Howard Marks on Management Quality

That’s certainly true in the area of trade and tariffs. The International Picture The impact of the developments on tariffs extends importantly to the international arena and goes well beyond economics. Global trade has had an enormous beneficial effect on the entire world since the end of World War II. Along with expenditures to rebuild after the war, technological and managerial progress, improvements in infrastructure, and the expansion of capital markets, globalization contributed to a rising economic tide that truly lifted all boats. Some countries and some people did better than others, of course, but virtually everyone was better off. I believe it was because of this, among other things, that we’ve generally enjoyed peace and prosperity for the last 80 years. As a result, we’ve been privileged to live in the best period in history. The main benefit from globalization is called “comparative advantage.” Every country has some things it produces better and/or cheaper, and others where the reverse is true. If every country makes the former products and sells them to the rest of the world, and buys the latter products from other countries, collective welfare is maximized thanks to increased overall efficiency. As I said on Bloomberg TV on Friday, we’re all better off because Italy makes the pasta and Switzerland makes the watches.

© 2024 Oaktree Capital Management, L.P. All Rights Reserved Follow us: • easy and cheap to lever investments; • easy and cheap for businesses to obtain financing; and • easy to avoid default and bankruptcy. In short, these were easy times, fueled by easy money. Like travelers on the moving walkway, it was easy for businesspeople and investors to think they were doing a great job all on their own. In particular, market participants got a lot of help in this period as they rode the 10-year-plus bull market, the longest in U.S. history. Many disregarded the benefits that ensued from low interest rates. But as one of the oldest investment adages says, we should never confuse brains with a bull market. As I’ve continued to think and talk about the switch from declining and/or ultra-low interest rates to more normal, stable ones, I’ve emphasized the fact that low rates alter investor behavior, distorting it in ways that have serious consequences. Thinking about the change in interest rates sensitized me to media mentions of low rates, and I’ve noticed many. This was particularly true following Silicon Valley Bank’s meltdown last March, which many articles attributed to faulty managerial decisions made “during the preceding period of easy money.” More recently, there’s been much discussion of the less-favorable outlook for private equity, usually related to expectations that interest rates aren’t going to return to the low levels of the recent past.

© 2023 Oaktree Capital Management, L.P. All Rights Reserved Follow us: Moral Hazard One problem with government solutions of any kind – like the so-called “Greenspan put” – is the possibility that they’ll generate moral hazard. That is, players will conclude that they’ll be rescued if they make a mistake. This suggests they can freely engage in high-risk, high-return behavior; if it works, they’ll get rich, but if it fails, they’ll be bailed out. People sometimes refer to this as “privatizing profits and socializing losses.” On March 9, when SVB was hanging by a thread while experiencing massive withdrawals, people started talking about a possible government guarantee of all deposits. One of the arguments against such a bailout was that it would create moral hazard. If people know they’ll be protected from losses, they’ll have no reason to examine the solidity of a bank before depositing money, meaning the diligence function won’t be performed. Consequently, poorly run, poorly capitalized banks will be permitted to stay in business and grow. But we simply cannot expect depositors to perform that function. Since banks’ operations are characterized by mismatched assets/liabilities and a dependence on depositors’ trust, it’s terribly hard to assess their financial health from the outside (maybe sometimes from the inside, too, since SVB succumbed to what in retrospect seem to have been obvious managerial mistakes).

The leadership of the Power Opportunities group has evolved and transitioned over these 25 years, but the talent keeps being regenerated and the returns roll on. Larry and Richard retired in 2009, as I said, and Ian took over. In 2016, Ian promoted Michael Cardito and Jason Lee to be his co-portfolio managers. Jason will be leaving us in the next few months to devote his energies to activities such as teaching, and while we’re sorry to see him go, we’re delighted to know he’ll remain an informal advisor. At the same time, Ian is stepping back from managerial responsibilities and has passed the day-to-day reins to Michael. Since Michael has been responsible for much of the success of our most recent Power funds and © 2021 OAKTREE CAPITAL MANAGEMENT, L.P.RESERVED

But why should this go on? How can it go on? Think about two cities. City A has more jobs than people, and city B has more people than jobs. Initially, people in city A – where labor is relatively scarce – will be paid more for doing a given job than people in city B. The key to their continuing to earn more is the existence of barriers that prevent people from moving to city A. Otherwise, people will move from city B to city A until the ratio of people to jobs is the same in both cities and so are the wages. Among other things, geographic inequalities are dependent on the immobility of resources. For much of the last century, barriers kept our pay high. Other countries’ output wasn’t as good as ours. Some lacked investment capital, and some were decimated by war from time to time. Perhaps they didn’t possess our ability to generate technological advancements or our managerial skills. High transportation costs, tariffs, prejudices (when I was a kid, “Japanese transistor radio” was synonymous with “low quality”) or legal restrictions (e.g., keeping foreign airlines from competing freely in our markets) may have protected American wages. International trade wasn’t what it is today. But all of these things can change over time, and it’s hard to see how the earnings supremacy of U.S. workers will be sustainable. . . . In 1949 we saw the arrival of a little car called the Volkswagen Beetle.

Other countries’ output wasn’t as good as ours. Some lacked investment capital, and some were decimated by war from time to time. Perhaps they didn’t possess our ability to generate technological advancements or our managerial skills. High transportation costs, tariffs, prejudices (when I was a kid, “Japanese transistor radio” was considered synonymous with “low quality”) or legal restrictions (e.g., keeping foreign airlines from competing freely in our markets) may have protected American wages. International trade wasn’t what it is today. But all of these things can change over time, and it’s hard to see how the earnings supremacy of U.S. workers will be sustainable. (Emphasis added) Unfortunately, these 2008 observations, and especially the final sentence, proved to be on target. And the central issue – globalization of trade, or the opening of national borders for the free movement of goods – has raised serious issues and become a source of controversy in the current election. The good news about free trade is that an overwhelming majority of economists believe it contributes to economic progress. For example: A study by the Peterson Institute found that past trade liberalization laws added between $7,100 to $12,900 in additional income to the average household. A study by Peter Petri and Michael Plummer estimates that the Trans-Pacific Partnership, which Trump opposes and Clinton sort of opposes, would boost American incomes by $131 billion.

© Oaktree Capital Management, L.P. All Rights Reserved For much of the last century, barriers kept our pay high. Other countries’ output wasn’t as good as ours. Some lacked investment capital, and some were decimated by war from time to time. Perhaps they didn’t possess our ability to generate technological advancements or our managerial skills. High transportation costs, tariffs, prejudices (when I was a kid, “Japanese transistor radio” was synonymous with “low quality”) or legal restrictions (e.g., keeping foreign airlines from competing freely in our markets) may have protected American wages. International trade wasn’t what it is today. But all of these things can change over time, and it’s hard to see how the earnings supremacy of U.S. workers will be sustainable. Among other things, our legacy airlines became weighted down with high-cost labor contracts and all have gone through bankruptcy to shed them. Likewise, high healthcare costs added to the cost of every car built in the U.S. to an extent that hurt our competitiveness. Thus the U.S. auto industry lost domestic market share, sent production overseas, and consists of three companies of uncertain creditworthiness. Protectionism favors the erection of trade barriers, but it’s usually resisted based on the totality of its effects.

© Oaktree Capital Management, L.P. All Rights Reserved One of the great investment books of the 1960s was The Money Game by the pseudonymous Adam Smith. Smith talked about a veteran investor, the Great Winfield, who knew he was falling behind the times but had the answer: “Our trouble is that we are too old for this market. . . . My solution to the current market: kids.” In the last decade or two, everyone hired quantitative whiz kids, and the results were disastrous. Hopefully, the events of the last few years will produce a sea change, in which investors come to rely more on seasoned judgment and less on financial engineers. UGreenspan and the Fed Alan Greenspan deserves a lot of credit for presiding over one of the greatest periods of prosperity and market gains in our history, and for saying, presciently, “. . . history has not dealt kindly with the aftermath of protracted periods of low risk premiums.” With apologies to my indirect personal connection to the ex-Fed Chairman, I must express my view that his stewardship wasn’t perfect. (Of course, I doubt he’d say it was perfect.)  Because he rarely used his bully pulpit to warn about excesses, advances were permitted to run unchecked. For example, his warning against “irrational exuberance” attracted a lot of attention, but I’ve always wondered why, if he considered it justified in 1996 with the Dow at 6,400, we heard nothing from him on the subject in 2000, when it topped out at 11,700.

(I wish I could coin the phrases I use in these memos, but usually I find myself relying on the creativity of others. In this case, I absolutely can’t improve on Jack’s way of putting it.) On November 8, The Economist quoted him as saying, “Amassing assets under management became the [mutual fund] industry’s primary goal, and our focus shifted from stewardship to salesmanship.” (Emphasis added) That’s it. Right there. In a nutshell. Of course some of the late-trading incidents involve individuals who simply took money out of their clients’ pockets and put it in their own (metaphorically). But in case after case – involving late trading and other issues – mutual funds companies forgot their duty as stewards of other people’s assets, doing things that disadvantaged clients in order to build assets under management for their own benefit. Each of us faces the need to balance our own interests against those of others.his

Despite this, Morningstar says, “Even as funds grow, their 12b-1 fees don’t usually decrease or go away.” Why are 12b-1 fees so widespread and so persistent? And what’s the reasoning of the independent directors who approve them? How do the directors feel about the buy-and-hold investor who invests in fund shares and pays distribution fees for the next twenty years? At best, I’m afraid, the director’s answer regarding 12b-1 fees can only be the same as it is on management fees: “Our practices are no worse than those of our competitors.” One gem on which to close: currently, 12b-1 fees are being collected by 227 mutual funds (or classes of multiple-share-class funds) that are closed. How can the directors of funds that aren’t trying to attract new investors justify the continuing imposition of fund distribution charges? How can they possibly interpret this as fulfilling their responsibilities to the funds’ investors? Who do these directors represent? U What Else? I want to make it clear that just as I do not universally indict mutual fund executives and directors, I don’t think stewardship problems exist only in the mutual fund industry.the

They're organic entities, and they have life cycles of their own. Most companies are born in an entrepreneurial mode, starting with dreams, limited capital and the need to be frugal. `Success comes to some. They enjoy profitability, growth and expanded resources, but they also must cope with increasing bureaucracy and managerial challenges. The lucky few become world-class organizations, but eventually most are confronted with challenges relating to hubris; extreme size; the difficulty of controlling far-flung operations; and perhaps ossification and an unwillingness to innovate and take risks. Some stagnate in maturity, and some fail under aging products or excessive debt loads and move into distress and bankruptcy. The reason I say failure carries within itself the seeds of success is that bankruptcy then permits some of them to shed debt and onerous contracts and emerge with a reborn emphasis on frugality and profitability. And the cycle resumes . . . as ever. The biggest mistakes I have witnessed in my investing career came when people ignored the limitations imposed by the corporate life cycle. In short, investors did assume trees could grow to the sky. In 1999, just as in 1969, investors accepted that ultra-high profit growth could go on forever. They also concluded that for the stocks of companies capable of such growth, no p/e ratio was too high. People extrapolated earnings growth of 20%-plus and paid p/e ratios of 50-plus.