Howard Marks, Legends of Wall Street Presentation @ SF State Downtown Campus June 27, 2012 In theory there is no difference

e between theory and practice, but in practice there is. Yogi Berra On the human side of investing: Markets are made up of people, and people make mistakes -> Take advantage of those mistakes Risk premiums must be demanded Too often forgotten during boom years Pendulum as analogy for market In constant motion between fear & greed, pessimism & optimism, risk aversion & risk tolerance Although the statistical mean is in the middle, this medium is rarely seen in markets Always ask, Where are we now? Memory must fail for extremes to be reached Having a good memory = prudence Being pro-cyclical = biggest mistake What a wise man does in the beginning, the fool does in the end. When you find you are on the same side as the majority, it is time to reform. - Mark Twain 3 stages of bull market: 1. Few realize improvement will come 2. Most recognize improvement is underway 3. Everyone thinks it will keep getting better forever (ideal time to sell) 3 stages of bear market: 1. Few realize markets are overpriced 2. Most recognize correction is underway 3. Everyone thinks will fall forever (ideal time to buy) On understanding what you dont know: There are two kinds of forecasters: those who dont know, and those who dont know they dont know. John Kenneth Galbraith It is okay to say I dont know Oaktrees investing philosophy falls under the I dont know camp: I dont know I know Hedged Positioned for one outcome only Diversified Concentrated Avoids leverage Levered up Seeks to avoid losses Seeks to maximize gains Investing is a losers game: Avoid the losers, and the winners take care of themselves. Analogy: Amateur tennis. When playing with your friends, as long as you get the ball over the net onto their side of the court, they will eventually hit a bad shot. You dont need to focus on hitting amazing shots, just get the ball over the net and wait for them to make a mistake.

On Risk: We are taught that risk is standard deviation, this is not true Risk means more things can happen than expected Most people ignore black swans Lesson of crisis: Pay attention to alternative histories. Also focus on decisions and processes, not only on outcomes Being right for the wrong reasons is the same as being wrong Good decisions can not work, bad decisions can work o Over long term, better to bet on good decisions 3 ingredients for successful investing: Aggressiveness, timing, skill If you have the first two, you dont need the third. But thats unlikely Its hard to do right things, impossible to do the right thing at the right time Twin impostors: Short term over and underperformance. They do not tell anything about ability to perform over the long run It takes a full cycle to have sufficient data Example: Amaranths blow up in 2006 (down 100%)The problems didnt start in 2006, but in 2005 when they were up 100%. o Going up or down 100% can be two sides of the same coin, and can be result of combination of sheer aggressiveness and luck/timing. You must also examine risk adjusted returns On Institutional Investors: Establishing and maintaining an unconventional investment profile requires acceptance of uncomfortably idiosyncratic portfolios, which frequently appear downright imprudent in the eyes of conventional wisdom." - David Swensen, Yale University Institutional investors often seek only to avoid embarrassment/keep their jobs so they over-diversify Other mistakes include investing only in funds with: Obvious appeal Easy to understand Popular leads to high prices and limited returns Have been performing well On Meeting Michael Milken in 1978: There is no upside surprise on a AAA bond, but if a B rated bond survives, you get upside surprise The big money comes from upside surprises Its a negative art

Smart Investing: Not necessarily buying good things, but buying things well It takes an expert to know the right price There are old investors and there are bold investors, but there are no old, bold investors Additonal Oaktree Philosophy: Risk management Consistency Inefficiency Specialization No forecasting No market timing Knowing things that others dont (Information edge) When presented with an investment idea, always ask Who doesnt know that already? Three Greatest Investment Adages: What the wise man does in the beginning, the fool does in the end Never forget the 6ft man who drowned crossing the river that was 5ft deep on average Being too far ahead of your time is indistinguishable from being wrong Q&A Q: What do you see happening in Europe? A: I dont know. Nobody knows. If you ask for an opinion and act on it then you are a nut Solution is to move forward but with caution. Q: How do you combat the institutional imperative? A: The problem is that if you take risk and it doesnt work out, you may get fired. Most people are concerned about keeping their jobs so they dont take the right risks. In order to take on risk to produce outsized returns, you must educate your clients. Explain to them what you are trying to do. Let them know that it will not work all the time. The best time to do this is during the up years. Q: 10Yr Treasury is yielding 1.6%, some high-yields are in 7-8% range. Whats your take on this spread? A: High yield is relatively more attractive now than it was in 2007 despite the similarly low yields as the spreads are generous right now versus the treasuries. At any point in time the best you can do is pick the best relative option, but the problem is that you cant eat relative returns. Q: How do you quantify risk, and please comment on future probability distributions (i.e. New normal/fat tails) A: Assessing risk comes down to judgment. It takes expertise, experience, and insight. Probability distributions are also all about judgment. You can read about it and listen to experts, but at the end of the day its judgment. It cannot be turned in an algo. Its not supposed to be easy. Anyone who finds it easy is stupid Charlie Munger