1994 1 24 Random Thoughts on the Identification of Inv. Opportunities

Random Thoughts on the Identification of Investment Opportunities Howard S. Marks -- January 24, 1994 U 1. No group or sector in the investment world enjoys as its birthright the promise of consistent high returns. There is no asset class that will do well simply because of what it is. An example of this is real estate. People said, You should buy real estate because it's a hedge against inflation, and You should buy real estate because they're not making any more. But done at the wrong ti
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  U Random Thoughts on the Identification of Investment OpportunitiesHoward S. Marks -- January 24, 19941. No group or sector in the investment world enjoys as its birthright thepromise of consistent high returns. There is no asset class that will do well simp   ly because of what it is. An exampleof this is real estate. People said, You should buy real estate because it's a hedgeagainst inflation, and You should buy real estate because they're not making anymore. But done at the wrong time, real estate investing didn't work.2. What matters most is not what you invest in, but when and at what price.  There is no such thing as a good or bad investment idea per se. For example, theselection of good companies is certainly not enough to assure good results -- seeXerox, Avon, Merck and the rest of the nifty fifty in 1974.Any investment can be good or bad depending on when it's made and what priceis paid. It's been said that any bond can be triple-A at a price. There is no security that is so good that it can't be overpriced, or so bad that itcan't be underpriced.3. The discipline which is most important in investing is not accounting oreconomics, but psychology.  The key is who likes the investment now and who doesn't. Future prices changeswill be determined by whether it comes to be liked by more people or fewerpeople in the future.Investing is a popularity contest, and the most dangerous thing is to buysomething at the peak of its popularity. At that point, all favorable facts andopinions are already factored into its price, and no new buyers are left to emerge.The safest and most potentially profitable thing is to buy something when no onelikes it. Given time its popularity, and thus its price, can only go one way: up.Watch which asset classes they're holding conferences for and how many peopleare attending. Sold-out conferences are a danger sign. You want to participate inauctions where there are only one or two buyers, not hundreds or thousands.You want to buy things either before they've been discovered or after there's beena shake-out.4. The bottom line is that it is best to act as a contrarian.     An investment that everyone knows to be undervalued is an oxymoron. If everyone knows it's undervalued, why haven't they bought it and driven up itsprice? And if they have bought, how can the price still be low?Yogi Berra said, nobody goes to that restaurant; it's too popular. The equallyoxy-moronic investment version is Everybody likes that security because it's socheap. 5. Book the bet that no one else will. If everyone likes the favorite in a football game and wants to bet on it, the pointspread will grow so wide that the team -- as good as it is -- is unlikely to be able tocover the spread. Take the other side of the bet -- on the underdog.Likewise, if everyone is too scared of junk bonds to buy them, it will becomepossible for you to buy them at a yield spread which not only overcompensates forthe actual credit risk, but sets the stage for their being the best performing fixedincome sector in the world. That was the case in late 1990.The bottom line is that one must try to be on the other side of the question fromeveryone else. If everyone likes it, sell; if no one likes it, buy.6. As Warren Buffet said, “the less care with which others conduct their affairs,the more care with which you should conduct yours. When others areafraid, you needn't be; when others are unafraid, you'd better be.  It is usually said that the market runs on fear and greed. I feel at any given pointin time it runs on fear U or U greed.As 1991 began, everyone was petrified of high yield bonds. Only the very bestbonds could be issued, and thus buyers at that time didn't have to do any creditanalysis -- the market did it for them. Its collective fear caused high standards tobe imposed. But when investors are unafraid, they'll buy anything. Thus theintelligent investor's workload is much increased.7. Gresham's Law says bad money drives out good. When paper moneyappeared, gold disappeared. It works in investing too: bad investors driveout good.  When undemanding investors appear, they'll buy anything. Underwritingstandards fall, and it gets hard for demanding investors to find opportunitiesoffering the return and risk balance they require, so they're forced to the sidelines.Demanding investors must be willing to be inactive at times.   Legal Information and Disclosures This memorandum expresses the views of the author as of the date indicated and such views aresubject to change without notice. Oaktree has no duty or obligation to update the informationcontained herein. Further, Oaktree makes no representation, and it should not be assumed, that  past investment performance is an indication of future results. Moreover, wherever there is the potential for profit there is also the possibility of loss.This memorandum is being made available for educational purposes only and should not be used  for any other purpose. The information contained herein does not constitute and should not beconstrued as an offering of advisory services or an offer to sell or solicitation to buy anysecurities or related financial instruments in any jurisdiction. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Oaktree Capital Management, L.P. (“Oaktree”)believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified theaccuracy or completeness of such information or the assumptions on which such information isbased.This memorandum, including the information contained herein, may not be copied, reproduced,republished, or posted in whole or in part, in any form without the prior written consent of Oaktree.
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