“Since knowledge is cumulative but we never know it all, I look forward to learning more in the years ahead. In investing, there’s nothing that always works, since the environment is always changing, and investor’s efforts to respond to the environment cause it to change further. Thus I hope to know things in the future that I don’t know now, and I look forward to sharing them in memos and books yet to come.”
The above quote is from the introduction part of Howard Marks (Trades, Portfolio)’ new book "Mastering The Market Cycle: Getting the Odds on Your Side." It reflects Marks humility, generosity and an attitude of continuously learning and adapting. I use this quote to begin this article as a reminder to all of us – nothing works all the time. Therefore, we need to keep learning and adapting to the changing environment.
Here I’ll share further notes I took from Marks' new book as well as the thoughts and observations inspired from Marks' wisdom.
A winning investment philosophy can be created only through the combination of a number of essential elements:
- A technical education in accounting, finance and economics provides the foundation: necessary but far from sufficient.
- A view on how markets work is important – you should have one before you set out to invest, but it must be added to, questioned, refined and reshaped as you proceed.
- Some of your initial views will come from what you’ve read, so reading is an essential building block. Continuing to read will enable you to increase the efficacy of your approach – both embracing those ideas you find appealing and discarding those you don’t. Importantly, it’s great to read outside the strict boundaries of investing. Legendary investor Charlie Munger (Trades, Portfolio) often points to the benefits of reading broadly; history and processes in other fields can add greatly to effective investment approaches and decisions.
- Exchanging ideas with fellow investors can be an invaluable source of growth. Given the non-scientific nature of investing, there’s no such thing as being finished with your learning, and no individual has a monopoly on insight. Investing can be solitary, but I think those who practice it in solitude are missing a lot, both intellectually and interpersonally.
- Finally, there’s no substitute for experience. Every year I have come to view investing differently, and every cycle I’ve lived through has taught me something about how to cope with the next one. I recommend a long career and see no reason to stop any time soon.
My observation: Of all the above elements, I think the technical element, the reading element and the experience element are intuitive. I have some of my own personal experiences with element two and four.
Let me start with the idea of how markets work. In my observations, some value investors often take it too far in terms of bottom-up research. I absolutely agree deep bottom-up research is at the core of value investing. But that doesn’t mean we shouldn’t have a framework of how macro-economics work and how different markets work. For instance, a while ago I decided to shift my focus from the U.S. equity market to the Chinese equity market. I can tell you the dynamics of these two markets are vastly different – policy impact, investor mix, valuation, shareholder structure, corporate governance etc. While I apply the same value investing philosophy in China, I still need to understand the different market dynamics to draw proper feedback.
For example, in China, it’s not uncommon for controlling shareholders to pledge their stocks as collaterals with the brokers as a way of financing. Sometimes a significant amount of the total float is pledged. In the U.S., such phenomenon is rare. Therefore, when analyzing Chinese companies, an additional risk factor is the controlling shareholder getting a margin call on their pledge stocks.
This is just one of many examples of how markets work. Cycle analysis, which is the theme of Marks' book, is absolutely an important element of understanding how markets work.
Moving on to exchanging ideas with fellow investors. I used to practice investing in solitude, partly because of Warren Buffett (Trades, Portfolio)’s influence, or my partial and incomplete understanding of Buffett’s looking-into-the-mirror independent thinking practice. It all changed in 2016, when I visited a value investor club in California for the first time. Since then, I’ve been to a few more meetings of the club and witnessed the spectacular growth of its members.
It slowly dawned on me that group learning, if organized and maintained properly, is like an open ecosystem that continuously takes energy and nutrient from both inside the outside and nourishes the members within the ecosystem. The cumulative result of the a well-organized learning group is accelerated and non-linear growth of all members, which then attract more high quality members and guests, which then help existing members' growth. It’s a fantastic feedback loop. I’ve also witnessed similar results at a value investor club in Asia.
Inspired by the aforementioned clubs, I started a value investor club in the city I where currently live. We meet every month formally to discuss one or two specific companies chosen by our members based on their passion and interests. We also invite guests, not limiting to investment professionals, to come to our meetings. It’s amazing how our own understanding of a company or an industry is enhanced by open-minded and honest group discussions - even for well-known and well-researched companies.
Why is that? I don’t know exactly why, but I think the story of blind men and the elephant is illustrative: Each blind man touched different part of the elephant but none knows what the real elephant looks like. In analyzing a company, sometimes we are not much different from the blind men – each touching a different part of the elephant. Without the help of the others, we can’t piece everything together and come up with the right conclusion. With an open mind, we acknowledge that we don’t know everything and others may know better than us and may view it from a different but useful angle. Over time, we help each other discover our blind spots and grow.
Now, let’s invert. How can a learning group fail? The group will likely not work if:
1). There are too many members (say more than 20).
2). Members think of knowledge and insight as proprietary to themselves and are unwilling to share.
3). The presence of defensive and non-open-minded members.
4). Uneven distribution of levels of thinking and experiences – similar to tennis, it’s more fun to play with an opponent on a similar level.
The bottom line: A properly organized and maintained learning group can accelerate learnings of all group members while a poorly organized learning group is unlikely to help its members to grow. I encourage you all to find reliable and like-minded fellow investors and start exchanging ideas and insights if you haven’t done so.
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