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Marks: 'I Don't Know' Is the Best Conclusion on Europe

Jason Stipp

Jason Stipp: I'm Jason Stipp for Morningstar.

In times of market uncertainty and volatility, it can help to get back to the basics--help investors save some of their money and even make some money.

Here with me to help us to do that today, calling in is Howard Marks. He is the Chairman of Oaktree Capital. Howard is the author of a book called, The Most Important Thing. A new addition of that book, The Most Important Thing Illuminated, will be published soon. It's going to include annotations from noted investors including Joel Greenblatt, Seth Klarman and also Chris Davis.

The book draws on Howard's letters to Oaktree shareholders over the years. I'd call it a philosophical touchstone for investors. Howard is calling in today to help us apply some of those concepts to the current market.

Howard, thanks for calling in.

Howard Marks: It's my pleasure, Jason.

Stipp: Howard, you argue in book that, "To achieve superior investment results your insight into value has to be superior. Thus you must learn things others don't; see things differently or do a better job of analyzing them."

Recently, in the market, I think, a lot of individual investors feel like that they don't have the upper hand, that Wall Street has all the information. I think the Facebook IPO seemed to underscore that for a lot of investors, but you also argue that some of the big guys, some of the pros, have different risks than individual investors.

So, even if individual investors are at a disadvantage sometimes, what upper hands would you say they have in the market?

Marks: Well, first of all, I'd like to make clear that, the so-called big guys don't have it easy, either, and they didn't share any better in Facebook than anyone else. The mistakes that are mostly made are pretty common across both individuals and institutional investors.

But I think that individuals do have certain advantages. Being smaller, they can be more nimble, their portfolios can be more liquid. Hopefully, they can make an active choice to invest or not invest, whereas most institutional investors don't have that choice and have to be invested.

One of the important keys to investment success is to look on from outside the maelstrom and understand what's going on. Believe me, institutions are not free of that requirement and it's no easier for them. There are a lot of institutional investors who are afraid they're going to lose their jobs if they don't keep up with their competitors. I think that the individual, of course, wants to do as well as the person next to him in the locker room and next to her on the train, but it's not the end of the world if they fall behind for a moment. These are all advantages that the small investor has, in my opinion.

Stipp: Howard, you mentioned the importance of being able to be outside the maelstrom and looking in. You write a lot about risk in the book, and one of the things that you wrote is, "We mustn't think of the future in terms of a single result, but rather as a range of possibilities. We must think about the full range not just the ones that are most likely to materialize."

As we're getting the headlines day-by-day, about what's going on in Europe, as we're seeing the U.S. economy continue to muddle along, I think that a lot of investors feel like there is tons of uncertainty out there.

As you're pondering the European crisis and the concerns about contagion there and all the potential outcomes that could come from that crisis, how do you incorporate these so-called systemic risks or these fat-tail risks in your analyses, especially when the range of outcomes seems so broad today?

Marks: Well, I'm glad to hear that, Jason, because I do feel that the range of outcomes is extremely broad. And another of the advantages that the individual investor has is that he can look at a situation like Europe and say, "I don't know." People who make their living in the market, I think, are intimidated into believing that they have to either know, or say they know, or act like they know.

There is a great quote from Mark Twain, who said, "It ain't what you don't know that gets you into trouble. It's what you know for certain that just ain't true." So, not knowing something is rarely fatal. Thinking you know something when you don't is much more dangerous.

When I look at Europe, I'm the first to say, I don't know what's going to happen. I hear a lot of people tell me what they think will happen. Nobody puts a probability on it. Very few people share a variety of scenarios. So, ... what I say about Europe is I'm only sure of three things. Number one, I don't know. Number two, nobody knows, and number three, if you ask an expert and you follow his advice, you're probably making a mistake. I believe that strongly.

Stipp: So, if you're a fundamental investor, and you're trying to look at a security, potentially that has exposure to Europe, how would you begin, if you trying to look at the range of possibilities, to know whether you should even invest there? If the answer is I really don't know, does that mean you would just avoid an investment that potentially could be affected by a very negative outcome in Europe?

Marks: No. I think there are intelligent ways to invest despite ignorance. You look at Europe, and first of all, there is a lot of uncertainty, it should be cheaper. It should be cheaper than the U.S., which is relatively more knowable.

So, if you look and you find two companies, maybe comparable industries, maybe comparable size, comparable quality--if one is much cheaper than the other in Europe, then I think you should be encouraged to keep looking. So, first, you look for value.

Then if you acknowledge that you're on thin ice, uncertain territory, that doesn't mean you stop. That means that in addition to looking for value maybe you favor companies that are less leveraged on the balance sheet, companies with less debt-- those are safer. Maybe you favor bigger companies, and maybe you favor companies and industries which are less discretionary--the consumer staples and utilities, and things like that.

So, there are things you can do to increase your chances of investing safely despite the fact that you don't know what's going to happen. And I think that's the wise thing to do.