Around 1980, a reporter from one of the first financial news networks asked me a provocative question: “How can you buy high yield bonds when you know some of the issuers are going to default?”
My response captured the essence of intelligent risk bearing, “How can life insurance companies insure people’s lives when they know they’re all going to die?”
Howard Marks
Legendary investor Howard Marks has released his latest investing memo. The co-founder of Oaktree Capital Management has become known for his memo’s, dispensing investing wisdom one PDF at a time. In this memo, he writes about the concept of risk in investing and how he has trained his team at Oaktree to think about risk when building portfolios.
Oaktree’s motto sums up their approach to risk management: If we avoid the losers, the winners will take care of themselves.
This is particularly relevant for Oaktree’s roots in fixed income investing (bonds) where the name of the game is to avoid companies that will default. As Marks explains, if you have 100 bonds all paying 8% a year, you don’t get paid more by choosing the excellent companies. Your only risk is the downside risk of choosing companies that will go bankrupt and won’t be able to pay their debts.
Marks also writes about the idea of risk in the sharemarket and how avoiding losers is the name of the game there. So much of a company’s future is uncertain. And the most successful companies often take surprising turns – Apple’s invention of the iPhone, Netflix’s hard pivot to streaming. The name of the game is to avoid the losers that will go out of business and ensure your portfolio is full of potential winners that can innovate and grow over time.
Risk is the price we pay as investors to access the opportunity to earn outsized returns. There are plenty of different ways to define it and try and manage it, but no way to avoid it completely. Marks’ focus on avoiding the losers – those companies that will go bankrupt and lose your money – is a great place to start.
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