We Study Billionaires - The Investor’s Podcast Network - TIP212: Billionaire Howard Marks (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. Boy, are we excited about today's show because we have the absolute honor and pleasure to talk to billionaire Howard Marks. For many people in the investing community, they know Mr. Marks because of his superior performance for five decades. In fact, Mr. Marks' performance in the distressed debt market has returned an average of 19% annually for the past 22 years. Back in 2008, Mr. Marks' company, Oak Tree. capital management. They raised $10.9 billion during the financial crisis, making it the largest the stressed debt fund in history. Mr. Marks is the author of the most important thing, and he also wrote a new book titled Mastering the Market Cycle. So, without further delay, here's our interview

Starting point is 00:00:46 with the legendary billionaire Mr. Howard Marks. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. All right, welcome to the Investors podcast. I'm your host, Preston Pish, and as usual, I'm accompanied by my co-host, Stig Broderson, and today we are joined with legendary investor, Mr. Howard Marks. Mr. Marks, welcome to the show. Thank you very much.

Starting point is 00:01:29 It's a pleasure to be here with you. So, Howard, you have a brand new book titled Mastering the Market Cycle, and in your book you start off with an excellent example that talks. about the importance of understanding risk and probabilities. To demonstrate this idea, you talk about a jar of black and white balls and I just loved this example that you provided. And I was wondering if you could share this idea with our audience. My first premise in investing is that we never know what's going to happen. We don't know what events will unfold. We don't know how the market will react to those. The future, in all

Starting point is 00:02:06 regards is a probability distribution. The best investors don't know what's going to have, but they understand the possible events and they can reasonably assign them probabilities. And your future as an investor in anything at any time is similarly a matter of a probability distribution. Now, that's not to say that the distribution is always the same. One of the things that the book is about is that where where we stand in the cycle dominate the shaping of the probability distribution. If we're high in the cycle, if psychology and prices are elevated, then the probability distribution shifts to the left. It becomes harder to make money and easier to lose money, and the expected outcome is less

Starting point is 00:02:56 good. If we're low in the cycle and prices and psychology are depressed, then the probability distribution It shifts to the right, and it's easier to make money. So I compare it, as you say, to, let's say, a bowl full of balls or lottery ticket. And you're going to pick one, that's the outcome, from a bowl that contains many. Those are the possibilities. So it sounds like an uncertain process, but if you develop the skill, if you understand what's going on and what the ramifications are, then you can say, well, now I'm.

Starting point is 00:03:33 know there are a lot of good balls in the bowl, not too many bad ones, the distribution and possibilities is favorable, I'm going to invest heavily and I'm going to be aggressive. If at another time you understand that the cycle is precarious, you might say, now I think there are not too many good balls in the bowl, only bad balls, I'm going to take some ships off the table and invest more defensively. In both cases, you don't know what's going to happen. but I think it's obviously essential to understand how the probability distribution shifts, the distribution of balls in the bowl. There will still only be one chosen, and there will be uncertainty and randomness associated

Starting point is 00:04:18 with that choosing. But that doesn't mean we can't know something about what's going on. One of the reasons why Preston and I, and really the show such big fans of yours, is that in value investing, we typically do not talk too much about macro and cycles. I mean, it almost seems like it's a curse word. Here we'll look at it differently, and we know that you do too. So I'm curious if anything happened to you in your career and personal career, perhaps in some of the early years, that led you to the opinion that you should understand

Starting point is 00:04:54 the market cycles, and it needs to be a part of your overall analysis. Sure. This summer marked my 50th anniversary in the business. I started with equities. After 10 years, I shifted to high-yield bonds and convertibles. And in the first 10, I was doing research. And the second 10, I was managing money. And then 20 years in, in 88, I was joined by my partner, co-founder of Oak Tree, Bruce Karsh. And we set about organizing what I think was the first distressed debt fund from a mainstream financial institution. and we organized the fund in 88. And then in 90, we had a sense that the LBOs of the 80s had been over levered and were precarious.

Starting point is 00:05:43 And the economy might falter. And so we raised a very large fund and the ability to add more capital if what we thought would materialize did. And it did. that fund was much larger than the first one and invested very aggressively and had an extremely high unlevered rate of return. And then we saw that the economy improved and the credit window reopened and it became easy to borrow again and companies were doing well and the incidence of distress massively subsided in the mid-90s. There was again very little to do. So we should contracted the size of our funds, and we invested more carefully, and we had to be more creative.

Starting point is 00:06:31 And then, of course, in 01-02, we had the telecom meltdown, and we had Enron's scandals, and we again had economic weakness, and we again invested aggressively. Things got so good that we quickly liquidated 102 funds, didn't raise a fund in 2003, raised much smaller funds in 0405, but then found ourselves on the first day of 07 on what we thought was the doorstep of another opportunity. Now we raised the biggest fund in history, $11 billion. So the point is, after 20 years in which I had a sense that the environment was stable, and in fact it didn't change very much from 68 to 88 in terms of the impact on me, I started to live with and be highly affected by these cyclical swings adapted to them and profited from them greatly.

Starting point is 00:07:28 Every once in a while we'd have a big fund in a distress moment that was with a high return. Then we'd go through some years of quiet when we did small funds that had low returns. And so my life became cyclical. And that's when and how I gained the appreciation that I have done. now. Howard, for many people that are listening to the show, their number one question might be, you know, where are we at today in the current credit cycle? I would assume that the approach that a lot of people might take to understand where we're at in a credit cycle would be to start with a narrative and then go back in history and study what was happening in that period of time to see

Starting point is 00:08:09 if it looks similar. So let me give you an example. If someone thought today that we were at a market high, maybe they'd go back to 2007 and look for clues and see. And, you know, see whether it's similar to what we're experiencing right now. So my question for you is, is that a good idea or is that really a bad approach? First of all, one of the main themes in the book, maybe the main unifying theme is the Mark Twain attributed quote, history does not repeat itself, but it does rhyme. And the cycles that we talk about are never the same from one to the next. The speed, the duration, the amplitude, the reasons, the features, the effects are always different from one cycle to another. You'll never find two that are exactly the same.

Starting point is 00:08:58 But we look for analogies in order to understand patterns so that we can know what happened in the past and prepare for what might happen in the future. I just put out a memo last week entitled The Seven Worst Words in the World. And for a credit investor, which is what we are at Oak Tree, the seven worst words in the world are too much money facing two few deals. I wrote a memo in February 2007 to entitled The Race to the Bottom. I felt there was too much money casing two few deals, which has a very dilutious effect on prospective returns and on safety. And of course, that memo was considered to have been roughly right. And I feel that in many ways the current environment is also analog to that.

Starting point is 00:09:44 period and reflects that theme. And in the memo, you know, I talk about what's going on in the markets. Nobody wants to invest in the safer markets, which pay one or two or three percent. And so the money is crowding into the smaller risk markets that people hope will pay six or eight or 10, but would be the effect that I described of forcing up prices, down yields, up risk, down safety. I think the analogy is there. Now, it doesn't hold in every detail. And I go to, of length in the memo to say, I'm not saying we're in a bubble. It is not a repeat of 07 in that regard, and I'm not telling people they should be out of the market, but I believe that people should behave with caution today because of the race to the bottom that I think is going on.

Starting point is 00:10:32 How is it different from 07? Well, first of all, the banks are not nearly as levered as they were, so they're unlikely to get into systemic trouble and require a bailout, which panics the whole system. The building block for the 07 events were subprime mortgages and mortgage-backed securities. And there is no analog to that today. There is nothing out there today, which is as massive in scale and also, so I'll say fraudulent. So the analogy is good as to the race to the bottom, but not good, in my opinion, as to bubble and crows. Let's take a quick break and hear from today's sponsors. All right.

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Starting point is 00:15:39 while you're managing your portfolio. I'm curious if that way of thinking is also pliable for you. You're managing so much money on behalf of not just yourself, but also clients. And it might seem that we are at the peak of the market cycle. Do you look towards stress-adjusted returns or are you looking to optimize returns? turns. How do you see that trade-off, perhaps if there's even is a trade-off? For the last several years, we've been operating under a mantra, move forward with caution. I reached the conclusion some years back, and I still feel the same, although a little less so,

Starting point is 00:16:22 that the outlook is not so bad and prices are not so high that we have to go to maximum defense, as we did in, let's say, 06. On the other hand, the prices are not so good. the outlook is not so good that we should be aggressive. And so we're trying to balance investing with defense and also, but stay in the game. When I came up with that mantra some years back and at moment since, there were times when you might have said, you know, this is a scary market. I want to take some chips off the table. Going to cash virtually at any point in time in the last 10 years would have been a mistake.

Starting point is 00:16:59 So move forward, but with caution means to us, We're investing. We invest every day. We are endeavoring to be fully invested, other than in funds which have a specific reserve components, but we are investing with caution. And since we consider ourselves a cautious firm, that means more caution than usual. One way you see that, that we haven't grown our AUM, our assets under management, in about five years.

Starting point is 00:17:29 We changed our accounting this year to reflect 20% of double line. assets where we own 20% of the company. But other than that, accounting change, we haven't really expanded our business in five years, not because we couldn't, but because we think this is not a time that warrants expanding the business. We try to do what I just said. We try to expand when we're in the propitious part of the cycle and not expand when we're in the, or even contract as we have at times when we're in the precarious market. I think I should mention a little bit about something you touched on. This question about whether what I call cycle positioning,

Starting point is 00:18:15 what other people might call market timing, has any place for a value investor. And, you know, clearly Warren and Charlie don't time markets as far as we know. And, you know, the goal is to buy into good situations, hopefully at good prices and hold for the long run. And that is absolutely the right thing to do. But the question is, if that is your underlying theme, and if you do that, then can you enhance the results

Starting point is 00:18:41 by also thinking about the cycle? I think he can. And frankly, not everybody is in the same position as Berkshire with regard to permanence, both the permanence of capital and the permanence of jobs. and I wrote a forward for a book called The Warren Buffett Way, and I described the things that I think make Warren Warren, the last one of which is that he's not worried about losing his job.

Starting point is 00:19:10 And that's a blessing. People who are in the business commercially of running money or people who might lose their nerve and sell out at the bottom, which is tantamount to losing your job if you're managing your own money, they can't ignore it. And if the market's going to go, through an up cycle for many years. They want to be part of it. If it's going to go through a down cycle, they might like to not bear the full brunt. So I think that the two can be integrated. We are value

Starting point is 00:19:38 investors, but we try to amp it up when the time is right and cool it off when the time is right. So, Howard, when we look at the 10-year treasury for the last 30 years, we can see that rates were as high as 16, 17 percent or something like that back in 1981. And they've progressed aggressively gone down since. Whenever I think about Warren and Charlie and one of their main engines for creating cash inside of their company, it's GEICO and the insurance industry in general. When you look at the model on why that has been such a great model is because they've got a huge float that they can invest. But what happens when interest rates, assuming that this trend that we've seen for the last 30 years and that central banks, when they get in any kind of trouble,

Starting point is 00:20:25 it seems like QE is the tool of choice. And we know that when you use QE, the impact on bonds is that the prices go higher and the yields go down. So if that's the case and we start paging our interest rates at 0% is the insurance industry become a big risk at that point because the only thing you can buy with a lot of this capital and a lot of this float are bonds that are yielding nothing. I'm kind of curious just to hear your opinion on that. that's really a high-level question. That's a $64 question. Going back to what Twain said,

Starting point is 00:21:01 history doesn't repeat, you have to accept the ability of events of the future to depart from the ability, from the events of the past. And you describe, accurately, a 36-year period since I would say 82, in which interest rates essentially have gone down. Now, arguably, they stopped going down

Starting point is 00:21:23 about four years ago, but they're still awful low. So we went from my so-called normal environment to a high return environment as a result of the inflation of the 70s and early 80s. And then we went through this period of compression of yields. And as you say, the 10-year went from I think 14 or 16 to 1.5. And you can't overstate the valutory of that on assets. Directly, when interest rates go down and bond prices go up, an old outstanding bond of an old interest rate becomes more valuable in a new

Starting point is 00:22:11 environment in which contemporary rates are lower. That's a direct impact. you take any income producing asset, you get a company, a stock, or a piece of real estate, and either in fact or implicitly, we value these things on discounted cash flow. We take the cash flows of the future, we discount them back to the present,

Starting point is 00:22:36 and we figure out what the thing is worth. And clearly, the discount rate changes. When you discount a given stream of future, cash flows at a low interest, at a high interest rate, you get a low value. And when you discount it at a lower interest rate, you get a higher value. And that happened. And QE and the interest rate cuts and all of the stimulative measures had the effect, to respond to the global financial crisis, had the effect of hitting savers

Starting point is 00:23:08 and hitting people living on their income from their portfolios. And it may cause asset appreciation, and it helped people who owned assets. And these things, the incremental impact of that is in the past. Rates got down to zero, and today they're two. But, you know, I have a piece of paper on my wall from a slip I had from the bank in 82 with the interest rate of three quarters over prime. And I have a slip from the bank saying the rate on your loan is now 22 and 3 quarters. More recently, I borrowed money at two and change.

Starting point is 00:23:48 So that's not going to happen again because we are at low levels. Businesses that depends on income and insurance is the prime one, don't have the opportunities today that they did then. If today the 10 years at 3, a business which is modeled on investing float, is just not as good. No doubt about it. Of course, if you can go into businesses today, which pencil out based on the return on float of three,

Starting point is 00:24:24 and rates go up to six, maybe you'll be back in the chips again. In the years just before the crisis, all the money I had in the world that wasn't at Oak Tree was in treasuries of one, two, three, four, five, six year to rate maturity, the lattered portfolio, the dumbest form of investing no demand. And I was perfectly happy

Starting point is 00:24:41 because I had total safety, total liquidity, and a yield in the sixes. And of course, today, that portfolio would yield in the twos. It's a very different story. The interesting question is, will it go back to six someday? That's the million-dollar question. That's the billion-dollar question. Of course.

Starting point is 00:24:57 Yes, and clearly the world is a very mysterious place in that regard. We can't predict the economy. We can't predict inflation. If six was right for that environment, shouldn't we kind of go back to six now. but who would bet there is money that the five year will yield six. And I feel the Fed and the central banks of the world did something in the global financial crisis by taking their balance sheet up to 20-odd trillion, tripling or quadrupling their balance sheets. They did something that had never been done before.

Starting point is 00:25:35 and now they're at least the Fed is in the process of unwinding and in Europe they're going to stop QE and someday they'll unwind I believe you can't say you know how it's going to go you can theorize let's take a quick break and hear from today's sponsors no it's not your imagination risk and regulation are ramping up and customers now expect proof of security just to do business That's why VANTA is a game changer. VANTA automates your compliance process and brings compliance, risk, and customer trust together on one AI-powered platform. So whether you're prepping for a SOC 2 or running an enterprise GRC program, VANTA keeps you secure and keeps your deals moving. Instead of chasing spreadsheets and screenshots, VANTA gives you continuous automation across more

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Starting point is 00:29:19 we're at in the credit cycle is the bond yield curve. And what we've seen since the cycle that we've been going through, you know, if you're calling the bottom of the last one 2009, the summer of 2009 was the bottom. And we've seen this huge upturn in the market, specifically talking about the equity market. We have been looking at the bond yield curve because typically when the bond yield curve goes flat, it starts to go inverted, and you're starting to see a top. So that's one of the main metrics that I've personally used, whether that's a good metric or not, but it's something that I pay very close attention to. And what we've seen recently is that the bond yield curve is really starting to flatten itself out. It's definitely not inverted at this point, but it's flattening itself out. I'm kind of curious to hear your thoughts on the bond yield curve as being one of those metrics that kind of gauge where you're at in a credit cycle. And then maybe some other really critical variables that you would assign to kind of giving yourself an idea where you're at in the cycle. For the most part, I'm not given to technical indicators of that nature.

Starting point is 00:30:23 The flat yield curve or inverted yield curve certainly seems to have been coincident with recessions in the past, but I'm not sure of the causality. And if I'm not sure of the causality, then I can't be too convinced that it's always going to be the case. It's not the main kind of thing I look at. I tend to look more at things that are internal to the markets like valuation, and behavioral, as I said, taking the temperature. How are people thinking? How are they acting? What are their attitudes? You know, when people are fearless and unconcerned about risk and risk tolerant and greedy and confident and credulous, bad things happen, they pay too much for securities,

Starting point is 00:31:11 they overlook risk, they bid too highly, they forget to demand risk premiums, they forget to to demand protective covenants and so forth. And prices go too high. When people are fearful and exceptionally risk-averse and skeptical, pessimistic, and so forth, then they demand high-risk premiums. And even good companies can't get money. And they insist on strong covenants. And deals go begging.

Starting point is 00:31:45 And that's the climate I want to invest in. That's what I watch for. And so far it has worked. Back in October of 2008, which for us investors in credit was pretty much the low point in terms of prices were very low. And you could buy huge quantities from entities that were melting down. I noted extreme negativism. And I wrote a memo called The Limits to Negativism. And I said that one of our main jobs as investors is skeptical.

Starting point is 00:32:16 Somebody comes in, he says, I've managed money for 30 years, and I've made 10% a year between a range of 9 to 11. I've never had a down month. Your job is to say, you know what, that's too good to be true, Mr. Madoff. But if somebody comes in and says, I tell the story in the book, the world is ending, and you posit some assumptions, and you show that even under those conservative assumptions, the portfolio was still do well and that person says no I think it could be worse than that and so you posit a more conservative assumption and they say it could be worse than that and you posit a more server somebody they say no it could be more concerned at some point you have to say no that's too bad to be true and that's what we were seeing in the fall of 08 post-leiman and it's all you had to know there was only pessimism and no optimism That really goes back to one of the first things we talked about knowing your probabilities

Starting point is 00:33:16 and estimating the array or what's going to happen. Yes. And, you know, people say, give me your worst case scenario. And I've learned, through my experience, that there is no worst case scenario that can't be exceeded. But the fact that you can posit an incredibly negative scenario doesn't mean that you should assign it a high probability. and people get confused. You can only deal with the world.

Starting point is 00:33:43 You can only be a good investor and deal with the future if you think probabilistically. And to say it could happen is not to say it will happen or that it has a reasonable chance of happening. We have to think in terms of probability distributions and assign odds and have a sense for what the future distribution looks like and how it shifts. So if you look at the current cycle, and perhaps the cycle has been longer than what most of us expected, you have a wealth of experience here, Howard. But I'm still curious. Have you learned anything new from this cycle that you didn't know before?

Starting point is 00:34:24 Well, I would postulate now we're into the ninth year of recovery and the ninth year of bull market. Historically, there's never been a recovery that went more than 10 years. So I think one thing we all learned is that history can be violated. As they say in sports, records are made to be broken. And one of the things, when people deal with cycles and they set out rules, like this has to happen after two years and this can only go four years and this has to happen when the market rises 10% or 20% or 30%. I reject all rules. That's the part that does not repeat. It affects the probabilities, but I absolutely reject rule-based.

Starting point is 00:35:08 investing with regard to history. So that's an important lesson. I think we've learned another important lessons did in this recovery because for a long time, this has been the slowest recovery in history. Everybody kind of despaired about that. I believe what I've learned is that a slow recovery, all things being equal, has a better chance of being a long recovery because the slowness of the recovery suggests that excesses are not being created, and it is from excesses on the upside that the need for a downward turn comes. I would like to talk more about the reflections that you have. What really materialized for you that you didn't know before, like as you were typing up all the experiences you have and was passing it on to the next generation of investors?

Starting point is 00:36:10 Did you have any one piece of advice? Great question. There's a good answer. I had an outline. And I think, you know, most authors probably have an outline. And I knew which chapter as I was going to write. I was going to write what is a cycle. And do they recur?

Starting point is 00:36:24 And talk about the economic cycle and the corporate profit cycle and the swing and cycle. psychology and then credit cycle and on and on. And as I was writing, one of the real reasons that I love to write is because I think of things, of new things as I write, that I hadn't thought of before. And I'm a real believer in the importance of risk aversion in the market. And the market is only makes sense if investors are risk-averse. As I was writing the chapter on psychology, I realized that risk aversion is such an important element in understanding markets and their potential that it deserved a chapter of its own. And so I added a chapter called The Cycle in Attitudes Towards Risk.

Starting point is 00:37:21 That and the credit cycle are probably the two most influential and most volatile. and most important. How are people thinking about risk? And frankly, the way I feel it in the good times, when everything's going smoothly, what do people say? They say risk is my friend. The more risk I take, the more money I'm gonna make.

Starting point is 00:37:45 So I'm gonna max out my risk. I've actually told, had people tell me that they're not gonna hire Oak Tree or give an assignment because they wanna maximize risk and they know they can't do it with that with oak tree. But people say, risk is my friend. The more you take, the more I'm going to make. And by the way, I don't see anything to worry about. That's how they think or speak in the good times. You want to get the hell out of the market. And if everybody says, I'll never

Starting point is 00:38:14 bear risk again, risk bearing is a big mistake. Then you want to get in. And it's rather simple. Now, knowing what's going on is not always so simple, and doing what I think is called for can be very difficult. It's uncomfortable to be a buyer when everybody else is a seller. For the simple reason that the reasons that motivate everybody else to sell will bear on you as well. When I was finishing my last book, I had lunch with Charlie Munger, and at the end, when I got up to go, he said, just remember, None of this is meant to be easy, and anybody who thinks it's easy is stupid. And I never want to portray that it's easy to come to correct superior conclusions and implement them. But it's pretty clear what we must do.

Starting point is 00:39:10 Pretty clear what we must do. You know, Dave Swenson, who runs the endowment at Yale and does a fantastic job, wrote investment management, by which I think he means superior investment management, requires the adoption of, uncomfortably idiosyncratic positions. First of all, the herd is usually wrong. Secondly, if you do the same as the herd, you can't expect to outperform the herd. That doesn't make anything. To be a superior investor, you have to figure out what the herd is doing, why the herd is wrong and do the opposite. And by definition, that has to be uncomfortable. Now, it can be satisfactory intellectually, but it's rare for it to be easy emotionally.

Starting point is 00:39:53 And I think that understanding the attitude toward risk was a revelation to me as I wrote the book. And as I say, I think it's one of the most important chapters in the book. Howard, we can't even begin to thank you for taking time out of your day to chat with us. You had mentioned in the interview the letters that you write. Stig and I are both on your email list to receive these letters. These letters are gold, folks. We will have a link in our show notes for you to sign up on his email list for these letters that he puts out there. and they are absolutely gold.

Starting point is 00:40:25 The name of the book is mastering the market cycle, getting the odds on your side by Howard Marks. Stig has read the entire book. I'm about halfway through the book, and I'll tell you what, this thing is awesome. As you can see, the thoughtfulness. Just hearing Howard respond to some of the questions. This is what the book is completely filled with.

Starting point is 00:40:45 I know Stig and I aren't probably the best endorsement, but here's an endorsement for you. Ray Dalio says Howard Marks, mastering the market cycle is a must read. Charlie Munger says, I've always said there's no better teacher than history in determining the future. Howard's book tells us how to learn from history and thus get better ideas of what the future holds. So Howard, thank you so much. Seriously, this was just incredible. We are big fans.

Starting point is 00:41:10 We've been big fans for quite a few years. And it's just an honor to talk to you. Well, it's been a great pleasure to respond to your questions. Thank you for having. Thank you, Howard. Pleasure. All right, guys. That was all the Preston and I had for this week's episode of The Investors Podcast.

Starting point is 00:41:26 We see each other again next week. Thanks for listening to TIP. To access the show notes, courses or forums, go to theinvestorspodcast.com. To get your questions played on the show, go to Asktheinvestors.com and win a free subscription to any of our courses on TIP Academy. This show is for entertainment purposes only. Before making investment decisions, consult a professional. This show is copyrighted by the TIP network.

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