Chess, investment returns and sacrifice: What Howard Marks says on risk

Howard Marks of Oaktree Capital Management says human nature makes it hard for many to accept the idea that the willingness to live with some losses is an essential ingredient in investment success. Marks of Oaktree in his latest memo to clients said the future is inherently uncertain and investors usually have to choose between (a) avoiding risk and having little or no return, (b) taking a modest risk and settling for a commensurately modest return, or (c) taking on a high degree of uncertainty in pursuit of substantial gain but accepting the possibility of substantial permanent loss.

“Everyone would love a shot at earning big gains with little risk, but the “efficiency” of the market – meaning the fact that the other participants in the market aren’t dummies – usually precludes this possibility,” he said.

Marks said most investors are capable of accomplishing “a” and most of “b.” But the challenge in investing lies in the pursuit of some version of “c.”

“Earning high returns – in absolute terms or relative to other investors in a market – requires that you bear meaningful risk – either the possibility of loss in the pursuit of absolute gain or the possibility of underperformance in the pursuit of outperformance. In each case, the two are inseparable,” he said.

Marks argued that individual investors who eschew risk may end up with a return that is insufficient to support their cost of living. Besides, professional investors who take too little risk may fail to keep up with their clients’ expectations or their benchmarks, he explained.

Marks said: “The bottom line on the quest for superior investment returns is clear: You shouldn’t expect to make money without bearing risk, but you shouldn’t expect to make money just for taking risk. You have to sacrifice certainty, but it has to be done skillfully and intelligently, and with emotion under control.”