Patient Opportunism

Patient Opportunism

An edited excerpt of Howard Mark's classic work, 'The Most Important Thing'

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The boom-bust cycle associated with the global financial crisis gave us the chance to sell at highly elevated levels in the period 2005 through early 2007 and then to buy at panic prices in late 2007 and 2008. This was in many ways the chance of a lifetime. Cycle-fighting contrarians had a golden opportunity to distinguish themselves. But one of the things I want to do in this chapter is to point out that there aren’t always great things to do, and sometimes we maximize our contribution by being discerning and relatively inactive. Patient opportunism—waiting for bargains—is often your best strategy.

So here’s a tip: You’ll do better if you wait for investments to come to you rather than go chasing after them. You tend to get better buys if you select from the list of things sellers are motivated to sell rather than start with a fixed notion as to what you want to own. An opportunist buys things because they’re offered at bargain prices. There’s nothing special about buying when prices aren’t low.

At Oaktree, one of our mottos is “we don’t look for our investments; they find us.” We try to sit on our hands. We don’t go out with a “buy list”; rather, we wait for the phone to ring. If we call the owner and say, “You own X and we want to buy it,” the price will go up. But if the owner calls us and says, “We’re stuck with X and we’re looking for an exit,” the price will go down. Thus, rather than initiating transactions, we prefer to react opportunistically.

At any particular point in time, the investment environment is a given, and we have no alternative other than to accept it and invest within it. There isn’t always a pendulum or cycle extreme to bet against. Sometimes greed and fear, optimism and pessimism, and credulousness and skepticism are balanced, and thus clear mistakes aren’t being made. Rather than obviously overpriced or underpriced, most things may seem roughly fairly priced. In that case, there may not be great bargains to buy or compelling sales to make.

It’s essential for investment success that we recognize the condition of the market and decide on our actions accordingly. The other possibilities are (a) acting without recognizing the market’s status, (b) acting with indifference to its status and (c) believing we can somehow change its status. These are most unwise. It makes perfect sense that we must invest appropriately for the circumstances with which we’re presented. In fact, nothing else makes sense at all.

In Berkshire Hathaway’s 1997 Annual Report, Buffett talked about Ted Williams—the “Splendid Splinter”—one of the greatest hitters in history. A factor that contributed to his success was his intensive study of his own game. By breaking down the strike zone into 77 baseball-sized “cells” and charting his results at the plate, he learned that his batting average was much better when he went after only pitches in his “sweet spot.” Of course, even with that knowledge, he couldn’t wait all day for the perfect pitch; if he let three strikes go by without swinging, he’d be called out.

Way back in the November 1, 1974, issue of Forbes, Buffett pointed out that investors have an advantage in that regard, if they’ll just seize it. Because they can’t strike out looking, investors needn’t feel pressured to act. They can pass up lots of opportunities until they see one that’s terrific.

Investing is the greatest business in the world because you never have to swing. You stand at the plate; the pitcher throws you General Motors at 47! U.S. Steel at 39! And nobody calls a strike on you. There’s no penalty except opportunity. All day you wait for the pitch you like; then, when the fielders are asleep, you step up and hit it.

One of the great things about investing is that the only real penalty is for making losing investments. There’s no penalty for omitting losing investments, of course, just rewards. And even for missing a few winners, the penalty is bearable.

Oaktree has always been explicit about our belief that missing a profitable opportunity is of less significance than investing in a loser. Thus, our clients are prepared for results that put risk control ahead of full participation in gains.

Standing at the plate with the bat on your shoulders is Buffett’s version of patient opportunism. The bat should come off our shoulders when there are opportunities for profit with controlled risk, but only then. One way to be selective in this regard is by making every effort to ascertain whether we’re in a low-return environment or a high-return environment.

You simply cannot create investment opportunities when they’re not there. The dumbest thing you can do is to insist on perpetuating high returns—and give back your profits in the process. If it’s not there, hoping won’t make it so.

When prices are high, it’s inescapable that prospective returns are low (and risks are high).

That single sentence provides a great deal of guidance as to appropriate portfolio actions. How are we to factor such an observation into our practices?

How might one cope in a market that seems to be offering low returns?

• Invest as if it’s not true. The trouble with this is that “wishing won’t make it so.” Simply put, it doesn’t make sense to expect traditional returns when elevated asset prices suggest they’re not available. I was pleased to get a letter from Peter Bernstein in response to my memo, in which he said something wonderful: “The market’s not a very accommodating machine; it won’t provide high returns just because you need them.”

• Invest anyway—trying for acceptable relative returns under the circumstances, even if they’re not attractive in the absolute.

• Invest anyway—ignoring short-run risk and focusing on the long run. This isn’t irrational, especially if you accept the notion that market timing and tactical asset allocation are difficult. But before taking this path, I’d suggest that you get a commitment from your investment committee or other constituents that they’ll ignore short-term losses.

• Hold cash—but that’s tough for people who need to meet an actuarial assumption or spending rate; who want their money to be “fully employed” at all times; or who’ll be uncomfortable (or lose their jobs) if they have to watch for long as others make money they don’t.

• Concentrate your investments in “special niches and special people,” as I’ve been droning on about for the last couple of years. But that gets harder as the size of your portfolio grows. And identifying managers with truly superior talent, discipline and staying power certainly isn’t easy.

The truth is, there’s no easy answer for investors faced with skimpy prospective returns and risk premiums. But there is one course of action—one classic mistake—that I most strongly feel is wrong: reaching for return.

Given today’s paucity of prospective return at the low-risk end of the spectrum and the solutions being ballyhooed at the high-risk end, many investors are moving capital to riskier (or at least less traditional) investments. But (a) they’re making those riskier investments just when the prospective returns on those investments are the lowest they’ve ever been; (b) they’re accepting return increments for stepping up in risk that are as slim as they’ve ever been; and (c) they’re signing up today for things they turned down (or did less of) in the past, when the prospective returns were much higher. This may be exactly the wrong time to add to risk in pursuit of more return. You want to take risk when others are fleeing from it, not when they’re competing with you to do so.

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The Most Important Thing, Howard Marks