The Most Important Thing Illuminated by Howard Marks (Book Review)

Updated. I bought the original version with my own money, but then got offered a review copy of the newly released The Most Important Thing Illuminated which contains the same material but with additional commentary from respected investors Christopher Davis (David Funds), Joel Greenblatt (Gotham Capital), Paul Johnson (Nicusa Capital), and Seth Klarman (Baupost Group) as well as an extra chapter from Howard Marks. Most serious investors will recognize these names. The original is great, but if you’re willing to spend a bit more money (eBook is $9.99), this new version does have a little more meat to it. I’ve updated this review to include the new chapter.

If you wrote a book about investing and wanted some big-name endorsements, you couldn’t do much better than this – The Most Important Thing: Uncommon Sense for the Thoughtful Investor by Howard Marks has recommendations from Warren Buffett, Jeremy Grantham, Jack Bogle, Joel Greenblatt, and Seth Klarman.

Howard Marks is already famous around many investment circles for his Client Memos as the chairman and cofounder of Oaktree Capital Management, although not as well-known as Buffett’s shareholder letters. This book is basically a distillation of those memos into book form. Here are my personal notes.

Efficient Markets
Marks is an active investor, and this book is about successfully generate excess turns (alpha). Some people seem to think that “efficient markets” is black and white – either you believe in the Easter Bunny or you don’t. Market prices are completely perfect or investing is purely skill. This book helps you view market efficiency as a continuum. Beating the market by trading large-cap common stocks which are following by thousands of professionals is exceedingly hard. Oaktree Capital chooses to focus on what he perceives as less efficient markets – things like convertible securities and high-yield debt from distressed companies (“junk bonds”).

Developing your own investment philosophy
I enjoyed this quote:

Where does an investment philosophy come from? The one thing I’m sure of is that no one arrives on the doorstep of an investment career with his or her philosophy fully formed. A philosophy has to be the sum of many ideas accumulated over a long period of time from a variety of sources. One cannot develop an effective philosophy without having been exposed to life’s lessons

Quality vs. Price
The title of the book is a bit misleading, as there is no single “most important thing”. Basically each chapter is an expansion of one or more of his memos and it titled “The Most Important Thing is… XXX”. However, an overarching theme of the book is about risk control. I’ve already written about higher risk vs. higher investment return.

A related idea is that people tend to think of investments only in terms of quality. Strong companies vs. struggling companies. Highly-rated bonds vs. Lower-rated bonds. Strong developed countries vs. Weaker emerging countries. But what’s important is the price. A high-quality company can be a high-risk or low-risk investment, depending on what price you pay for it. A junk bond can be a high-risk or low-risk investment, depending on what price you pay for it.

Cycles
Marks strongly believes in the recurrence of cycles. One side of the pendulum occurs when people seems think that there are minimal risks, either because of recent history or some new invention that eliminates risk (CDOs?). Often, the only worry remaining is that we’ll miss out on the opportunity for great returns. The other side of the pendulum is when uncertainty is everywhere. Here, people say things like “I’m staying out of the market until the dust settles.” This reminded me of a chart I pulled out a lot during the housing bubble:

If you’re going to pick a time to invest, it’s better when people are scared, because at least they are properly considering all the potential risks. It should be scary and uncomfortable. He reminds you, as Charlie Munger says, “It’s not supposed to be easy.” If you wait until the dust has settled, there won’t be great prices anymore.

Illuminated-only Bonus Chapter: Reasonable Expectations
This is good reminder about having a clear goal as to what you want to achieve with your portfolio, but also to keep that goal within reason:

The key questions are what your return goal is, how much risk you can tolerate, and how much liquidity you’re likely to require in the interim.

Extraordinary skill is rare. When someone else promises returns “too good to be true”, the next question to ask is “why me?” If they found a can’t miss investment opportunity, why are they sharing this with you? If some talking head on TV makes a bold prediction, why aren’t they busy betting their net worth on the outcome? With today’s complex derivatives and betting markets, they should be rich and sunning themselves on a yacht instead.

Recap
Even though I am primarily a low-cost, buy, hold, & rebalance type of investor, I felt this book still provided me with new information for my own evolving investing philosophy. Creating alpha is not easy, and most people who try to do so consistently fail, so you should be very careful and realistic when assessing your own skills. I’ll be sure to read his future memos. Thankfully, they can be found at the Oaktree Capital website, free and available to all.