Black and White Balls

“Everyone knows that if you reach into a bag containing both black and white balls and pull out ten white ones in a row, the probability has increased that the next one will be black. But in the investment world, events like that serve to convince people that there are only white balls – favorable outcomes – in the bag. That’s part of the illogical, emotional thinking that makes for bull markets and bubbles.

“It’s my firm belief that the riskiest thing in the investing world is widespread belief that there’s no risk. Usually that dangerous condition stems from excessive conviction that the future is knowable and known . . . and benign. Today there’s very little of that. I think that’s a substantial positive.

“A world that’s perceived as safe can be rendered unsafe if the perception of safety causes investors to move out the risk curve, bid up prices, or take actions that assume greater certainty than turns out to be the case. I think that perfectly describes the years leading up to the crisis. Conversely, an uncertain world can be safer than people perceive if their concern causes them to behave cautiously (and especially if it causes them to sell down assets to prices from which the likelihood of further declines is reduced). Certainly few people in the world today are oblivious to the litany of outstanding negatives.

“Please note, however, that while investor ardor and risk-blindness are at reassuringly low levels today – and that may be the best single thing that can be said for the current environment – the actions of central banks to minimize interest rates have served to force investors out on the risk curve in search of return. They may not be blind to the risks, but many are participating in pro-risk activities nevertheless. I refer to these coerced participants with a phrase from my late father-in-law, Sam Freeman: “handcuff volunteers.”

“The simplistic view says that because the world is uncertain today, we shouldn’t venture forth. But I think it’s much wiser to say that despite the uncertainty, we shouldn’t automatically settle for assets believed to be entirely safe – especially since (a) flight of capital to their seeming safety has rendered their promised returns low and (b) that safety can prove to be illusory. Instead we should attempt to take control of our fate and strive for reasonable returns with the risks handled responsibly.

“The outlook certainly isn’t so propitious (and assets aren’t so cheap) as to call for investing aggressively. But at the same time, market conditions tell me this isn’t a time for hiding under the bed. “Move forward, but with caution” — that’s my mantra today. The environment is uncertain, but we shouldn’t find that paralyzing.”

Howard Marks’ recent letter, On Uncertain Ground, recaps many of the well-documented black swans, landmines and long-term problems faced by investors today.  Despite the litany of outstanding negatives, Marks offers some refreshing thoughts on strategy – “We should attempt to take control of our fate and strive for reasonable returns with the risks handled responsibly.”

Coincidentally, an investment in the firm founded by Marks in 1995, offers investors quite a reasonable return at today’s price.  We will offer up a closer look at our investment in Oaktree (OAK) in an upcoming post.