Howard Marks and the Power of Patience: Lessons in Risk and Reward

Howard Marks, co-founder of Oaktree Capital Management, is widely recognized for his deep insights into the nature of investing. Over several decades, Marks has built a reputation not for bold predictions or spectacular one-off trades, but for his methodical approach to risk and his ability to navigate the cycles of the market. Through his widely read memos and books such as "The Most Important Thing," Marks has shared a philosophy that stands in contrast to the allure of shortcuts and rapid wealth: wealth is built slowly, through consistency, compounding, and a clear-eyed understanding of risk and reward.

Early Lessons: The Value of Risk Awareness

Howard Marks began his career in finance in the late 1960s, joining Citicorp after earning degrees from the Wharton School and the University of Chicago. Early on, Marks gravitated toward areas of the market that were less crowded, such as high-yield bonds and distressed debt. These areas, often overlooked or misunderstood by mainstream investors, required a nuanced understanding of risk.

In his memos, Marks frequently recounts how his early experiences taught him that the relationship between risk and reward is not linear. In his words: "Risk is what’s left over when you think you’ve thought of everything." (Memo: "Risk Revisited Again," 2008). This perspective shaped his approach to investing: rather than seeking the highest possible returns, Marks focused on achieving reasonable returns while carefully managing the possibility of loss.

The Importance of Market Cycles

One of the central themes in Marks’s writing is the inevitability of market cycles. He argues that markets move in cycles of optimism and pessimism, expansion and contraction. Recognizing where the market stands in its cycle is, in his view, essential for making sound investment decisions.

For example, in his 2001 memo "You Can’t Predict. You Can Prepare," Marks discussed the dangers of extrapolating recent trends into the future. He observed that investors often become overconfident during bull markets, underestimating risk and overestimating potential reward. Conversely, during downturns, fear can lead to missed opportunities. Marks’s approach was to remain vigilant, always considering the possibility that conditions could change.

He wrote: "The greatest risk does not come from low quality or high volatility. It comes from paying prices that are too high for assets." (Memo: "Risk," 2006). This insight reflects a core tenet of his philosophy: understanding the cycle, and one’s position within it, is more important than trying to predict short-term movements.

Second-Level Thinking: Looking Beyond the Obvious

A recurring concept in Marks’s writing is "second-level thinking." This is the idea that successful investing requires going beyond surface-level analysis. First-level thinking might ask, "Is this a good company?" Second-level thinking digs deeper: "Is this company undervalued relative to its prospects, and how does the market’s current mood affect its price?"

In "The Most Important Thing," Marks explains that second-level thinking is rare because it requires both insight and the willingness to be different from the crowd. He notes that superior results can only come from thinking differently and better than others. This does not mean taking more risk, but rather understanding risk more thoroughly.

Marks’s own career provides examples of this approach. In the late 1980s and early 1990s, he and his team at TCW Group (and later Oaktree) invested in distressed debt—bonds and loans of companies in financial trouble. Many investors avoided these assets, viewing them as too risky. Marks, however, applied second-level thinking: he recognized that the market’s aversion had pushed prices down to levels where, with careful analysis, the risk was manageable and the potential reward attractive.

Consistency Over Time: The Oaktree Approach

Oaktree Capital Management was founded in 1995, with Marks and his partners focusing on alternative investments, particularly in areas where risk and reward could be carefully evaluated. Oaktree’s strategy was not to chase the highest returns in any given year, but to deliver consistent, above-average results over the long term.

This approach is reflected in Oaktree’s performance. According to public filings and investor letters, Oaktree’s flagship distressed debt funds have generally produced strong returns over multi-year periods, often outperforming benchmarks during downturns. For example, during the 2008 financial crisis, Oaktree was able to deploy capital into distressed assets at favorable prices, benefiting from the recovery that followed. Marks later wrote that the firm’s success was not due to predicting the crisis, but to being prepared and disciplined enough to act when opportunities arose (Memo: "The Race Is Not Always to the Swift," 2009).

Marks cautions against the temptation to measure success by short-term results. In his 2014 memo "Getting Lucky," he notes that even well-reasoned decisions can have disappointing outcomes in the short run, while poor decisions can be temporarily rewarded by luck. Over time, however, consistent application of sound principles tends to produce favorable results.

The Role of Discipline and Humility

A key aspect of Marks’s philosophy is the importance of discipline—sticking to a well-defined process, even when it is emotionally difficult. This can mean resisting the urge to buy when prices are high and others are optimistic, or having the courage to invest when fear dominates the market.

Marks has often emphasized the need for humility in investing. In his 2011 book, he writes: "We have to practice defensive investing, since many of the outcomes are beyond our control." He argues that no one can know the future with certainty, and that the best investors focus on controlling what they can—primarily, the risks they take and the prices they pay.

This humility is evident in Oaktree’s investment process, which involves rigorous analysis and debate. Decisions are made collectively, with an emphasis on questioning assumptions and considering alternative viewpoints. Marks has described how this process helps avoid the pitfalls of overconfidence and groupthink.

Case Study: Navigating the Dot-Com Bubble and Its Aftermath

The late 1990s and early 2000s provide a concrete example of Marks’s approach in action. During the dot-com boom, technology stocks soared to unprecedented valuations. Many investors, swept up in the excitement, ignored traditional measures of value and risk.

In memos from this period, Marks expressed caution. He noted that the high prices of many tech stocks were not justified by their underlying earnings or prospects. Oaktree largely avoided the most speculative areas of the market, focusing instead on assets where the relationship between risk and reward remained favorable.

When the bubble burst in 2000-2002, many high-flying stocks collapsed. Oaktree’s funds, which had maintained a disciplined approach, were less affected by the downturn. Marks later reflected that their restraint during the boom was not easy—it required going against prevailing sentiment and accepting that they might underperform in the short term. However, over the long run, this discipline preserved capital and positioned the firm to take advantage of opportunities that emerged in the aftermath.

Compounding: The Quiet Force Behind Wealth

Marks often returns to the idea that wealth in investing is built not through dramatic wins, but through steady compounding of reasonable returns. In his 2015 memo "Liquidity," he writes: "If you avoid the big losses and let compounding work for you, the results can be very powerful over time."

This perspective is supported by Oaktree’s long-term track record. While the firm’s annual returns may not always top the charts, the cumulative effect of consistent, risk-aware investing has led to significant wealth creation for its clients and partners. Marks cautions that the pursuit of outsized gains often leads to excessive risk-taking and, ultimately, disappointment.

Learning from Mistakes and the Limits of Control

Marks is candid about the inevitability of mistakes in investing. In his memos, he frequently discusses errors—both his own and those of others—as opportunities for learning. He argues that the goal is not to avoid all losses, but to ensure that no single setback can threaten long-term success.

For example, in the aftermath of the 2008 financial crisis, Marks reflected on the challenges of assessing risk in complex financial instruments. He acknowledged that even the most careful analysis cannot eliminate uncertainty. The key, in his view, is to build portfolios that are resilient to a range of possible outcomes.

Conclusion: The Enduring Value of Patience and Process

Howard Marks’s career offers a clear lesson: wealth in investing is built slowly, through the disciplined application of sound principles. His emphasis on understanding risk, recognizing market cycles, and practicing second-level thinking provides a framework for navigating the uncertainties of the market.

Marks’s memos and books do not promise easy answers or quick riches. Instead, they offer a sober assessment of what it takes to succeed over the long term: patience, humility, and the willingness to think differently. By focusing on what can be controlled—risk, process, and discipline—Marks has demonstrated that enduring wealth is the product of many small, thoughtful decisions, compounded over time.

Sources:

• Marks, Howard. "The Most Important Thing." Columbia University Press, 2011.
• Marks, Howard. Oaktree Capital Management Memo Letters (various years, 2001–2015).
• Oaktree Capital Management public filings and investor communications.