A Survey of “Value Investors”
Part III - Howard Marks
We continue our series in which we profile the infamous “value investors.” In our first post, we talked about David Einhorn and then we followed it up with a long piece on Seth Klarman. The patterns are very similar; two brilliant men who have amazing insights, yet are still falling for the “value investing” fallacy. In case you are wondering whether we are simply creating a big semantic mess, rest assured that we are not. Yes, this is about definitions, but it’s also much more than that. That definitional problem is precisely what takes society to an alternate reality where people “invest” in crypto and NFTs. In that paradigm, at least one and potentially many cryptos may end up escaping securities laws. It is also in that universe where the CFTC Chair can take a position that seems very much the exact opposite of three of his current or former colleagues. Simply put, the real-life financial and legal implications are enormous.
Today, our series continues with Howard Marks. Marks is the Co-Chairman of Oaktree Capital Management, a global investment manager specializing in alternative investments. Founded in 1995, Oaktree amassed $183 billion of assets under management, burgeoning from just $5 billion. He is the author of The Most Important Thing: Uncommon Sense for the Thoughtful Investor and Mastering The Market Cycle: Getting the Odds on Your Side. Marks has also been writing memos since 1990, which you can find here.
Like others in this series, he is often described as a legendary “value investor.” So, what are his thoughts on value investing vs. growth investing?
Growth vs. Value - The Age-Old Question
This 2015 video where Marks sat down with another “value investor,” Joel Greenblatt serves as a great starting point (spoiler alert: we will profile Greenblatt next in this series).
Around the 8:45-minute mark, Marks poses this question:
So Joel, you mentioned, buying things for a lot less than they’re worth, and that provides the margin of safety. Would you say that those are the core elements in value investing? And, do you want to enhance that definition, or is that enough?
And, one other question. You mentioned that you didn't think it would be a great idea for your in-laws to try to find the next Picasso. Would you analogize that to growth investing?
The answers to these questions are:
This is the very definition of investing, not value investing; and
Not at all. Trying to find the next Picasso or the next great art piece that will appreciate in value, is pure speculation because art does not generate cash flows.
Greenblatt did not give much attention to the second question. To his credit, Greenblatt mostly dismissed the growth vs. value distinction, though he stopped short of denouncing value investing altogether as he should have. Here is his answer:
Umm, sometimes. I mean, my definition of value investing is figure out what it’s worth, pay a lot less. It has nothing to do with low price/book or low price/sales. So that’s how a lot of people like Russell or Morningstar would classify value investors, and so they probably wouldn’t classify me as a value investor or a growth investor, they kind of don’t know what to do with us.
And you know, as Buffett has said, you know, growth and value are tied at the hip. I mean, part of what makes value is investing in a business that can grow over time. So they are not two different way they are classified by, let’s say, Morningstar or Russell, maybe there is much lower growth in value and much higher growth in growth, and they make it that way. But I’m looking for good businesses that are cheap. You know, Ben Graham said, figure out what it’s worth, pay a lot less, leave a large margin of safety. Between those two, big space between those two things.
Warren Buffett, his best student, made one little twist that made him one of the richest people in the world. Buffett simply said, if I can find a good business cheap, even better. Part of good is a business that can grow over time. So, I slowly gravitated, not fast enough, you know, certainly in my first decade of investing, gravitated more towards the way that Warren Buffett invests, he is looking for good and cheap businesses and growth is part of sometimes being good.
Certainly, Greenblatt seems to align more with Buffett than Einhorn or Klarman, more on that in the next post. As for Howard Marks, his thoughts, too, evolved over time…
Crypto
Two years later, Howard Marks wrote a memo titled There They Go Again…Again (PDF). In it, he expressed skepticism about cryptocurrencies:
In my view, digital currencies are nothing but an unfounded fad (or perhaps even a pyramid scheme), based on a willingness to ascribe value to something that has little or none beyond what people will pay for it. But this isn’t the first time. The same description can be applied to the Tulip mania that peaked in 1637, the South Sea Bubble (1720) and the Internet Bubble (1999-2000). (emphasis original)
This comes close but needs some refining. A pyramid scheme is not an adequate phrase to use; the Greater Fool Theory is much better. Of course, the same concept would apply to art. Second, there is a subtle, but very meaningful difference between the Tulip Mania and the South Sea Bubble/Internet Bubble. The latter two were about overpaying for assets by acquiring them at too high a price relative to value. The Tulip Mania, on the other hand, was about acquiring an asset (if you can call it that) that doesn’t generate cash flows in the first place.
Should both of these types of trades be characterized as speculation? We sure think so, but we also believe that the time has come to treat them differently. That’s precisely why we proposed that a distinction needs to be made between Type 1 Speculation and Type 2 Speculation. We are unaware of anybody else making this distinction, but we believe it’s of substantial importance. Type 1 speculation involves paying the wrong price for the “right” asset ( “right” meaning that it generates cash flows). Type 2 speculation, on the other hand, refers to buying an asset (if you can call it that) that is not designed to generate cash flows in the first place. The media and financial participants alike tend to treat all speculative episodes the same, but they are not the same.
In his memo, Marks then continued with this:
Serious investing consists of buying things because the price is attractive relative to intrinsic value. Speculation, on the other hand, occurs when people buy something without any consideration of its underlying value or the appropriateness of its price, solely because they think others will pay more for it in the future. (emphasis original)
It is true that both type 1 speculation and type 2 speculation depend on somebody else paying more for the asset, so Marks’ description is correct; we just think distinguishing between the types of speculation is well overdue.
Beyond that, the paragraph above holds another important clue that is very relevant to this discussion: The qualifier “serious” is unnecessary. We understand it may have been done for impact. We even engage in this practice ourselves sometimes, using phrases like true investing or genuine investing. The truth is, that the word investing does not need any qualifiers. Ben Graham’s title of choice, The Intelligent Investor, while well-intended, also suffers from the same conundrum. An investor is an investor, and, if the correct process is followed, all investing is intelligent. Qualifiers are not needed.
Why does this matter? Because once you’ve allowed a qualifier to precede the word investment, it invites the possibility of an opposite, which does not exist. In other words, if there is good, intelligent, serious, [insert qualifier of your choice] investing, then it becomes quite rational to conclude that there must also be bad, unintelligent, non-serious investing. But investing is about process, not outcomes, which Howard Marks himself explained well here:
You can’t tell from an outcome whether a decision was good or bad. It’s very important, most people don’t understand this, totally counterintuitive.
While perhaps not as dangerous as the myth of “value investing,” these qualifiers certainly give speculation cover to qualify as investing because speculation has the potential to generate phenomenal results from a profit perspective. Once Marks noted that the outcome is a bad proxy for process, he aptly observed:
In the real world, where there is randomness, good decisions fail to work all the time. Bad decisions work all the time. Investment business is full of people, who are, quote, right for the wrong reason.
Enter, “have fun staying poor,” which is often used to deride people who are critical of Bitcoin, like this Tweet exchange from 2021:
This little exchange, in fact, demonstrates not one but two extremely common fallacies. First, Bitcoin is not an investment, and calling it such, is the root cause of the problem. Our June 2023 posts were exclusively dedicated to this concept. Second, many people confuse the outcome with the process, thinking Bitcoin is a good investment because it made them a lot of money.
Curiously, Howard Marks seems to have softened his crypto stance a bit, perhaps because his son Andrew Marks owns some Bitcoin and had good results. Is Howard Marks making the very mistake he warned against, namely confusing the outcome with the process?
Something of Value
Three years later, the COVID-19 pandemic arrived, and apparently, Howard Marks started to have conversations with his son Andrew about investing. Howard Marks’ influential memo titled Something of Value (PDF) apparently came from those very conversations.
In the Acquired podcast cited above, this is how the hosts open the conversation:
We are your hosts. Today, we have two guests with very different investment styles, a value investor and a growth-oriented tech investor, head to head, but not just any investors. We are joined today by the legendary value investor, Howard Marks, the co-founder of Oaktree Capital Management and his son, Andrew Marks, the co-founder of TQ Ventures.
We find it quite amusing that the hosts take this position in a podcast whose purpose is to discuss Something of Value, in which, arguably the most important message was Howard Marks starting to realize the distinction between value and growth being artificial. This is also what he heard from Joel Greenblatt back in 2015. So, why do the hosts continue to put labels on the father and the son, when they themselves are saying those labels are meaningless?
These are the critical excerpts from Something of Value. Howard Marks gets right to the point on page 1:
I’ve written before about how the questions I’m asked give me a good sense for what’s really on people’s minds. These days, one I frequently field is about the outlook for “value” investing. “Growth” stocks have meaningfully outperformed “value” for the last 13 years – so long that people are asking me whether it’s going to be a permanent condition. My extensive discussions with Andrew led me to conclude that the focus on value versus growth doesn’t serve investors well in the fast-changing world in which we live. I’ll start by describing value investing and how investors might think about value in 2021.
We love the quotation marks! It is quite refreshing to see that an investing legend is seeing the world the same way we’re seeing it.
More - on page 3:
The two approaches – value and growth – have divided the investment world for the last fifty years. They’ve become not only schools of investing thought, but also labels used to differentiate products, managers and organizations. Based on this distinction, a persistent scoreboard is maintained measuring the performance of one camp against the other. Today it shows that the performance of value investing lagged that of growth investing over the past decade-plus (and massively so in 2020), leading some to declare value investing permanently dead while others assert that its great resurgence is just around the corner. My belief, especially after some deep reflection over the past year – prompted by my conversations with Andrew – is that the two should never have been viewed as mutually exclusive to begin with. We’ll get to that shortly. (emphasis original).
Page 5:
Despite these points, I don’t believe the famous value investors who so influenced the field intended for there to be such a sharp delineation between value investing, with its focus on the present day, low price and predictability, and growth investing, with its emphasis on rapidly growing companies, even when selling at high valuations. Nor is the distinction essential, natural or helpful, especially in the complex world in which we find ourselves today. (emphasis original).
Page 10-11:
Value investing is thought of as trying to put a precise value on the low-priced securities of possibly mundane companies and buying if their price is lower. And growth investing is thought of as buying on the basis of blue-sky estimates regarding the potential of highly promising companies and paying high valuations as the price of their potential. Rather than being defined as one side of this artificial dichotomy, value investing should instead consist of buying whatever represents a better value proposition, taking all factors into account. (emphasis original)
So… It’s fairly clear that Howard Marks is seeing right through the value vs. growth myth. The hosts of the podcast seem to be under the mistaken impression that the discovery totally came out of the left field. Their opening blurb for the podcast was:
We sit down with legendary investor Howard Marks of Oaktree Capital and his son Andrew who, while less-well-known, is also an incredibly accomplished investor in a very different arena: early-stage VC. The purpose of the conversation was to discuss their joint work together on Howard’s all-time most popular memo, “Something of Value”, which made the then-shocking argument that Value and Growth investing are not diametric opposites but rather two sides of the same investing coin. We of course dive deep into that, and also cover plenty of fun Oaktree and investing history, as well as Andrew’s favorite topic: selling (or not selling, as the case may be). This is not one to miss! (emphasis added)
Why exactly is that shocking? Warren Buffett said the same thing more than 30 years ago in his 1992 letter, and reiterated it at Berkshire’s 2001 Annual Meeting. Charlie Munger saw right through it. Joel Greenblatt said it back in 2015. More recently, Seth Klarman took the same position. What’s really shocking is not the statement Howard Marks is making, but the fact that the statement is being perceived as shocking!
The question for Howard Marks, then, is this: Does he now believe that there is no such thing as “value investing?” If yes, great, he should pound the table with this message. If not, we have a follow-up question for him, the same one we have for Seth Klarman: What is it that prevents him from reaching the same conclusion that one should have no problem reaching, one that was already reached by both Buffett and Munger?
Before we conclude, just a couple of items related to crypto. It appears that Andrew should take the credit for helping his father realize the artificial distinction between growth and value. That’s good. What is not so good is the fact that Howard Marks had a firmer position on crypto originally, which was the correct one. That firm position seems to have been replaced by a softer stance, and that new stance seems to have taken shape as a result of Andrew’s Bitcoin success. Consider this excerpt from Something of Value:
Back in 2017, my memo There They Go Again . . . Again included a section on cryptocurrencies in which I expressed a high level of skepticism. This view has been a source of much discussion for me and Andrew, who is quite positive on Bitcoin and several others and thankfully owns a meaningful amount for our family. While the story is far from fully written, the least I can say is that my skeptical view has not borne out to date. This brings up what Andrew considers a very important point about the value investor’s mentality and what is required for success as an investor in today’s world.
Why does it matter that his skeptical view has not borne out to date? It’s about process, not outcomes, isn’t it? Is Howard Marks letting a good outcome cloud his judgment?
This is how he concludes:
In the case of cryptocurrencies, I probably allowed my pattern recognition around financial innovation and speculative market behavior – along with my natural conservatism – to produce my skeptical position. These things have kept Oaktree and me out of trouble many times, but they probably don’t help me think through innovation. Thus, I’ve concluded (with Andrew’s help) that I’m not yet informed enough to form a firm view on cryptocurrencies. In the spirit of open-mindedness, I’m striving to learn. Until I do, I’ll be referring all requests for comments on the subject to Andrew (although I’m sure he’ll decline).
We disagree. The position Howard Marks originally developed around cryptocurrencies was the correct one; it’s speculation, pure and simple. The blockchain technology holding a lot of promise does not change that fact. The fact that Bitcoin continues to appreciate does not change that fact, either. It can go to $1 million, or it can go to zero. If the Marks family wants to hold Bitcoin, that’s great. To be fair, we did not see any statements from either the father or the son where they took the position that they are investing in Bitcoin. Maybe they do realize it’s all speculation and want to engage in it, and that’s all good, but his public messaging should reflect exactly that.
Will it, though? It seems to go in the opposite direction. Here is a conversation Howard Marks had with The Korea Economic Daily:
An earlier segment in this video confirms Marks’ later thinking on the redundancy of value vs. growth. That message should be spread wide and far. Where we wish Marks didn’t change his mind is his Bitcoin stance. Here are a couple of nuggets from the last segment of the video above:
As I said in the memo, my initial response was a knee-jerk reaction without information. And, that’s not a good way to behave.
Knee-jerk reactions can be wrong sometimes. In this case, it wasn’t.
Look, as I said, I was dismissive in 2017, and I can’t claim to be proven right yet. It was $5,000 when I said that, and now it is $50,000. So, the people who bought it at $5,000, so far they look right.
We suppose they look right because they made a profit. That has nothing to do with whether something is investment or speculation, does it? As Marks conceded:
When it first became well known, which was 2017 I believe, I came out and I was very dismissive of it because it doesn’t have intrinsic value. But there are a lot of things that people want and value highly which have no intrinsic value. How about a painting, or a diamond, you know, or a bar of gold?
Sure. And that’s why purchases of those things are also speculation, not investments.
The bottom line is this: The language has softened, and even though Howard Marks does not call it an investment, the pro-crypto media took these statements and ran with it. In that sense, it does have important consequences, and we can only hope that Howard Marks, in a future memo, clarifies his stance and takes a clear position.
