund, which we did in 88. And I think it was one of the very first from a mainstream financial institution. On the first closing, we raised$65 million.

34:12And then the second close brought it up to a grand sum of 96. We thought we had all the money in the world. But the point is that Bruce is extremely analytical. He's like a chess player, And he is a chess player. And he looks, moves ahead, highly competitive in what you describe, a low-key manner. But really smart and really focused. Great executor. And we have enjoyed a partnership for now 37 years, 38. And it's one of the shining things in my life. After my family relationships and friendships, I mean, we've had... Warren Buffett wrote a letter a couple of weeks ago about stepping down and he talked about his relationship with Charlie Mugger.

35:01And he said that in Charlie, he had a big brother who was protective. And the way I see it, Charlie was the wise philosopher who gave Warren advice. And Warren was the six years younger implementer who performed the analytical legwork and did the investing. What I really loved in that brief mention, he said, and the words, I told you so, were never mentioned. And so what Bruce and I have done with each other is our relationship is very similar to that. He's nine years younger than me. And we both acknowledge so healthily, we both acknowledge that the other can do things we can't do, which is such a great thing because that's the only basis for a healthy partnership.

35:54Once you start thinking that you can do everything you can do and everything the other person can do, your partnership is doomed. But we both acknowledge that each can do things the other can't. And it's been extremely complimentary and nobody has ever said, I told you so on any mistakes. There are plenty of mistakes made all the time. And I think that we have supported each other. And spending$7 billion in the fourth quarter of 08 would have been very difficult without support, you got to book somebody up and never say, oh, I would never have done that. You know? This fact also that he came to you originally and said, let's get into distressed debt raises a really important point that I think comes up in a lot of your writing.

36:47Going back, I think, as far as the getting lucky memo in 2014, where you said the easiest way to win at investing is by sticking to inefficient markets. And I think actually way back in 1995, in How the Game Should Be Played, you wrote, study the micro like mad in order to know your subject better than others. You can expect to succeed only if you have a knowledge advantage. Can you talk about that? Because it strikes me as something that I see again and again with the great investors, like with your friend Joe Greenblatt, where he initially got rich partly through his brilliance in special situations or Bill Ruane who told me, I just try to learn as much as I can about seven or eight good ideas.

37:28And it seems like this focus on specializing narrowly, but also in an inefficient market has been absolutely central to your success. Yeah. Well, let's take the counterfactual. So remember I said, you got to be thoughtful when you sit down to start investing, you have to think, what's the process, what are the elements that are going to make me a success? And again, success means doing better than others. So you can't say I'm smart. You're not the smartest person in the world. And everybody else in the business is pretty smart. You can't say I went to the best schools. That doesn't count for that much.

38:10You can't say I have this generalizable intelligence that I can apply to every asset class and no more than others in every asset class, you have to develop a knowledge advantage. And you have to, usually that comes from, at number one, developing an approach, which is the right approach and that you implement consistently. And from knowing more than the other people, it may be having more data, although that's hard because the SEC's job is to make sure that everybody has the same data, or it may be doing a better job with the data or having more insight in looking at it, or it may be in what you said, going into inefficient markets where the information is not evenly distributed, but you got to have some source of superiority.

38:58Otherwise, how can you expect to win? Investing is an incredibly competitive game, and winning consists of beating a bunch of other people who are similarly intelligent, numerate, computer literate, hardworking, and very highly motivated. So you have to have an edge. And I think that specialization is one way to try to get an edge. The other thing though, is it's really important, the concept of the less efficient market. When I try to illustrate market efficiency to people, what I say is, well, what if when I got out of University of Chicago in 69, I had been approached by a guy and he says, look, I'm a bookmaker and I book bets on football.

39:48And I have concluded that I can make a lot of money on football if I know which team is going to win the coin toss at the beginning of the game. So I'm going to give you 15 PhDs and a crazy supercomputer. And all you have to do is predict the coin toss at the beginning of every game. Now, if it's a fair coin, it can't be done. it's a waste of time because there's no edge. And that's an efficient market. An efficient market is a market where everybody knows as much as you do, and there's no edge, and you're wasting your time. So our definition of a less efficient market is a market where hard work and skill can pay off.

40:28And I was, as you said, I wrote in Getting Lucky in January 14, that I was lucky to find some inefficient markets early in my career. In August of 78, I got the phone call that changed my life from the head of the bond department at Citibank. He says, there's some guy named Milken or something in California, and he deals in something called high yield bonds. Do you think you can figure out what that is? That was it. But they were called junk bonds. Most people wouldn't touch them with a 10-foot pole. That was 78. I didn't get my first... The big pools of money in America are the public pension funds, states, mostly cities.

41:08I didn't get my first public pension fund account for 18 years. They wouldn't go there because they were reputationally and politically unpalatable. Oh, great. You mean it's an asset class that I can buy that nobody else will buy at any price? Well, maybe it's full of bargains. That's the way these things work. But if you look at the things that everybody thinks are great and will gladly buy at any price, why should you think you can get a bargain there. When I started in 1969, Citibank, where I worked, was an investor in what we're called the Nifty 50, the greatest stocks in America. And if you bought them the day I got to work in September of 69, and you held them tenaciously, faithfully for five years, you lost about 95 % of your money.

41:56Because at the time you bought them, everybody thought they were the greatest things since sliced bread. So it's something you have to watch out for. You have to look into things that are the road less taken. You talk about the nifty-fifty and that blow up, which obviously had a profound effect on your career and your philosophy. I've been thinking a lot about this question that you raise in some of your memos about how we can prepare for these extreme exogenous events, whether it's a market crash or a pandemic or a war or whatever it might be, given that we can't predict them. And you wrote in one of your memos, I think it was the second of your memos on uncertainty in 2020.

42:37We can do so by recognizing that they will inevitably occur and by making our portfolios more cautious when economic developments and investor behavior render markets more vulnerable to damage from untoward events. Can you talk a little bit about that? Because I think this whole question of how to deal with uncertainty is at the absolute core of what you do as an investor? Well, first of all, one of the great sayings is that there are two kinds of people who lose money in the market, the people who know nothing and the people who know everything. So I hope I never know nothing, but I never think I know everything.

43:16And specifically, I believe that the macro future is unpredictable. But there are things that can give us a hint at what lies ahead. So I wrote my second book, Mastering the Market Cycle, published in 2018. and it talked about tendencies. And I say, we never know what the market's going to do, but we can have a feeling for when its tendency will be to do well, or its tendency will be to do poorly. And its tendency will largely be determined by where we are in the cycle. So when things have been going great and prices have been rising, as you can say, for 16 years, and PE ratios are high and bond yield spreads, which are a barometer of fear, are narrow.

44:04We can assess that the tendency of the market may be to do less well and act accordingly. You don't have to make any predictions. None of those five calls I talked about a little while ago was based on a prediction. It was based on an observation. And what I say, William, is we never know where we're going. We sure as hell ought to know where we are. And are prices and valuations high? Is risk being ignored? Are people acting in an exuberant, buoyant way? These are the questions that can tell you what the odds are, even though you don't know what the future holds. And I never care for the title of that book.

44:50I had a more erudite title in mind. I thought mastering the market cycle was a little cheesy, but it's what the publisher wanted because they thought they'd sell more books. But I like the subtitle of the book. And of course, subtitles don't get much attention. But the subtitle of that book was getting the odds on your side. You never know what's going to happen. You can have a sense sometimes for what the odds of a certain event are. And when the market is high in its cycle, the odds are against you. And when it's low in the cycle, the odds are in your favor. But, you know, the odds can be in your favor and you can lose money for the next year or two or three and vice versa.

45:32I think when I wrote my book, Richer, Wiser, Happier, where you were one of the central characters, I think in a way that was my biggest revelation over the five years of working on the book and digesting that material was that. We have this fundamental problem that the future is unknowable, and yet, as you often write, we have to make decisions about the future. And it struck me, I think probably deeply influenced by you, was that there are all of these ways in which you, even though you have no control, you can very subtly stack the odds in your favor. And that strikes me. I mean, it kind of is simultaneously, like most truths, sort of banal and incredibly profound.

46:14Can you talk a little bit about that idea? Because it seems like a sort of guiding principle that actually I think runs through all of the great investors' lives is this ability. You see it with someone like Ed Thorpe, right, who you know, just to very subtly stack the odds by say, not playing games that you're ill-equipped to win, or by making sure you analyze the evidence in a very rational, independent way, whether it's about COVID or markets or anything like that. Can you unpack that a little? Well, you know, I mean, there are so many thoughts on that subject, but one of the things that Warren Buffett has been most outspoken about is that in baseball, for example, you should get up to the plate and you should wait for a good pitch.

46:58And first of all, you have to have a sense for what's a good pitch and what's a bad one. And he tells the story that Ted Williams, not only was Ted Williams waiting for good pitches, but he was very studious about his accomplishments and he charted all his batting. And he figured out where was the pitch and what was the result. and he figured it out. He broke the strike zone into 18 spots and he said, well, if the ball is in spot number one, two, or four, I tend to get a single. If it's in five or six, I tend to get a double. And if it's in seven or eight, I tend to strike out. So you got to figure out what's a pitch and you got to wait for it.

47:33He says, and Buffett has always advocated patience and not hyperactivity. But he points out that in investing, unlike baseball, in baseball, if you stand there with the bat on your shoulder and you'll let three pitches go by in the strike zone, you're out. But in investing, you can wait more. You don't get called out on strikes. Now, it's not exactly true because if you're a professional investor, you're investing for others and you sit there with the bat on your shoulder and the market goes up for 16 years, you might be called out. Warren had the particular benefit that he never thought he might get fired, but the rest of us might.

48:11But still, patience is very important. And waiting for a good pitch objectively and your kind of pitch, your kind of investment. And you can do that. And we talked before about playing within yourself, figure out the kinds of things you're looking for. You can't buy something because you think it's attractive to others. It has to be attractive to you and has to satisfy your criteria and you should have a set of criteria. So these are the things you can do to get the odds on your side. I think there's another really critical related lesson that I've tried to deeply internalize from you over the years, which is not to fool oneself about the conditions, the environment in which we find ourselves.

48:54And I often, I couldn't find it when I rereading your memos this week, but there's a really beautiful quote from your intellectual hero, Peter Bernstein, that I often quote that I'll probably gobble, where he said something like, the market is not a very accommodating machine. It won't give you high returns just because you need them or want them. Can you talk about that? Because I think that's also so distinctive to your approach. And it's such a profound and central idea, this idea of accommodating yourself to reality as it is, not as you wish it might be? Well, first of all, the good news is that on the occasion of the anniversary of the mammals, we published an online digital compilation.

49:37And by the way, it's free, so the price is right. But it's searchable. So if you want to find that quote, you can find it next time. And I mean, the thing is, don't kid yourself. And Charlie Munger always used to say delightfully. He used to quote the philosopher Demosthenes, who said, for that which a man wishes, that he will believe. And we tend to do that, and that's injurious. Because let's say you're a stockbroker, and you get paid on commission. And you say, well, there's always something good to buy. And so you buy every day for your clients, and you make a lot of commissions. Well, guess what?

50:15Some days there's nothing but to buy. And you have to accept that and be mature about it and be patient and hold back. And so it all goes with being mature, analytical, patient, insightful, understanding yourself and your biases, understanding the process of how money is made, and then waiting until the odds are on your side to turn up the wick. Now, I believe you should have investments all the time. But sometimes you do it more aggressively, and sometimes you do it more defensively. You wait for those golden moments to really turn up the wick and become more aggressive. And you've made the point that Charlie really made most of his hay on about four big bets in the course of his lifetime.

51:01Well, Charlie used to say that, four big bets. And I think either he or Warren said that Warren had eight. But yeah, Charlie would say that he made all his money in four things. Let's take a quick break and hear from today's sponsors. I'm curious about online trading, but haven't taken the first step yet. You're not alone. And Plus 500 Futures is a great place to start. The futures markets are moving fast. And with Plus 500, you can explore popular assets like oil, gold, S &P 500, Bitcoin, and more. From crypto to commodities, there's always something happening. The platform is super easy to use, so you can trade on the go right from your phone.

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54:45That's shopify.com slash tip. All right, back to the show. You've written a lot about Charlie over the years, mentioning, for example, his great line, I think at a lunch that you had with him once where he said, it's not supposed to be easy. Anyone who finds it easy is stupid. Can you talk a little bit about what you learned from Charlie, not just about investing, but really about a life well lived? Well, look, he was brilliant. He was extremely well read. He loved thinking and he would just think about stuff. And he developed these things he called mental models for thought. And he had a lattice, what he called the lattice work of mental models.

55:31And it's like a toolkit. And a lot of what we do as adults and as investors is what you might call pattern recognition. And the great thing about having lived a while and paid attention to what's gone around you and applying some intelligence is that X, Y, Z happens. You don't have to stay like, what was that? What is it? Why did it happen? What does it mean? What should I do about it? At some point, you might reach a point where you say, oh, that's one of those. I know what to do about that. So you have to have a toolkit so you know which tools to apply. And that was Charlie. And so very smart, very incredibly thoughtful in interior life, very outspoken, said, exactly what he thought all the time, regardless of who he was saying to or what it was, or whether it would be, you know, he was a good, kind person, but he was the furthest thing from PC that you ever met.

56:34And he would just say what he thought was right. And in fact, I think he has a biography. Yeah, there's a biography of him out. It came out maybe 20 years ago or something. and the title is Damn Right, because that's what he would say. Well, Charlie's thinking, damn right, emphatic. And so, I mean, he just was obviously brilliant, but had this process. And unharnessed brilliance will get you only so far, but he harnessed it into a process. And he came up with a lot of the philosophical points that guided Warren. The big one he's credited with is they convinced Warren to stop looking in the gutter for cigar butts that others had thrown away that had one puff left.

57:19And instead, instead of trying to buy okay companies at great prices, try to buy great companies at okay prices. And that's why Buffett and Berkshire became what they did. You talked there a little bit about patent recognition and the ability to say this is one of those. And obviously, there's a lot of interest at the moment in your view of the current investment environment. I know you've been on a big trip around Asia and the like over the last three weeks, meeting with lots of clients. I'm sure you're hearing a lot of these questions. In August, you wrote a piece called The Calculus of Value, where you said the market has moved from elevated to worrisome.

57:57I'm wondering, when you look at this period compared, say, to 1973, 74, or 99, 2000 or 2007 to 2008, what is it that rhymes in terms of where we stand in the pendulum between greed and fear and optimism and pessimism and risk tolerance and risk aversion? And what makes you not think that we're at that kind of extreme yet, if that's still the case that you don't yet think we're at that kind of extreme most likely? Well, I don't have my finger on the poll, so I don't know where we are today or this week. But I think that when you look for comparisons, the strongest comparison, not a perfect comparison, and I'm not saying this is true in degree, William, but in kind, the strongest comparison is to the TMT, internet.com bubble of 98, 99, 2000.

58:51The nifty 50 was different because it was not around one novel technology and it was around established great companies for the most part. I mean, there were no technological marvels that cracked out in the nifty-fifty. And then the years 0567 with the subprime and the mortgage-backed securities, subprime mortgage-backed securities is not comparable because that was not a technological innovation. That was a financial invention. Nobody thought that, oh, subprime mortgage is going to change the business of housing. The houses were unaffected. It's just that they said, well, we can make money by giving financing to a new class of buyers, which turned out to be a bad idea.

59:42People who wouldn't document their earnings or their assets. So this is comparable to the internet bubble. People said the internet will change the world. But guess what it did? Can you imagine today's world without the internet? It's completely changed in a million ways. In fact, including the fact that we're talking over it. And so this is comparable. It's a technological innovation that I think is going to change the world. But my recollection is we had a clearer view of how the internet would change the world. And the view of many in 99, 2000, has become true. And I think a lot of the excitement surrounded e-commerce, and e-commerce has become a major force.

1:00:29So it just feels to me like we had a vision of how that was going to work out, and it mostly came true. Today, I think we have less of that. I personally, I'm not an expert. I'm the furthest thing from an expert in the world, But I've never heard anybody tell me how AI is going to change the world. We know it's a powerful force. It can think, it can process data, it has access to all the data that's ever been compiled. Exactly what it's going to do, how that's going to be a business, how people are going to make money at it, how it's going to impact life, I think is less clear. But I do think that the two are comparable.

1:01:07And in both cases, there was a new, new thing that fired the imagination. And most bubbles are around something new. In 69, it was growth stock investing. In 06, it was subprime mortgages. In 99, it was the internet. In 1720, it was the South Sea Company. And in 1620, it was Tula Bowls in hollow. So I always make this point that the bubbles are very, very around something new because the imagination is untrammeled and it can go off on a flight of fancy. And you can imagine trees growing to the sky. You're never going to have a bubble in caper stocks or timber stocks. It's too prosaic. And people can say, well, we can tell how many houses you're going to build.

1:01:53We know how much wood is needed in each house. We can tell where we're going to get it from. And so you can't have these tree grow to sky moments in the prosaic areas. It's always something you'll - You had a very interesting conversation recently, Howard, that I was listening to yesterday with Edward Chancellor, author of Devil Take the Hindmost, which had had an important impact on you when you first saw the 2000 bubble. And one of the things you said in that conversation, you made two bold statements. You said, number one, AI will change the world. Number two, most of the companies people are investing in today, in other words, to profit from AI will end up worthless.

1:02:31And then you said, when the naive or hopeful investor takes the leap that the irresistible trend will produce sure profits, that's when you get into trouble. Well, I should go back and reread that, Ramon, I think. But that's right. And change the world and investors making money are not the same thing. And in fact, Warren Buffett pointed out, And I think he said this about the internet that I think was in his 2000 annual meeting. There's no doubt that the internet will produce a great increase in productivity. It's not clear that it'll have a positive impact on profitability. And I think the same is true with AI.

1:03:14AI is going to, you know, I mean, my concern is, I saw CNN is running an ad on my travel. I watched CNN International and they're drumming up interest in a show. And the anchor says to a guest, you say that AI has the ability to eliminate half of entry-level jobs. That was the whole conversation because then they cut to something else. But the point is that may be true. And obviously, if you can produce the US GDP and eliminate half the entry-level jobs, it could be more profitable, or certainly more productive. But the question is, will it be more profitable? To whom will the savings accrue? If different companies are competing to provide the AI service, maybe they'll compete on price to the point where it's not profitable for them.

1:04:05Or if the people who employ AI service compete for market share, maybe all the savings will go to the consumer in the form of lower prices. So exactly how the labor saving tool with AI is going to turn into profits, I don't think anybody can say. You often like to ask, Howard, what's the mistake here? And so obviously we don't have any idea how this is going to pan out, but when you ask yourself what would be the likely mistakes worth avoiding at a time like this, particularly for either naive and credulous investors or just for smart investors who get sucked into euphoria? What are the likely mistakes we ought to be trying to avoid here?

1:04:54Well, what I've seen in euphoria after euphoria is, number one, you shouldn't make the assumption that today's leaders are certain to be the leaders of tomorrow. They may well be, but you shouldn't bet your life on it. Number two, you shouldn't assume that because the leaders are selling at high prices, that it's a good idea to invest in the laggards because they're cheaper. People say, well, they have a low probability of success, but maybe a big payoff, so I should buy it. And that's what I call lottery ticket mentality. And if they have a low probability of success, you should accept that that means chances are good of unsuccess.

1:05:32And then on the AI, I'm led to believe that you can make binary bets in companies that have nothing else going on, which will be sink or swim bets. Or you can invest in through great tech, pre-existing great tech companies, which will get moderate benefits from AI if they're successful, but still be in business and profitable if it's not that big a deal. And now we're back to the very beginning of our conversation. Do you want to have a novel entrepreneurial startup, pure play, which has no revenues and no profits today, but could be a moonshot if it works? Or do you want to invest in a great tech company, which is already existing and making a lot of money where AI could be incremental, but not life-changing?

1:06:26That's a choice. What's your style? What's your game plan? But I mean, if you're going to make binary bets on novel companies, you have to understand how risky that is. There's also been a lot of speculation, obviously, both on gold, which recently hit more than$4 ,000 an ounce, and on Bitcoin. And I was looking back at one of your old memos where you were saying Either you believe in gold or you don't, and you compared it to whether you believe in God or not. There's no analytical way, in my opinion, you wrote to value an asset that doesn't produce cash flow. And I've never been able to bring myself to buy Bitcoin either.

1:07:06And it's now down about a third since October to$90 ,000 a coin. And you've debated this obviously a lot with your son, Andrew. How do you feel now when you look at Bitcoin and gold and you kind of try to wrestle with whether they belong in someone's portfolio? Well, you know, look, I and Oaktree consider ourselves value investors. And what the value investor does is you look at a situation, whether it's a stock, a company, a bond, a building, whatever it might be, and you try to figure out its intrinsic value. value. And then you see how the price today compares to that intrinsic value. And intrinsic value invariably comes from the fact that it can make money, that it can be profitable and produce cash flow.

1:07:56And so let's say I have a building and it produces a million dollars a year in profit, and I'd like to sell it and you'd like to buy it, we can have a discussion. And I say, I'd like$12 million for it, in which case you'll get an 8 % rate of return. And you say, no, I want to pay$8 million for it because I want a 12 % return because it's risky. And I say, no, you have to pay$11 million, but I'll give you a 9 % return, but that'll go up over time and it'll make you the reason. So we can talk, but we're talking in a range centered around the value. But if you're doing Bitcoin or gold or diamonds or paintings, there is no intrinsic value.

1:08:35And I always talk about oil. Oil, as I recall, oil, William, was$147 a barrel in June or July of 07, and then$35 a barrel in January. Nothing changed about oil. It was still black. It still made the vice go. And we were using it faster than we were finding it. Oil doesn't have an intrinsic value. And all these assets, all they're worth is, the price is what the market will bear. But how can you invest analytically? If I say to a gold fan or a Bitcoin fan, well, what do you think the price will be in a year? How do they reach that conclusion? What do they base it on if they don't have cash flow to base that conclusion on?

1:09:23And what I think I said in the memo, you probably remember it better than I do since it's 15 years ago, and you probably read it yesterday. But I think I said, you can invest in it out of superstition, gold. You can invest in it because you think it'll go up. You can invest in it because you think it'll be a store of value because it always has, but you can't invest in it analytically on the basis of something called intrinsic value. I still think that's true. So the people who bought gold a year ago have made a ton of money. The people who bought gold at the time, I just haven't to look at the numbers at my lunch before coming here to do this phone call with you.

1:10:04And if you bought gold at the end of 2010, I think you've had a 7.7 % annual return since then. And if you bought the S &P at the same time, you've had a 12.7 % rate of return. So it's not that gold was a disaster, but you shouldn't be distracted by the gains of the last month. It's been a lackluster investment. You wrote a really important memo called Sea Change in, I think, December 2022, where you talked about really the end of an era where we could rely on declining interest rates that had gone on since 1980. And one thing you wrote in that memo was investors can now potentially get solid returns from credit investments, sorry, from credit instruments, meaning they no longer have to rely as heavily on riskier investments to achieve their overall return targets.

1:11:02Can you talk a little bit about the best way for regular investors to take advantage of opportunities in areas like high yield bonds and the like? Because this is an area where my ignorance really runs deep and obviously your knowledge runs very deep. If we actually want to get equity-like returns in a fairly worrisome environment, what do you do? What's a smart, practical way for a regular investor to do that? Well, high-yield bonds, for example, are part of a group of assets. I call them lending assets. The world calls them debt or fixed income or bonds or notes or loans, but they all fall under the same heading.

1:11:42And they're all instruments where you give somebody your money, they rent it from you, and they promise to pay you interest every six months, and then give you your money back at the end. And you can take those facts and do a calculation and figure out what the rate of return will be if you lend them money at that rate of interest today, and then they pay you back at the end. And it's called fixed income because the outcome is fixed. It's a contractual relationship that promises a fixed return. And so there's only one moving piece in the whole equation. Once you've bought it and the interest rate is set and the price at maturity is set and you've paid a fixed price, there's only one moving piece, which is the probability that they'll keep the promise of interest in principle.

1:12:30And it's the job of the credit analyst to assess that. And it's a fairly arcane thing.

1:12:42People buy stocks because they like the idea of the company or they like the product or something like that. I don't think it's a great idea, but they do. Credit analysis is more arcane. You can't say, well, they make good hamburgers, so I'm going to buy their bonds. It's a totally different story. So for most people who are listening. Well, let me say this. In most areas, the amateur should go into funds or ETFs or some managed product. Remember what Charlie Munger said, it's not easy. Embedding is as easy as stupid. And so that's true in the things I do, but it's also true in my opinion for stocks, Mutual funds, ETFs, index funds, something like that.

1:13:27And investing is a funny business. It's very easy to get an average return. It's very hard to get an above average return. But if you're content with an average return, you can get managed products at a relatively low cost and have a high probability of getting an average return. And the point is that I-Yield bonds yield around seven. Other forms of credit may have a slightly higher return. and if you're happy with that, there are lots of managed products that will deliver it. Going back to this general question that we've been discussing about dealing with risk and dealing with uncertainty, you often quote one of your favorite adages, which is from Elroy Dimson, who said, risk means more things can happen than will happen.

1:14:14It feels like the range of possible things that can happen today is wider than it's been in the past. I'm wondering how you deal with it, not only as an investor, but actually personally, this sense that as you talk to your kids or as you talk to your grandkids, how one actually keeps an even keel in a period where you often quote a lovely line from Peter Bernstein, who said, we walk every day into the great unknown. How do we deal with it? Well, first of all, I've concluded in the last few months, William, that the toughest questions I get are the ones that start with how. Because I can tell you what you have to do.

1:15:00You have to keep an even keel. I can tell you that it may be desirable if you want to be, safe to have a more defensive portfolio. But how to make that decision and how to keep an even keel is a little harder. But obviously, if you let your emotions run away with you, if you buy when things get exciting, which usually means when prices are high, and you sell when things get depressing, which usually means prices are low, it's obviously going to be very counterproductive. So I think the even keel is essential. And I think most of the people that you've met with and written about have a pretty even keel.

1:15:44So that's my strongest recommendation. And this goes back to not being hyperactivity, not trading, not trading all the time. Don't just do something, sit there. Investing is not a fluke that it works. It's not a pachinko game or a roulette wheel. It works over time because economies grow and companies improve their profitability over time. And the most important thing for investors is to get on that gravy train and stay on it. Invest, invest early, invest a lot, and don't tamper with it. And having your emotions under control is essential if you're going to be able to do that last thing of don't tamper with it.

1:16:32And getting on the gravy train and staying on it and not tampering with it is much more important than getting on, getting off, picking the right times to get in and picking the right times to get out, picking exactly the stocks that'll go up the most and avoiding the stocks that'll go up the least. That's all kind of just embroidering around the edges. The most important thing is to be a low-term investor. You also said to me something that really helped me in the the chapter that I wrote about you in my book about just not overreaching, like the big question being how much you push the envelope.

1:17:05And I think that's another really key thing is just ensuring survival. But I was also very struck, you quoted something in your Risk Revisited Again memo from 2015, where you said, in my personal life, I tend to incorporate another of Einstein's comments, which is, I never think of the future, it comes soon enough. And I was wondering whether you were being kind of facile, a little bit facetious, or whether actually that is something that helps you get through uncertainty, that idea. Well, I don't think, I'm not a futurist. I don't think that my vision of the future is bound to be more right than anybody else's.

1:17:43So no, I don't think about it that much. And I just try to do, you know, all these things are kind of a little bit counterintuitive and a little illogical. I I just try to think of laboring in the here and now to buy things that are going to do okay. Well, then you say, yeah, but Howard, in order to know whether something's going to do okay, don't you have to have a review of the future? Yeah, well, you kind of do. So again, don't think you know everything. Don't think you have it right. You've quoted Elroy Dempsey. The future is not a set single thing that if you're smart enough, you can figure it out what it's going to be and it's going to materialize and make you right.

1:18:21It's a probability distribution. It's a range of possibilities in each thing, whether it's GDP growth next year or inflation next year, or who's going to win the next election, who's going to win the next World Series, or whether we're going to have geopolitical peace or any of these things. Only one thing will happen, but many things can. And you should accept that. You should accept that it introduces this uncertainty into the equation. And you shouldn't form a certainty around one outcome and bet heavily on it unless you have special expertise, which very few people do. So I think that humility is a great way to stand out of trouble.

1:19:05And I once wrote in some memo or other about my favorite fortune cookie. You probably read that one too. But it said that the cautious seldom err, or write great poetry. Every person has to decide for themselves. Do I want to try to write great poetry and get rich if my bets are right? Or do I want to avoid erring and be sure that I'll do okay if my bets are wrong? It's a choice. You can't have both. Or you can try to do both, but you have to put your emphasis on one or the other. You can't emphasize both at the same time. And so I think that this is a matter of mindset. that I think most people should adopt.

1:19:50Life is uncertain, the future is uncertain, investing is uncertain. Are you going to go for winners or are you going to try to avoid losers? I wanted to ask you one last quick question, if I may. You've been very generous with your time. I was struck the other day when I was listening to a conversation between you and your Oaktree co-founders, Bruce Karsh and Sheldon Stone, that Sheldon said that when he first met you back in 1983 and came to work with you in high yield debt. You talked even then about the importance of having a balanced life and having time to enjoy your personal life. Bruce also talked about the importance of family to you and all of the founders of Oak Tree.

1:20:28I was very struck as I was looking back on your life that you found plenty of time to play tennis and backgammon and card games with friends like Bruce Newberg and to buy and decorate and fix up houses and spend time with your kids and grandkids. And you mentioned even that you'd spent thousands of hours playing backgammon and card games with Bruce Newberg over 40 years. What advice do you have for investors or other professionals who clearly need to work really hard to compete? And yet you also want to have a balanced life in some form and you don't want to just look back and be like, yeah, I made an enormous amount of money and I never got to hang out with my family at all or my friends or to enjoy my hobbies?

1:21:14Well, you know, we all have to choose what's important to us. Charlie Munger used to say, oh, that guy's a maniac. A maniac was somebody who only cared about working hard and making money. You have to decide whether that's for you. And it's not for me. And, you know, there's an old detritus of all the sayings is that nobody on their deathbed ever said, I wish I worked more. And I think it's true. And I don't, that's not how I'm living my life. And I have, as you say, pursuits that I enjoy greatly, I wouldn't give them up. And once you have enough money or more than enough money, why should you give away part of your enjoyment to have more?

1:21:52I think the greatest saying that I always use when I give advice to young people is from the writer Christopher Morley, who said, there is only one success, to be able to live your life in your own way. Now, the hard part is figuring out what your way is. What is it that you're 22, you're figuring out a career course, what is it that will make you happy at 70? Not easy to know. We change. We sometimes have an inaccurate vision of ourselves. If I described myself to you 40 years ago, I would not describe the person I am today, mainly because maybe I was wrong and maybe I changed. But yet, our goal should be to get to the end and say, I'm happy with the choices I made.

1:22:40But again, that should be a choice that is made consciously. And just pursuing work and money and career and prestige because other people are doing it because it's glorified in the media or because you want to emulate XYZ, become the richest man in the world, you shouldn't do it unless it's really right for you. And I don't think it's right for most people. So I think live your life your way, figure out what's good for you and pursue it. I feel like when I look at your life, you've done a great job of setting things up so that it suits you. So you're writing memos, which you love doing. You're not making individual investments yourself.

1:23:19You're not managing lots of employees. You're setting the firm's investment philosophy and meeting clients. There's something really lovely about seeing the way you've set yourself up in this sort of very internally aligned way. So it's a great model for us all. Thank you. Well, William, my idol, Warren Buffett, always says he skips to work in the morning, and I feel I do. I'm happy to go to work, and I like what I do. I hope to keep doing it for a long time to come. I hope so too. Thank you so much, Howard. It's been a real delight chatting with you. And I really learned so much from you over the years.

1:23:56And I really tried to not just read these memos, but really truly internalize the lessons. And I know that I'm one of many thousands of people whose lives are actually tangibly better because you've shared these lessons. So thank you. Thank you. It's a pleasure speaking with you and let's do it again. I look forward to it. All right. Take care. Thanks, Howard. Thank you for listening to TIP. Make sure to follow Richer, Wiser, Happier on your favorite podcast app and never miss out on episodes. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only.

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