market folly

Oaktree Capital's Chairman Howard Marks has released his latest memo entitled "It's All a Big Mistake."  In it, he categorizes active management as "the search for mistakes." 

If you think about it, it makes total sense.  Forced selling is one example that comes to mind, especially during the financial crisis.  In that regard, Dan Loeb's talked about how his hedge fund Third Point steps in to be a buyer for those forced sellers in his Q1 letter.  That's one example of searching for mistakes.
 
Marks goes on to say that, "people should engage in active investing only if they're convinced that (a) pricing mistakes occur in the market ... (b) they - or the managers they hire - are capable of identifying those mistakes and taking advantage of them."

David Einhorn of Greenlight Capital has based his investment philosophy on looking for mispricings and trying to understand why something is mispriced.  We've also highlighted East Coast Asset Management on mispricings as they penned an entire letter on the subject.  Obviously, the focus on mispricing is a key component of investing.

Marks highlights how there's often behavioral sources of investment error (emotions like greed, fear, envy and hubris rule the roost more often than not).  He also touches on herd behavior as market participants all pile in the same names instead of diverging from the pack.

Oaktree's leading man concludes that, "In the end, superior investing is all about mistakes ... and about being the person who profits from them, not the one who commits them."


Embedded below is the latest memo from Oaktree Capital's Howard Marks:




You can download a .pdf copy here.

Lastly, we wanted to draw attention to Marks' definition of hedging in his above memo: "In other words, hedging consists of an attempt to cede some potential gain in exchange for a great reduction in potential loss."

For more on this firm, head to Howard Marks on Oaktree's IPO as well as Marks on contrarianism.