In his book – The Most Important Thing, Howard Marks reflects on the 2004–2007 period, where investors mistakenly believed that cutting risk into small pieces and distributing it could eliminate risk. This false sense of security contributed to the financial crisis of 2008.
Popular strategies like absolute return funds, low-cost leverage, and tranched debt vehicles elevated risk due to overconfidence and a lack of skepticism. Contrarian investors who reduced risk during this overheated period were better positioned to minimize losses during the 2008 meltdown and capitalize on the bargains that emerged.
This underscores the value of contrarianism and risk awareness in investing.
Here’s an excerpt from the book:
Marks: In the years 2004–2007, the notion arose that if you cut risk into small pieces and sell the pieces off to investors best suited to hold them, the risk disappears. Sounds like magic. Thus, it’s no coincidence that the tranched securitizations from which so much was expected became the site of many of the worst meltdowns: there’s simply no magic in investing.
Absolute return funds, low-cost leverage, riskless real estate investments, and tranched debt vehicles were all the rage. Of course, the error in all these things became clear beginning in August 2007. It turned out that risk hadn’t been banished and, in fact, had been elevated by investors’ excessive trust and insufficient skepticism.
The period from 2004 through the middle of 2007 presented investors with one of the greatest opportunities to outperform by reducing their risk, if only they were perceptive enough to recognize what was going on and confident enough to act. All you really had to do was take the market’s temperature during an overheated period and deplane as it continued upward.
Those who were able to do so exemplify the principles of contrarianism, discussed in chapter 11. Contrarian investors who had cut their risk and otherwise prepared during the lead-up to the crisis lost less in the 2008 meltdown and were best positioned to take advantage of the vast bargains it created.
You can find a copy of the book here:
The Most Important Thing: Uncommon Sense for the Thoughtful Investor – Howard Marks
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