Transcription
So, uh, good morning, uh, um, Howard. So, it's an honor to have you, uh, visit Korea. I know you're doing a regional trip. Uh, this will continue for a couple of weeks. And we've got a lot of the live audience here who, uh, have long admired your uh, philosophy and your investment thought process. So today I would like to know more about your views on the market but more fundamentally your investment philosophy and particularly how you look at the risk because investing is all about uh understanding the risk and by the way congratulations on your 35th anniversary on your memo very impressive and I actually uh uh am on your distribution list and I actually read your recent memo which I think you wrote u last month before you left for Asia. That's right. Uh that was published uh last week. Mhm. Uh we'll have another one out this week. Okay. So, you're writing while you're traveling. I'm writing while I'm traveling. It gives me a great opportunity. It's great to be here today.
Uh I began to write the first memo on October the 12th of 1990. Uh for one reason. I thought I had an interesting story to tell. And uh it was a story of a dinner with a client who ran a pension fund where the equities were never above the 27th percentile for 14 years in a row or below the 47th percentile solidly in the second quartile for 14 years in a row and as a result for the whole 14 years at the very top fourth percentile. So I thought this taught an important lesson, the important of consistency and risk control as opposed to uh trying for grand gestures and and that is how we've always run money and uh it works for us, it works for our clients.
Um uh you know uh [snorts] as you know because you went to University of Chicago for business school. We went to the same school. So as as I did or is about 20 years ahead of me investing is um a complex subject and you know I think that from the outside it looks easy. uh all you have to do is buy things that go up, but from the inside it's not so easy. And um in fact, a friend of mine in England wrote a book in about investing called simple but not easy. And um it's not easy. You know what what does investing consist of? It consists of positioning your capital to benefit from future events. And yet I believe very strongly as you know that you can't predict the future or anyway you can't predict the future better than anybody else. So how how can you become a superior investor if you can't do a better job of predicting the future? And I think uh the answer lies in risk control. Uh it's easy to participate in the markets. Most of the time the markets do well. Most of the time if you just get on board and stay on board, you'll do well. But in the professional investing business, doing well is not enough. uh in order to uh have a valuable service and be well paid for it, you have to do better than others. That's not so easy. And given that we can't do a better job than others of seeing the future, I think we do a better job by understanding risk, taking it into account, uh hopefully controlling it skillfully and uh so if we can uh accomplish a similar return to others with less risk, I think that's a substantial accomplishment. And it comes to to fruition in the difficult periods and we we historically have delivered superior returns in the bad times which is when you need them because that's when the clients want to be secure that they did the right thing.
I mean I I fully agree that investing itself is about understanding the risk right the the better you understand the risk you would have a much less downside but for most investors you just think about the upside right um and I think some sophisticated investors like hedge funds they understand and manage the risk better but you're known for very simplifying things what is your thought process to understand, analyze and manage the risk. Can you give a very simple example?
Well, I think understand, analyze, manage is what you said. And I think those are the three stages. And you know, I was very fortunate in my youth in 1978 uh at City Bank, I was asked to start a portfolio of high yield bonds. And that was considered uh a a disrespectable part of the market. They were called junk bonds. Nobody wanted to do it. Uh they were under a cloud. Um and and uh they were obviously risky. So uh but that was the beginning of that world. And one of the great lessons is that it's wonderful to be in on something at the beginning. So I started to manage those bonds which are risky bonds. They're rated non-investment grade. Investment grade is AAA, double A, single A, triple B. And then we have non-investment grade or speculative grade. Double B, single B, C, D, F. And um and you know uh I was interviewed by a a reporter for one of the first cable uh financial networks in 1980 or 81 and she said to me, "How can you invest in high yield bonds when you know some of them are going to default?" And I said, "How can a life insurance company give people insurance against death when they know they're all going to die?" And it's the same principle. That's a good analogy. If you think if you think of the insurance company, it's a risk they're aware of. It's a risk they can analyze. It's a risk they can diversify. And it's a risk they're well paid to take. So when I got my first insurance policy, they sent a doctor to my apartment to give me a physical to see if I was in good health. They put together a diversified portfolio. Not all old or all young, not all smokers, not all skydivers, diversified. And they charged me, they assessed the risk and they said, they looked at this guy, they said, "Oh, he's probably going to live till 80. I'm not consequent. Sure, he's going to lift a baby, but we're going to send sell him a policy and we're going to price it as if he's going to die at 70 and then he's going to pay so much in premium that by the time he's 80, we'll have extra. That'll be our profit. So, that's how you do it. And you know in high yield bonds what we we we uh we made an estimate of what the default rate would be and we did the math and we ascertained that that would probably be sufficient to reward us. We've had defaults every year for the last 47 years but less than the universe average. And after the losses, we still had uh plenty of uh return because we got a risk premium to take the risk which was more than commensurate with the risk. So that's what it comes down to. Figuring out what the risk is, quantifying it, seeing if the reward for taking it is adequate. No, I can't tell you exactly how to do it. And and uh in the last several months, I've come to the conclusion that all the hard questions that I'm asked are the ones that start with the word how. I can tell you what you have to do to be successful.
So, you need to be truly uh diversified and you need to do your own homework to understand the risk. I think our audience are very keen to uh get your view on the current market. So I I I know that couple of months ago you indicated that the US equity valuation is elevated but not at a be bubble territory. the market has uh further moved and I think there was a very interesting comments by um uh Amazon uh founder Jeff Bezos that AI is real but when all the funds all the companies with AI names get funded this is uh something that worries them. So what is your take on the current US market situation? Because I think it's uh everything rally we call it seems a little uh odd and I mean I I'm a little concerned about what's going on.
Well, you're right to be a little concerned. I wouldn't jump off a building yet, but um but uh the term I used was worrisome, right? And uh in it it's interesting as you said I started writing the memos 35 years ago. I wrote memos for 10 years without anybody ever responding. Not only did nobody say that was good, nobody ever said I got it for 10 years. And yet I kept doing it because I enjoyed it. You actually mail these. Yes. And you know fold them, print them, fold them, address them, put a stamp on, put it in the mailbox. This was the old days. But then on the first day of 2000, I put out a memo called bubble.com which talked about the excesses that I thought were taking place in the tech stocks and it turned out to be right and uh and and then uh the memos began to uh attract attention. So 25 years later on the first day of this year I put out a memo called on bubble watch and I said that the stock market is expensive and factoring in optimism and I said lofty but not nutty and uh and of course the stock market has risen uh 15% from there. Uh I think in June, a few months ago, I put out a memo uh called the calculus of value. Now I said we've gone from elevated to worrisome. And I think I think that uh there's so much optimism in prices. The average price earnings ratio on the S&P is quite high relative to history. Uh, and there's so much enthusiasm about AI and so much is riding on AI, the future of the economy, all this money that's being spent on capital expenditures and of course the level of the stock market dominated the S&P dominated by seven tech companies, the magnificent seven, which account for roughly 40% of it and most of the gains. So, uh, I'm glad to hear you're worried because I think if you weren't worried, there'd be something wrong. However, it's not the worst I've ever seen. I'm not convinced that it can't go up further. Uh, and um, I don't use the word bubble at this point. Bubble, a bubble is a mania. It's a temporary insanity. And I don't detect that quite yet. But, you know, I'm not in the midst of tech investing or AI investing in stocks. We don't do that. So, I may be missing it. Uh, or maybe it is locally uh in in in Romania. Uh, but I think you have to worry because no, if you think about it, we we I think everybody in this room would agree that that AI will change the world. Raise your hand if you think AI will change the world. Okay. In 1999, we thought that the internet would change the world and the internet stocks were doing very well and we had an internet bubble. And guess what? Here we are 26 years later. Certainly, the internet has changed the world. None of us could recognize the world of 26 years ago. And yet the vast majority of the internet companies of 1999 ended up worthless.
So, so what you have to say is not only will AI change the world, but in what way? I think nobody knows. To what degree? Nobody knows. In what time frame? Nobody knows. And by the way, it's not going to be that we're going to have an answer because it's not going to be like there's going to be a a radical change from AI and then it's going to stop and the world will solidify so that we can study it. The future will always be I think more in flux than it has been in the past. So I think we have to deal with great uncertainty. And and then the last question I want to raise is and I think this was in the the 2000meobbubble.com a quote from Warren Buffett saying certainly the internet will increase efficiency but will it increase profitability and the two are not the same because we know what the internet what AI is going to do for the But who's going to make money from it? Will it be the people who create AI, the companies that use AI in their products, or the customers who buy from the companies that use AI? And we don't know where the profitability is going to go. And if this is a competitive world rather than a world ruled by one or two parties, maybe it'll be so competitive that there is no exceptional impact on profitability. So uh I think there's a near 100% probability AI will change the world but I think there's much less than 100% probability uh that investing in any given AI company or sector today will be profitable. And you know one of the things that happens in bull markets and bubbles is that number one people overestimate the degree to which it'll be successful. Overestimate the certainty that the current leaders will remain the leaders and overestimate the probability that the lagards could succeed too. That's why it's a bubble because optimism is is excessive. And I think there's no denying the fact that optimism is high today. I'm not smart enough to know whether it's excessive, but it is certainly high.
So I mean to summarize, we have to admit that we cannot predict the future and because of so much uncertainty, you should be diversifying. Exactly. Yeah. Yeah.
So, uh, I want to go back to your writings, your memos, right? And it's been wonderful 35 years. And I had a chance to look at on your website. So, there were uh a collection of the best. I know all of them are good, but you handpicked like a 30 40 uh u 45 45. Yeah. So, how did you start uh writing memos and what inspired you to th start writing memos? And you said you will write something this week, right?
Well, I I write them when there's something worth talking about. I try really hard not to write about unimportant things or about things that everybody's talking about where I don't have something extra to contribute. I I try to write where I think I see something that other people don't see. And uh I enjoy it, you know. I enjoy the writing. It for me it's like a creative outlet and and I'd rather write than not write. It's not like work, you know. Um and if you look at the memos, there's almost always one published in September and one published in January. So, what that means is that I uh I wrote over the summer and I wrote over Christmas when I wrote something that I had never thought before. So, you're sitting at the computer and you're writing and your thoughts are flowing and you're thinking deeply about your subject and you reach conclusions that you hadn't ever read thought of before. In ' 06, I wrote a memo about risk. The first one dedicated completely to risk. The title was risk. And I said, what I usually say is that you can't quantify risk in advance. There's no number that you can provide which fully captures the risk. Now, uh, they taught us at Chicago to talk about volatility and volatility can be quantified historically and and applied to the future. But the only problem is that's not risk. The real risk that matters is the risk of losing money for good. And there's no way you can read that. There's no place you can find that number. and uh you know you you you find a stock or a building or a company that you're thinking about buying, the probability that you'll have a permanent loss of capital and that the investment will be successful is is is in the future doesn't exist yet can only be estimated and and you can put a number on it but that's not quantification. you can't measure it in any way. And so I wrote that out. Risk cannot be quantified in advance. And then I hit the return button. I went on to the next section and I wrote something which I found very provocative but I had never thought about before. Risk cannot be quantified after the fact. You buy something for $100. A year later you sell it for $200. Was it risky? You don't know. It might have been a brilliant investment that was sure to double or a crazy investment where you got lucky. And the fact that it doubled doesn't tell you which of those two it was. So risk is an intangible and it's it's not volatility and it can't be measured and it can't be reduced to a number. And in fact in 2015 I I I wrote a memo entitled riskrevisited again because I found a a note from a brilliant philosopher named Peter Bernstein. The title was can we reduce risk to a number and the answer is no. It's it's a subjective judgment about the future and I think that the best investors are best because their subjective view of the future is superior.
I mean I if we apply what you have told us to real world investing for us here for the audience or the uh the retail investors. So do you when you have some great ideas or the risk factors that emerge do you write down and do you think hard and how do you use in a real world so I mean you don't directly manage funds these days but you advise but you used to run uh you know a lot of high yield portfolio rights
Well, we now have 20 strategies um and I think the thing they all have in common is that they're all risk strategies we don't invest in treasure uries uh or short things or safe investments. We're trying for superior returns and and the way to access that is by taking risk. I think the answer to your question is to have a risk control mentality and when we started Oak Tree which was 30 and a half years ago um we had been working together for nine years already the founders and we had been managing money with success and all we wanted to do was do the same thing. So we thought about what we had been doing and we wrote it down into an investment philosophy and there are only six points. The importance of risk control. Consistency not top bottom top bottom less efficient markets only. That's a term from the University of Chicago, which means trying to invest in things that not everybody else knows about, understands, and likes, high degree of specialization, non-reliance on forecasts, as I said, macro forecasts for the economy and the markets, non reliance on market timing, getting in, getting out, getting in, getting out. And and th those are the six things that guide us. Um but we but risk control is number one. Our motto is if we avoid the losers, the winners take care of themselves. And that you know we remember we started off doing what's called fixed income investing, convertible bonds and high yield bonds. That's what I started with in 1978. So if you buy a 100 high yield bonds and they're all 8% bonds, it doesn't matter which ones you buy because all the ones that pay will pay 8%. Only one thing matters. Don't buy the ones that don't pay. That will go bankrupt. Well, that's right. The ones that go bankrupt, the ones that default won't pay you and there you'll lose your money or much of it. So the point is that you improve your performance not by which ones you buy but by which ones you exclude. So that was the perfect motto for a fixed income investing firm. If we avoid the losers, the winners take care of themselves. Now since then we have gotten into new strategies that are much more I call it aspirational. We're not just trying to make a fixed income return. Whether it's distress debt, real estate, emerging market equities. We're trying for returns much higher than fixed income returns. And to do that, we have to take risk. We have to have some losers. And merely avoiding the losers is not sufficient because we also have to find some winners. If you want to be the best equity investor or the best uh uh distressed debt investor, you have to find winners. And yet we keep risk control as number one because we want it to be in the front of everyone's mind. Whether whether you're in a fixed income strategy or a more aggressive aspirational strategy, we want you to be thinking about risk first. I think that too many people in the investment business pick up an opportunity, they look at it and they think about how much money they can make. But I want our people to also think about what could go wrong, how bad could it go, if it goes wrong, what could happen, what's the probability it could go wrong. I want everybody to answer these questions. And even in our most successful, highest returning strategies, most of our success has come from avoiding losers. And I hope to continue doing that.
I mean, for our audience, if you look up uh Oak Tree's uh website, I think the funds that you advise have generated long-term return net of fees after fees close to 20% peran. That's very impressive.
Well, uh, we we had a lot we just like my friend in Minneapolis that I started off talking about, we've had a lot of funds with good returns. By good, I mean, um, let's say 8 to 12% a year, but on occasion, mostly the funds that invested during crisis, we've had return funds that returned 20 30%. But we never had a fund that lost money or a fund that returned in in in our distress debt strategy which we're talking about here that returned less than eight. So I think that this really uh summarizes the essence of uh investment management and the Financial Times of London newspaper has a column on Saturdays called Lunch with the FT. So they take somebody to lunch and they write a column about the person, the restaurant, and the food. And they took me to lunch three years ago and it was published in December of 22. And we went to my favorite Italian restaurant in New York near our office. And I said to the reporter that eating in this restaurant is like investing at Oak Tree. Always good, sometimes great, never terrible. And and I think that that is the recipe for excellent performance. I would love to be great all the time. It's not possible. The the future is too hard to predict and there's too much randomness in our world for every effort to be great. But if we can if if the times when we're not great, we can be good and never terrible. I think after a few decades, you'll have one of the best recades records. And I think that's true for us. How do you accomplish that? How do you how do you avoid ever having a fund that's terrible? Risk control. Risk control.
So last question. So as we as you mark this 35th anniversary of the memos, could you give us one last message for the audience, our investors and the the people here?
Investing is a is an optimistic activity. It must be optimistic. You take your money, you give it to somebody else in the expectation you'll get back more later. You have to be optimistic to be an investor. I think my worst failing as an investor is that I wasn't optimistic enough. My parents were uh lived through the depression. And if your parents lived through the depression, they filled you with ideas like don't put all your eggs in a in in one basket and uh and save for a rainy day. And I grew up very conservative. Now I went into interesting parts of the market. I mined them pretty well, but uh not with high optimism. I think everybody in this room should be optimistic about the long run. I think that over time economies grow, companies increase in profitability, ownership of investments uh is rewarding in the long run. Certainly there are fluctuations meaning there are some bad times as well as good. So the real bottom line is to invest and stay invested and don't try to be too clever and get out and get in and get out and get in. It's hard to do. You know, Warren Buffett, his greatest advice is and his strongest advice to everybody is in in our case, he says, "Don't ever bet against the United States." And he's been right and and it's been extremely rewarding. I would encourage you all of you to invest and stay invested, but also to diversify. Remember, we concentrate our investments to take advantage of what we think we know and we diversify to protect against what we don't know. And I I think I'll leave it there.
Thank you. Thank you very much. Thank you all. [applause] [cheering] [music]