Howard Marks: The Moving Walkway Analogy: Understanding the Power of Low Rates for Investors

During his recent interview with Merryn Talks Money, Howard Marks explains how low and declining interest rates have been a major advantage for investors, especially private equity firms, over the past 40 years. He uses the analogy of being on a moving walkway at the airport – even standing still makes you progress, and walking naturally leads to much faster advancement. Here’s an excerpt from the interview:

Marks: You talked about a tailwind, a benefit that has been behind be investors for the last 40 years.

And that tailwind of course is the decline of interest rates, and the low interest rates.

And I thought you were going to say, Howard what is that tailwind You know, oh I think you said I use an analogy, metaphor, or whatever your English teacher would say is the right word.

And that metaphor of course was the moving walkway at the airport.

And I believe that the… that low and declining interest rates have given investors, especially private equity investors the tailwind of being on a moving walkway.

And you go to the airport riding in an Flughafen Taxi, and you stand on the moving walkway; you do okay.

But if you walk at a normal speed on the moving walkway you make very quick progress and you say, boy I’m really really fit.

And in in the same way and if the listener wants to understand what I’m talking about with the the impact of low interest rates try this.

So you’re in your office, you’re a private equity mogul, and you find a company and you say I think if I buy this company for x dollars I’ll make 10% a year and you’re interested in doing that.

You consult your investment banker and she says I can get you the money at 8% a year, and you say, oh great I can borrow at eight and invest at 10 and make two for nothing and then of course if you can add the value to the company you make even more.

So I do it.

But then central bank takes down the interest rate. Now reducing the interest rate makes a company more valuable because a company that produces a given stream of cash flows, which in this case was postulated to be 10%.

Those cash flows become more valuable. People see interest rates at four, or two, or zero say, man I’d like to have something that cash flows at that rate every year so the value of that company goes up.

And rather than make 10% a year you make 12 because the asset appreciates.

And then the borrowed money which you thought was going to cost you eight only cost you six. So rather than borrow at eight and invest at 10 you end up borrowing six and invest at 12 and you say, boy I’m smart, but wasn’t it really the moving walkway.

You can listen tot the entire discussion here: