Chairman's Memo

Below are some exceprts from Oaktree Capital Management L.P. Chairman, Howard Marks regarding the current market. The memo dated 15th October 2008. Click here to view full memo..... You need to download pdf file read to view it. Click here to download pdf reader.

"But in dealing with the future, we must think about two things: (a) what might happen and (b) the probability it will happen. During the crisis, lots of bad things seemed possible, but that didn’t mean they were going to happen. In times of crisis, people fail to make that distinction."

"In general, following the beliefs of the herd – and swinging with the pendulum – will give you average performance in the long run and can get you killed at the extremes."

"The message of The Black Swan is how important it is to realize that the things everyone rules out can still come to pass. That might be generalized into an understanding of the importance of skepticism. I’d define skepticism as not believing what you’re told or what “everyone” considers
true. In my opinion, it’s one of the most important requirements for successful investing. If you believe the story everyone else believes, you’ll do what they do. Usually you’ll buy at high prices and sell at lows. You’ll fall for tales of the “silver bullet” capable of delivering high returns without risk. You’ll buy what’s been doing well and sell what’s been doing poorly. And you’ll suffer losses in crashes and miss out when things recover from bottoms. In other words, you’ll be a conformist, not a maverick (an overused word these days); a follower, not a contrarian."

"Skepticism is what it takes to look behind a balance sheet, the latest miracle of financial engineering or the can’t-miss story. The idea being marketed by an investment banker or
broker has been prettied up for presentation. And usually it’s been doing well, making the tale more credible. Only a skeptic can separate the things that sound good and are from the things that sound good and aren’t. The best investors I know exemplify this trait. It’s an absolute necessity."

"Skepticism and pessimism aren’t synonymous. Skepticism calls for pessimism when optimism is excessive. But it also calls for optimism when pessimism is excessive. I’ll write some more on the subject, but it’s really as simple as that."

"I found very few who were optimistic; most were pessimistic to some degree. Some became genuinely depressed – even a few great investors I know. Increasingly negative tales of the coming meltdown were exchanged via email. No one applied skepticism, or said “that horror story’s unlikely to be true.” Pessimism fed on itself. People’s only concern was bullet-proofing their portfolios to get through the coming collapse, or raising enough cash to meet redemptions. The one thing they weren’t doing last week was making aggressive bids for securities. So prices fell and fell – the old expression is “gapped down” – several points at a time. The key – as usual – was to become skeptical of what “everyone” was saying and doing. One might have said, “Sure, the negative story may turn out to be true, but certainly it’s priced into the market. So there’s little to be gained from betting on it. On the other hand, if it turns out not to be true, the appreciation from today’s depressed levels will be enormous. I buy!” The negative story may have looked compelling, but it’s the positive story – which few believed – that held, and still holds, the greater potential for profit."

"Most people don’t repeat their mistakes; they make new ones."

"That’s the main reason why we shouldn’t expect there to be any limit on the resources thrown at the problem. All it will take is running the printing presses long enough to rebuild financial institutions’ capital accounts, make good guarantees and enable borrowers to roll over their outstanding debt, all of which is reckoned in nominal terms. The philosophical bridge of unlimited aid to private institutions appears to have been crossed, and printing the necessary money is unlikely to be an issue."

"In the longer term, we have to wonder about the effect on the world of a glut of newly printed dollars, sterling and euros. The reason owning printing presses makes repayment easy is that it lets a nation cheapen its currency. But one would think that more units of currency per unit of GDP means a debasement of the currency, and thus reduced purchasing power (read: higher inflation).
Walking along Hyde Park on Sunday, I saw a street vendor selling old stock certificates.
Do you have any banknotes, I asked? Anything from the Weimar Republic? For the last
few weeks, I’ve wanted to get some of those.
In Weimar Germany, the government enabled itself to pay World War I reparations by
cheapening its currency . . . literally. So the 1,000 mark note I bought was simply overstamped
One Million Marks in red. Voila! Now we’re all rich.

The mark fell from 60 to the U.S. dollar in early 1921 to 320 to the dollar in early 1922
and 8,000 to the dollar by the end of 1922. It’s hard to believe, but according to
Wikipedia (user-maintained and perhaps not always the most authoritative):
In December 1923 the exchange rate was 4,200,000,000,000 Marks to 1
U.S. dollar. In 1923, the rate of inflation hit 3.25 x 106 percent per month
(prices double every two days).
One of the firms printing these [new 100 trillion Mark] notes submitted an
invoice for 32,776,899,763,734,490,417.05 (3.28 x 1019, or 33 quintillion)
Marks. [That’s not a misprint.]
Lord Keynes judged the situation this way:
The inflationism of the currency systems of Europe has proceeded to
extraordinary lengths. The various belligerent governments, unable, or too
timid or too short-sighted to secure from loans or taxes the resources they
required, have printed notes for the balance.
But it’s not that easy. People with things to sell aren’t that stupid. So instead of 1,000
marks, a goat now costs one million marks. That piece of paper used to be a thousand
mark note – and now it’s a million mark note – but it still buys the same goat.
The benefit to the government is that it’s able to pay off its old nominal debts in currency
of which it suddenly has a lot more . . . but which no longer has much purchasing power.
So when repaid in the cheapened currency in 1923, the person to whom the government
owed 1,000 marks can only buy one-thousandth of a goat – not a whole goat as in 1920.

My late friend Henry Reichmann was a boy then, working as a busboy in a restaurant in
Berlin. He told me he used to be paid at lunchtime and immediately ran out to spend his
salary, since it would buy less if he waited until after work to shop.
That’s hyperinflation. Just as the Great Depression became a model during the credit
crisis, Weimar Germany gives us something to think about regarding our new future.
I’m not smart enough to know what’s coming, but I’m also not dumb enough to
think a few government actions on Monday were enough to solve all our problems.
At best, we usually substitute one problem for another – usually one later on in lieu of
today’s.
I don’t know what to do about this risk, whether it’ll come home to roost, or to what
extent. And I certainly don’t think hyperinflation can be assigned a high enough
probability to make it worth doing much about. But it may cause one to rethink holdings
of low-yielding, flight-to-quality-elevated, long-term Treasurys."

"I’ve believed for many years that just as success carries within itself the seeds of failure (see 2003-08), so does failure carry the seeds of success."

"a forest fire: a year after, bright green shoots grow from the ashes; in fact, I think they’re fertilized by the ashes."

"a quote from Warren Buffett, and often it’s the same one:
The less prudence with which others conduct their affairs, the greater the
prudence with which we should conduct our own affairs."

"When others conduct their affairs with excessive negativism, it’s worth being positive."

"That doesn’t mean it can’t decline further, or that a bull market’s about to start. But it does mean the negatives are on the table, optimism is thoroughly lacking, and the greater long-term risk probably lies in not investing."

Note: Oaktree Capital Management L.P. is a fund manager that HQ based in US and manages USD 54.5 Billion assets.