Howard Marks: How to Identify Skilled Investors

In Part 1 of his series – How To Think About Risk, Howard Marks discusses the importance of understanding risk in investing, highlighting that returns alone do not reflect an investor’s skill.

He compares various types of managers, from those who merely track market performance to those who show either excessive aggressiveness or defensiveness. Marks stresses the value of “asymmetry,” where a manager delivers market-level returns during good times while limiting losses during downturns.

He argues that matching the market’s performance when it rises is satisfactory, but true skill lies in declining less when the market falls, which demonstrates effective risk management.

Here’s an excerpt from Part 1 of the series:

The title of this class is “How to Think About Risk.” That’s an important title—not what to think, but how to think. The first question is: What is risk? Risk, in my opinion, is the ultimate test of an investor’s skill. The return alone doesn’t tell you how good a job the manager did. The key question is: you see the return, you must ask, how much risk did the manager bear to get that return?

Now let’s look at this range of managers. What we posit is that the market is up 10% or down 10%. Now let’s look at some individual managers. The first one is up 10 when the market’s up 10 and down 10 when the market’s down 10.

Accomplishes nothing.

You might as well have invested in an index fund that emulates the performance of the market. No skill, no value added.

Now let’s look at the second one. Up 20 when the market goes up 10, down 20 when the market goes down 10. No skill, no value added. Just a lot of aggressiveness.

What about this one? Up five when the market’s up 10, down five when the market’s down 10. Again, no selection ability, no discernment, no value added. Just defensiveness. You don’t need help in achieving that, and you sure shouldn’t pay a lot for it.

But what about the next one? He or she is up 15 when the market’s up 10 and down 10 when the market’s down 10. So in other words, market-type losses on the downside but superior gains on the upside. Value added. What I call asymmetry: does better in the good times than does poorly in the bad times.

But what about this one? And I think this is the most interesting. I think maybe it characterizes me, maybe it characterizes Oaktree to some extent. Up 10 when the market’s up 10, down five when the market’s down 10. So, market-type gains in the good times.

I personally think that performing with the market when it does well is good enough—and that’s almost all the time. Nobody should have to beat the market when it does well. But if you can do that and at the same time be ready to decline less when the market has its down spells, I think that’s accomplishing something very important:

You can watch Part 1 of the series here: