Investing Style And Execution Generate Good Returns, Says Howard Marks

Adding winners to the investment portfolio and avoiding losers needs to happen in tandem for optimum returns, according to Howard Marks.

Risk control—and not risk aversion—should be practiced simultaneously, Marks, co-chairman and co-founder of Oaktree Capital Group, said in his recent memo, 'Fewer Losers, More Winners?' on Sept. 12.

Marks highlighted two matches from this year's Wimbledon. The first was the quarterfinal match between Daniil Medvedev and Christopher Eubanks. The unseeded Eubanks played aggressively against the third-seeded Medvedev but lost the game due to more unforced errors.

The second match the note refers to is the Wimbledon final between Novak Djokovic and Carlos Alcaraz. The 20-year-old Alcaraz scored twice as many winners as the 23-time Grand Slam winner Djokovic to lift the coveted laurel.

"So, Alcaraz beat Djokovic with a "bigger," high-risk game, while Medvedev beat Eubanks with his steadier, risk-controlled style. Neither approach is better than the other per se. Style alone never determines outcome; it’s a matter of style plus execution," Marks said.

Equity indices are often dominated by a few stocks, with tech stocks being the case in point for the recent past. The rising value of these stocks could trigger the desire to book a profit, Marks said.

"The gains of the leaders can make them seem expensive, arguing for profit-taking. Human nature—especially the desire to avoid regret—adds to the motivation to sell. By definition, if you reduce your holdings of the winners relative to their representation in the indices and these winners continue to outperform, you’ll have a tough time keeping up," he wrote.

"The bottom line is that winners aren’t entirely dispensable. If you hope to at least keep up with the indices, you probably have to have an average representation in them."

Avoiding risk entirely should not be the underlying principle for investors, Marks wrote. Risks that one is aware of, can analyse, diversify, and is well-paid to assume "can be borne prudently and profitably", he said.

"The few who possess genuine skill—what I call "alpha"—produce jumbo returns in their good years, such that their long-term returns are exceptional. Their clients are well-rewarded... assuming they have enough intestinal fortitude to hang in through the bad years. Thus, risk-taking isn’t unwise per se, and risk avoidance is appropriate only for investors who feel they can’t survive tough times."

Investors either have the skill to generate "stunning" returns with tolerable risk or give good returns with minimal risk, Marks said. "Almost no investors possess both forms of alpha, and most possess neither."

"The proper choice between the two approaches—fewer losers or more winners—depends on each investor’s skill, return aspiration, and risk tolerance. As with many of the things I discuss, there’s no right answer here. Just a choice," he said.