Howard Marks on Risk

We are big fans of Oaktree's Howard Marks. If you have not read his most recent letter, you really have to read it here: Howard Marks on Risk.

Now I can not time the market. Actually I have no idea where the market is going today, tomorrow or some subjective time period. That being said, I do know when people get greedy, it is time to start de-risking. And with that, I have come up with a new investment philosophy I think all credit investors should adopt:

"When investor demand is so strong in the leveraged loan and high yield market that second lien dividend deals are being oversubscribed, it is time to start selling"

I think you would sleep a little better at night with that in hand.

Back to Marks. The paragraphs I cite below really left me in awe when I read it earlier this morning. It makes so much sense from a value investor's perspective but I feel like it gets lost in the weeds of the Mr. Market's of the world. Enjoy:
For about a year, I’ve been sharing my realization that there are two main risks in the investment world: the risk of losing money and the risk of missing opportunity. You can completely avoid one or the other, or you can compromise between the two, but you can’t eliminate both. One of the prominent features of investor psychology is that few people are able to (a) always balance the two risks or (b) emphasize the right one at the right time. Rather, at the extremes they usually obsess about the wrong one . . . and in so doing make the other the one deserving attention.
Followed by:
But when people get excited about the prospect of easy money – even if from assets or investment strategies that have become far too popular, turning into overpriced manias – they frequently drop their risk aversion and adopt risk tolerance instead. Thus they swarm into the investment du jour without concern for its elevated price and risk. This behavior should constitute an important warning flag for prudent investors.

In the same way that expanded risk tolerance accompanies appreciated asset prices and contributes to the risk of loss, so does risk aversion tend to rise in times of depressed prices, increasing the risk of missed opportunity. When people refuse to buy assets regardless of their low prices, they miss out on the best, lowest-risk returns of the cycle.
Fantastic stuff.


persistentone 5/18/2010  

What is the best way to continuously monitor the demand level in the high yield and second lien dividend markets? What would be the objective criteria for saying demand is extremely strong?

Anonymous,  5/18/2010  

a lot of psycho babble there, but essentially this is an area of behavorial finance, a fascinating subject that i wish i can learn more about.

Anonymous,  5/20/2010  

What's going on with the DDIC? It always seems to be down these days...


hunter [at] distressed-debt-investing [dot] com

About Me

I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.