This NYTimes article fits in nicely with a previous blog post I wrote.
Another great quote from OakTree’s Howard Marks:
“Whatever few awards are presented for risk control, they’re never given out in good times. The reason is that risk is covert, invisible. Risk—the possibility of loss—is not observable. What is observable is loss, and loss generally happens only when risk collides with negative events. This is a very important point, so let me give you a couple of analogies to make sure it’s clear. Germs cause illness, but germs themselves are not illness. We might say illness is what results when germs take hold. Homes in California may or may not have construction flaws that would make them collapse during earthquakes. We find out only when earthquakes occur.
Likewise, loss is what happens when risk meets adversity. Risk is the potential for loss if things go wrong. As long as things go well, loss does not arise. Risk gives rise to loss only when negative events occur in the environment. We must remember that when the environment is salutary, that is only one of the environments that could have materialized that day (or that year). (This is Nassim Nicholas Taleb’s idea of alternative histories, described in more detail in chapter 16.) The fact that the environment wasn’t negative does not mean that it couldn’t have been. Thus, the fact that the environment wasn’t negative doesn’t mean risk control wasn’t desirable, even though—as things turned out—it wasn’t needed at that time. The important thing here is the realization that risk may have been present even though loss didn’t occur. Therefore, the absence of loss does not necessarily mean the portfolio was safely constructed. So, risk control can be present in good times, but it isn’t observable because it’s not tested. Ergo, there are no awards.”
I’ve been reading Howard Marks’ book “The Most Important Thing” and the number of quotes that are brilliant are adding up, it’s a great book. I thought I’d share this one from my reading last night:
“But even when we know the shape of the probability distribution, which outcome is most likely and what the expected result is—and even if our expectations are reasonably correct—we know about only likelihoods or tendencies. I’ve spent hours playing gin and backgammon with my good friend Bruce Newberg. Our time spent with cards and dice, where the odds are absolutely knowable, demonstrates the significant role played by randomness, and thus the vagary of probabilities. Bruce has put it admirably into words: “There’s a big difference between probability and outcome. Probable things fail to happen—and improbable things happen—all the time.” That’s one of the most important things you can know about investment risk.”
Scott Dauenhauer, CFP, MPAS, AIf
Howard Marks released another must read memo to his clients and made an appearance on bloomberg. I’ll try to embed the Bloomberg video, but if it doesn’t work, here is the link.
Before I present his memo, I’d like to present one of my favorite Howard Marks quotes (which I think is applicable to the current time period):
“Good times teach only bad lessons: that investing is easy, that you know its secrets, and that you needn’t worry about risk. The most valuable lessons are learned in tough times.”
Scott Dauenhauer CFP, MPAS, AIF