In his latest memo titled – 2020 in Review, Howard Marks discusses the extremes compiled in financial markets in 2020, and emphasises the point of the difficulty in finding good returns in the current environment without taking on additional risk and being lucky enough to do so in an environment where such action is rewarded. Here’s an excerpt from the memo:
When it comes to finding decent returns in this environment, the options are slim. Investors have plowed capital into the mainstream public “beta” markets. As a result, prospective returns have come down – fully reflecting the reduction in interest rates – and markets have become quite efficient. In most cases, price has converged with – if not run ahead of – intrinsic value. That means it’s harder than ever to outperform, other than by taking on additional risk and being lucky enough to do so in an environment where such action is rewarded.
Although no markets are starved for capital these days, there may be alternative “alpha” markets where investment skill can add to returns, hopefully without a commensurate increase in overall risk. Some of this additional return is simply a premium for bearing illiquidity, and the pain suffered by some institutions during the 2008-09 crisis shows how important it is to correctly assess one’s ability to live with illiquidity. And some of the return increment will come from employing managers with alpha, or the ability to add to return without a corresponding increase in risk. However, relying on positive alpha exposes investors to manager risk, or the possibility of hiring managers who turn out to have negative alpha.
This past year challenged many preconceived notions about the economy, markets and policy – and even changed the way we live. But the inescapable truth of investing remains unchanged: there is no magic answer, no solution (other than superior skill) that will enable an investor to earn a high return safely and dependably. And that’s especially true in today’s low-return world.
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