Dear Fellow Investors:
In the March 9, 2013 issue of Barron’s, writer Jonathon Laing wrote an excellent piece about Howard Marks. This article provides the base from which we can discuss the main components of investment portfolio composition. These components are information, analysis of information, and decisions made from information and analysis. In doing so, we will bring to light why we believe today’s best opportunity is in long-duration common stock investing.
Here is how Laing introduced this esteemed portfolio manager:
Yet, over his four decades on Wall Street, the trim 67-year-old co-founder and chairman of Oaktree Capital Management has acquired true star power -- partly because the size of his firm ($77 billion in investments), partly because of his returns (solidly into the double digits), and partly because of the hundreds of long memos he sends to clients and others; they're larded with astute commentary on financial markets and perceptive disquisitions on investor psychology.
Marks earned his MBA at the University of Chicago, a bastion of efficient market theory. As an equity analyst at Citigroup, Marks learned early in his career that he needed to be fairly lonely in his outlook if he wanted to have an advantage over other investors. Here’s how he responded to the Fifty Nifty circumstance of the 1970s:
"I found myself agonizing over silly things like whether to buy Lilly or Merck and spouting the two sentences of the conventional wisdom that I knew on a narrow subset of some 400 stocks. The model was just crazy," he recalls ruefully.
This led him to believe that you must operate in markets where you have a competitive advantage in information. The more esoteric markets, like distressed debt, private equity, and arbitrage have been the domain of better information. There is a need for your investment arena to be lonely and you hope to have the best information left to you.
Interestingly, mega-wealthy investors like Warren Buffett and John Paulson worked originally in markets where the advantage was better information. As a student of Ben Graham, Buffett read annual reports or gleaned through the S&P sheets on companies looking for deeply undervalued situations. There were few people doing it at the time and Buffett made huge returns when his information was better than everyone else in the marketplace. Paulson first worked in arbitrage and later got the break of his life by getting better information about the subprime mortgage market. He made a killing in the subprime meltdown. We don’t deny that these men did extremely good analysis and made good decisions, but we believe having better information is a huge advantage.
Howard Marks has proven over four decades that he does excellent analysis and makes consistently good decisions with his information. He uses the math, history, and psychology of the markets as well as anyone. He exposes this mastery through his writing which the article points out is read by Warren Buffett and many other savvy investors. However, are there investment markets today which are lonely and have the opportunity of better information?
We, as a firm, believe that the only lonely category today is the one which Howard Marks fled in 1977. US large cap equity appears under-owned and under-valued for long-duration common stock owners. The NACUBO study of college endowments and foundations showed that institutions have dropped their dollar-weighted US long-only equity exposure from 36% in 2002 at the end of the year, to 15% by the end of 2010. If Lipper data can be trusted, that ownership is lower today. In our opinion, significant alpha is available for long-duration investors because so few want to use information everyone else has available. The long-term analysis has never been more scarce on Wall Street and equity mutual fund activity levels prove the behavior is lonely.
Has the proliferation of participation in alternative investments by institutions and high net-worth individuals eliminated any loneliness in everything but the most obscure sectors of the marketplace? There are estimated to be around two trillion dollars in hedge funds/funds of funds. With so much money being so heavily incentivized, we at Smead Capital Management (SCM) fail to see how anyone can pursue superior information in an esoteric category. Can private equity investors make a claim of better information when too many firms are drowning in money? Just ask the Dell shareholders, who have the same information as Michael Dell and his private equity partners. These common stock owners would like to take the same actions as Dell, but do it as a public entity.
Has the Internet leveled the playing field by democratizing the information available to investors? The answer is an unequivocal yes. If you are willing to do the digging, the information is available. The only differentiator we can see is that the analysis done with the information and the decisions made from that analysis must be lonely. In the opinion of SCM, the only significant differentiator today is the time frames used in analysis and decisions. If anything, the Internet information, 24-hour news cycle, and difficult markets of 2000-2010 have shortened the holding periods of money managers and their clients. Ironically, if Howard Marks were starting today, we think he would feel the same way. Here is how he said it to Jonathon Laing:
"I can tell you from talking to institutions that, after 13 years of having their hearts broken by the stock market, they still are still leery of stocks even with the recent rally," Marks says. "You can see that in their low stock allocations, compared with the period of 2000 and before. But imagine a couple of more years of good performance for stocks, which well could happen, and the love affair will really be rekindled."
We couldn’t agree more.
The information contained in this missive represents SCM's opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. It should not be assumed that investing in any securities mentioned above will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past twelve month period is available upon request.
© Smead Capital Management