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03-03-2013, 09:28 AM
The Straits Times
www.straitstimes.com
Published on Mar 03, 2013
Don't become a 'handcuff volunteer'
Low returns on 'safe' products are leading people to take on more risk at a time when they should be exercising caution, says investment guru Howard Marks
The bottom line on the source of investment risk is simple: No asset is so good that it cannot be bid up to the point where it's overpriced and thus dangerous.
And few assets are so bad that they cannot become underpriced and thus safe (not to mention potentially lucrative).
Since participants set security prices, it is their behaviour that creates most of the risk in investing.
The riskiest thing in the investment world is the belief that there's no risk. On the other hand, a high level of risk consciousness tends to mitigate risk. I call this the perversity of risk.
It is essential to observe that investor attitudes in this regard are far from constant.
In 2004, I said that while it would be good for most investors (the ones not suited to be contrarians) to always hold a moderate position that balances risk aversion and risk tolerance - and thus the fear of losing money and the fear of missing opportunities - this is something very few people can do.
Rather, attitudes towards risk cycle up and down, usually counter-productively.
Becoming more and less risk-averse at the right time is a great way to enhance investment performance. Doing it at the wrong time - like most people do - can have a terrible effect on results.
The excessive nature of the swings in psychology - and thus prices of securities - dependably creates opportunities arising from over- and under-valuation.
In bad times, securities can often be bought at prices that understate their merits.
And in good times, securities can be sold at prices that overstate their potential. And yet, most people are impelled to buy euphorically when the cycle drives prices up and to sell in panic when it drives prices down.
For about a year from the middle of 2011 to the middle of last year, I was thinking and saying that given the many problems and uncertainties afflicting the investment environment, the biggest plus I could find was the near-total lack of optimism on the part of investors. And I thought it was a major plus.
There's little that is as helpful for the availability of bargains as widespread low expectations.
Arguably, everything I've said leading up to this point is there for the sole purpose of establishing that when investors are sanguine, risk is high, and when investors are afraid, risk is low.
Today, there is no question about it: Investors are highly aware of the uncertainties attached to the sluggish recovery, fiscal imbalance and political dysfunction in the United States; the same or worse in Europe; lack of growth in Japan; slowdown in China; resulting problems in the emerging markets; and geopolitical tensions.
If the global crisis was largely the product of obliviousness to risk - as I'm sure it was - it's reassuring that there is little risk obliviousness today.
Sober attitudes on the part of investors should be a source of comfort since, in normal times, we would expect them to bring down asset prices to the point where they are attractive.
The problem, however, is that while few people are thinking bullish today, many are acting bullish. Their pro-risk behaviour is having its normal dangerous impact on the markets, even in the absence of pro-risk thinking.
I have become increasingly conscious of this inconsistency in recent months, and I think it is the most important issue that today's investors have to confront.
What is the reason for this seeming inconsistency between thoughts and actions?
The answer is simple. These people are not buying because they want to, but because they feel they have to. In the past, I've referred to them as "handcuff volunteers".
The normal response of investors to uncertain times is to say: "Because of the risks that are present, I'm going to shy away from risky investments and stick with a very safe portfolio."
Such views would tend to depress prices of risky assets. But, thanks to the actions of the world's central banks to keep rates near zero, that very safe portfolio - especially in the credit markets - will produce little, if any, return today.
It is relatively easy to make good investments when capital is in short supply relative to the opportunities and investors are reticent. But when there is "too much money chasing too few deals", investors compete to put it to work in ways that are injurious to everyone's financial health.
I have written often about the tendency of people to accept lower returns, higher risk and weaker terms in order to deploy their capital in "hot" times. The deals they do get worse, and that makes investing riskier and less profitable for everyone.
Because the returns on "safe" investments are so low today, people are moving further out on the risk curve to pursue returns that meet their needs and are close to what they used to get. And the weight of their capital is bringing down prospective returns and making riskier deals doable.
The good news is that today's investors are painfully aware of the many uncertainties.
The bad news is that, regardless, they are being forced by the low interest rates to bear substantial risk at returns that have been bid down. Their scramble for return has brought elements of pre-crisis behaviour very much back to life.
Please note that my comments are directed more at fixed-income securities than equities.
Fixed income is the subject of investors' ardour today, since it is there that investors are looking for the income they need.
Equities are still being disrespected, and equity allocations reduced. Thus they are not being lifted by comparable income-driven buying.
In 2004, I stated the following conclusion: There are times for aggressiveness. I think this is a time for caution. Here, as 2013 begins, I have only one word to add: Ditto.
The greatest of all investment adages states that "what the wise man does in the beginning, the fool does in the end". The wise man invested aggressively in late 2008 and early 2009. I believe only the fool is doing so now.
Today, in place of aggressiveness, the challenging search for return should incorporate goodly doses of risk control, caution, discipline and selectivity.
stmoney@sph.com.sg
The writer is the chairman and founding principal of Oaktree Capital Group, a global investment management firm. He frequently writes memos about his personal perspectives of the global economy.
www.straitstimes.com
Published on Mar 03, 2013
Don't become a 'handcuff volunteer'
Low returns on 'safe' products are leading people to take on more risk at a time when they should be exercising caution, says investment guru Howard Marks
The bottom line on the source of investment risk is simple: No asset is so good that it cannot be bid up to the point where it's overpriced and thus dangerous.
And few assets are so bad that they cannot become underpriced and thus safe (not to mention potentially lucrative).
Since participants set security prices, it is their behaviour that creates most of the risk in investing.
The riskiest thing in the investment world is the belief that there's no risk. On the other hand, a high level of risk consciousness tends to mitigate risk. I call this the perversity of risk.
It is essential to observe that investor attitudes in this regard are far from constant.
In 2004, I said that while it would be good for most investors (the ones not suited to be contrarians) to always hold a moderate position that balances risk aversion and risk tolerance - and thus the fear of losing money and the fear of missing opportunities - this is something very few people can do.
Rather, attitudes towards risk cycle up and down, usually counter-productively.
Becoming more and less risk-averse at the right time is a great way to enhance investment performance. Doing it at the wrong time - like most people do - can have a terrible effect on results.
The excessive nature of the swings in psychology - and thus prices of securities - dependably creates opportunities arising from over- and under-valuation.
In bad times, securities can often be bought at prices that understate their merits.
And in good times, securities can be sold at prices that overstate their potential. And yet, most people are impelled to buy euphorically when the cycle drives prices up and to sell in panic when it drives prices down.
For about a year from the middle of 2011 to the middle of last year, I was thinking and saying that given the many problems and uncertainties afflicting the investment environment, the biggest plus I could find was the near-total lack of optimism on the part of investors. And I thought it was a major plus.
There's little that is as helpful for the availability of bargains as widespread low expectations.
Arguably, everything I've said leading up to this point is there for the sole purpose of establishing that when investors are sanguine, risk is high, and when investors are afraid, risk is low.
Today, there is no question about it: Investors are highly aware of the uncertainties attached to the sluggish recovery, fiscal imbalance and political dysfunction in the United States; the same or worse in Europe; lack of growth in Japan; slowdown in China; resulting problems in the emerging markets; and geopolitical tensions.
If the global crisis was largely the product of obliviousness to risk - as I'm sure it was - it's reassuring that there is little risk obliviousness today.
Sober attitudes on the part of investors should be a source of comfort since, in normal times, we would expect them to bring down asset prices to the point where they are attractive.
The problem, however, is that while few people are thinking bullish today, many are acting bullish. Their pro-risk behaviour is having its normal dangerous impact on the markets, even in the absence of pro-risk thinking.
I have become increasingly conscious of this inconsistency in recent months, and I think it is the most important issue that today's investors have to confront.
What is the reason for this seeming inconsistency between thoughts and actions?
The answer is simple. These people are not buying because they want to, but because they feel they have to. In the past, I've referred to them as "handcuff volunteers".
The normal response of investors to uncertain times is to say: "Because of the risks that are present, I'm going to shy away from risky investments and stick with a very safe portfolio."
Such views would tend to depress prices of risky assets. But, thanks to the actions of the world's central banks to keep rates near zero, that very safe portfolio - especially in the credit markets - will produce little, if any, return today.
It is relatively easy to make good investments when capital is in short supply relative to the opportunities and investors are reticent. But when there is "too much money chasing too few deals", investors compete to put it to work in ways that are injurious to everyone's financial health.
I have written often about the tendency of people to accept lower returns, higher risk and weaker terms in order to deploy their capital in "hot" times. The deals they do get worse, and that makes investing riskier and less profitable for everyone.
Because the returns on "safe" investments are so low today, people are moving further out on the risk curve to pursue returns that meet their needs and are close to what they used to get. And the weight of their capital is bringing down prospective returns and making riskier deals doable.
The good news is that today's investors are painfully aware of the many uncertainties.
The bad news is that, regardless, they are being forced by the low interest rates to bear substantial risk at returns that have been bid down. Their scramble for return has brought elements of pre-crisis behaviour very much back to life.
Please note that my comments are directed more at fixed-income securities than equities.
Fixed income is the subject of investors' ardour today, since it is there that investors are looking for the income they need.
Equities are still being disrespected, and equity allocations reduced. Thus they are not being lifted by comparable income-driven buying.
In 2004, I stated the following conclusion: There are times for aggressiveness. I think this is a time for caution. Here, as 2013 begins, I have only one word to add: Ditto.
The greatest of all investment adages states that "what the wise man does in the beginning, the fool does in the end". The wise man invested aggressively in late 2008 and early 2009. I believe only the fool is doing so now.
Today, in place of aggressiveness, the challenging search for return should incorporate goodly doses of risk control, caution, discipline and selectivity.
stmoney@sph.com.sg
The writer is the chairman and founding principal of Oaktree Capital Group, a global investment management firm. He frequently writes memos about his personal perspectives of the global economy.
My Value Investing Blog: http://sgmusicwhiz.blogspot.com/
