In his Memo – A Look Under the Hood, Howard Marks reflects on the experience of sitting in with a state pension board and its consultant, describing it as “very informative for me,” and a reminder of how vital it is that investment decisions “are done explicitly and intelligently.”
Marks begins with a discussion of risk, noting that the consultant’s “two-by-two matrix” defined risk through both “ability to bear risk” and “willingness to bear risk.”
He appreciated how this framework captured the nuances between being “capitalizing,” “defensive,” “protective,” or “naive,” adding, “What could be more foolish than taking risk that entails potential consequences you might not be able to survive?”
He drew parallels to his own past decisions, recalling that when he chaired the University of Pennsylvania’s investment committee in 2000, “Penn’s endowment performance had lagged that of its peers,” and people were asking whether it should take on increased risk. His advice was to stay conservative: “It was too late to start chasing a horse so long after it had left the barn.”
The pension board, he observed, “accept that risk isn’t something to be avoided.” They “recognize that their conservative bent may lead to underperformance in strong markets,” but they prefer that to “a more aggressive posture with its attendant risks.”
Marks praised this realism: “They’re not looking for the illusive black box that others say will give them return without risk.”
When it came to objectives, he was “very impressed to see that the members ranked beating peers last among the plan’s possible objectives.” He emphasized that “the success of an entity like a pension plan isn’t reckoned in terms of whether it did better than others,” but rather by its ability “to pay benefits and minimize the cost to the plan sponsor. Period.”
Marks also challenged conventional thinking on volatility: “Investors pay too much attention to volatility. It’s absolutely essential for investors to think about limiting their risk, but I don’t think volatility is the risk they should be most concerned with.”
Instead, “the risk of permanent loss is the most important investment risk.” He quoted Warren Buffett approvingly: “He’d rather earn a lumpy 15% return than a smooth 12%. Why wouldn’t everyone?”
Ultimately, Marks admired the board’s discipline and self-awareness: “They’re happy to take less than 100% of the risk the plan’s finances might permit. They prefer to forego some return potential in order to avoid the full force of market declines.”
It was, as he wrote, a case study in realism: “The board and its consultant are considering the right questions and reaching reasonable conclusions.”
You can read the entire memo here:
Howard Marks Memo – A Look Under the Hood
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