04/08/2022
Last week renowned value investor Howard Marks released a memo titled “I Beg to Differ” which has useful learning for long-term value investment firms, even in Nepal. Below we have summarized the key learnings for investors with busy schedules:
· There are two approaches to investment – Passive Investment (Index Investing) and Active Investment. In Passive Investment, an investor’s focus is simply to generate GUARANTEED AVERAGE returns. S/he does so in order to avoid below-average returns, but it comes at a cost – not generating above-average returns. Just GUARANTEED AVERAGE returns.
· In Active Investment, the focus of an investor/manager is to generate returns well above what the average market offers. This pursuit requires fund managers to think differently from the crowd and place investment bets differently from the average market. However, the desire to outperform the market comes at a cost – if the manager is wrong with his/her bet, they will generate below-average returns and this will jeopardize the career of the manager/fund. Active investment is not easy; it requires managers to risk being wrong.
· Apart from superior thinking skills, successful active investment requires the manager to look wrong for a while (because the average market disagrees with the manager today) and survive some mistakes to ultimately generate above-average returns in the long run. However, this gut-wrenching, uncomfortable behavior necessary for a successful manager is further disincentivized by Institutions as they want to ‘avoid looking wrong even temporarily’ to their committees, board, clients. They would rather pass profitable long-term bets than select such bets which produce temporary losses. Such institutional culture is harmful to the pursuit of successful active investment.
· Howard also addresses what the entire world is talking about – Macros (inflation, rising interest rates, recession). He states that these are short-term phenomena that should not bother long-term investors; investors are better off evaluating the fundamental qualities of an asset rather than trying to time the market or rotate sectors. Using S&P 500 data over the past century, he concludes that time NOT timing leads to wealth accumulation.
· To conclude superior active management strategy requires (a) using superior second-level thinking to identify undervalued securities (b) taking contrarian bets which look temporarily wrong with the confidence that the investments can generate superior returns over the long term (c) ignoring short-term performances (d) ignoring macro-economic trends and most importantly (e) embracing a culture in institutions (including committees, board, clients) where managers can confidently pursue active investment strategy despite the risk of being wrong, – where managers can say – I BEG TO DIFFER!
