Money and risk
Howard Marks
Second-level thinking
Howard Marks (United States · 1946–) — Second-level thinking.
What actually happened?
In September 2008 Lehman failed, the market went into free fall, and almost every institution was reducing. Oaktree had raised an eleven-billion-dollar distressed debt fund beforehand and had deliberately sat on it through the hot market of 2007. In the fifteen weeks after the collapse it invested roughly six hundred million dollars a week, about six billion in all. His reasoning was nearly crude: if the world really is ending, it does not matter what you own; if it is not, then not buying was the mistake. This gets told as a story about nerve at the bottom. The decisive half is the first one — raising eleven billion while everybody was making money, and then not spending it.
Second-level thinking
First level: it is a good company, buy it. Second level: it is a good company, everyone knows it, the price already says so, sell it. You have to judge not the fact but whether the market has overpaid for the fact. Excess return needs a view that differs from the consensus and is more correct than it. Both, or neither.
Different and wrong hurts far more than losing money with the crowd. The real cost of second-level thinking is looking like a fool for long stretches.
Risk is permanent loss, not volatility
The academy treats volatility as risk because volatility can be measured. What actually puts people out of the game is capital that never comes back, and being forced to sell at the bottom. Volatility is harmless until it makes you sell.
That is what leverage really costs. Without it only permanent loss can kill you; with it volatility can, and volatility is far more common.
The pendulum
Markets swing between greed and fear, this time it's different and it will never recover, and they almost never rest in the middle. You cannot know when the swing reverses. You can always know which side of the arc it is on, and that is his entire standing ground.
Measure the present instead of predicting the future
He keeps a concrete checklist: are investors discussing returns or risk, is a new fund easy or hard to raise, can poor assets get debt away, is diligence lengthening or being compressed. All observable, none of it requiring any forecasting ability at all.
When everyone is asking how much there is to make and nobody is asking how much there is to lose, the thermometer has already given you its reading.
You do not have to swing at everything
Nobody calls a strike on you for not swinging. The market quotes a price every day and you are under no obligation to answer. Most losses come not from a wrong judgement but from the pressure to be seen doing something.
How do I use it today?
Write a market temperature note once a quarter, answering only observable questions: is money easier or harder to raise than three months ago, are people discussing returns or risk, can weak projects still get funded, is diligence stretching or shrinking? Predict nothing; record the present. Six months later you will find you already knew. The harder discipline is the other half: in a good market, deliberately set aside money you do not invest. Its true cost is watching other people earn with it, and it only pays in the few weeks after a crash.
Deep read
Read alongside
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Lines to keep
We may never know where we're going, but we'd better have a good idea where we are.