Risk is something to be managed and controlled; not avoided. Risk control is indispensable. Risk avoidance is not an appropriate goal in investing.
"You have to go out on a limb sometimes because that's where the fruit is." Risk avoidance equates to return avoidance.
Intelligent bearing of risk should be able to enable us to make good returns with the risk under control. The great challenge in investing is to limit uncertainty and still maintain substantial potential for gains.
Superior investors are superior for their superior sense for the probability distribution that governs future events.
Summary of Howard Marks' "How to Think About Risk"
Core Philosophy
Risk is the ultimate test of investment skill, not return alone. Superior investors don't just chase returns—they understand and manage the probability of loss.
What Risk Really Is (and Isn't)
Risk is NOT volatility (that's just an academic proxy)
Real risk = probability of permanent loss—what investors actually worry about
Risk is unquantifiable in advance and even in hindsight—profitable outcomes don't reveal whether an investment was actually risky
Multiple forms of risk: loss of capital, missing opportunities, being forced to sell at bottoms (the "cardinal sin")
Key Insights on Risk Perception
1. Risk is Counterintuitive
Safety can increase risk: When people feel safe (e.g., better climbing gear), they take riskier actions
Danger can reduce risk: When perceived danger increases (e.g., no traffic signals), people become more cautious
Prices distort perception: Rising prices make assets seem safer but actually increase risk; falling prices make assets seem riskier but may reduce actual risk
2. Quality ≠ Safety; Price = Everything
High-quality assets can be dangerously risky if overpriced (Nifty 50 example: lost 90%+)
Low-quality assets can be relatively safe if cheap enough (high-yield bonds in 1970s)
"It's not what you buy, it's what you pay"—Investment success comes from buying things well, not just buying good things
3. The Risk-Return Relationship
Traditional view is flawed: Riskier assets don't guarantee higher returns—they only promise higher returns to attract investors
Better framework: As potential return increases, the range of possible outcomes widens, including worse potential losses
Expected value can mislead: Probability-weighted averages may ignore catastrophic possibilities you can't afford
Practical Risk Management
1. Think in Probabilities, Not Predictions
"More things can happen than will happen"—Consider the full range of outcomes
Focus on probability distributions, not single-point forecasts
"We live in the sample, not the universe"—We experience only one outcome from many possibilities
2. Continuous, Not Sporadic Management
Risk control must be constant, not switched on/off with market conditions
Analogy: Soccer, not American football—no stoppages to change strategy
Like car insurance: Maintain protection even when you haven't had an accident
3. The Intelligent Risk-Taker's Approach
Be aware of risks you're taking
Analyze them thoroughly
Diversify to avoid concentration
Demand adequate compensation (risk premium)
The Goal: Asymmetric Outcomes
Superior investing = asymmetry:
Participate strongly in gains when markets rise
Limit losses when markets decline
Achieve this through prudent price discipline and understanding probability distributions
Actionable Takeaways for Investors
Focus on loss prevention as much as return generation
Price matters more than quality—avoid overpaying even for "great" companies
Embrace uncertainty—no one knows what will happen, but you can understand what could happen
Balance offense and defense constantly—don't wait for clear signals to become defensive
Seek investments where the upside potential meaningfully exceeds the downside risk
Never be forced to sell at bottoms—maintain staying power through prudent risk management
Bottom Line: Outstanding investors excel because they better understand the "tickets in the bowl"—the full range of possible outcomes—and position their portfolios to benefit from favorable outcomes while protecting against unfavorable ones.
=====
Here is a summary of the first 6 minutes of Howard Marks' talk:
0:00–1:30 – Introduction & Defining Investor Skill Through Risk
The ultimate test of an investor’s skill is how they handle risk, not just the return they achieve.
Shows examples of managers:
One who matches market returns (up 10%, down 10%) → no skill added.
One who is more aggressive (up 20%, down 20%) → also no value added.
One who is more defensive (up 5%, down 5%) → no discernment, not worth paying for.
1:30–2:40 – Asymmetry as the Key to Value-Added Investing
Highlights two types of asymmetry as signs of skill:
A manager who beats the market on the upside (up 15% when market is up 10%) while performing in line on the downside.
A manager who performs in line with the market on the upside (up 10%), but loses less on the downside (down 5%).
Marks notes the second type may characterize his own firm’s philosophy: performing well enough in good times and protecting capital better in downturns.
2:40–4:00 – What Risk Really Is (Not Volatility)
Rejects academic definition of risk as volatility – says it’s just a quantifiable proxy, not true risk.
Defines real-world risk as the probability of loss – what investors actually worry about and demand compensation for.
Emphasizes that investment decisions are based on potential for loss, not volatility.
4:00–6:00 – Risk Is Unquantifiable and Multifaceted
Argues risk cannot be precisely measured in advance or even after the fact.
A profitable investment could have been either safe or risky; outcomes alone don’t reveal true risk.
Lists various forms of risk, including:
Risk of missing opportunities
Risk of not taking enough risk
The cardinal sin: selling at the bottom (forced selling during a downturn), which is worse than buying at a high.
Ends with a philosophical point from Peter Bernstein: risk comes from ignorance about the future – we never know exactly what will happen, only that a range of outcomes is possible.
Here is a summary of 6:00–12:00 from Howard Marks' talk:
6:00–7:00 – Philosophical View of Risk
Quotes Peter Bernstein: “Risk means we don’t know what’s going to happen” — we walk into the unknown with only a range of possible outcomes, not knowing exactly where the actual outcome will fall.
Marks highlights GK Chesterton’s idea: The world is “nearly reasonable, but not quite.” Life has hidden inexactitudes — the “wildness lies in wait.”
This “wildness” refers to tail events — highly unlikely but possible outcomes that are not captured by standard models.
7:00–8:30 – Key Principles for Thinking About Risk
“More things can happen than will happen.”
There are many potential future events, but only one will occur.The future should be seen as a range of possibilities with varying probabilities — a probability distribution, not a single predictable outcome.
Knowing probabilities doesn’t eliminate uncertainty — you still don’t know which outcome will happen.
Uses dice and backgammon examples: even with known odds, the single roll outcome is uncertain.
“We live in the sample, not the universe.”
Statistical probabilities describe possible outcomes over many trials, but in reality, we only experience one sample path.
8:30–10:00 – The Fallacy of Expected Value
Expected value (probability-weighted average of outcomes) can be misleading because:
The expected value may not even be among the possible outcomes.
Some remote but catastrophic outcomes (like ruin) may be unacceptable, even if the expected value is high.
Choosing a lower expected value investment without catastrophic risk may be rational if the worst-case scenario is unbearable.
10:00–12:00 – Risk Is Counterintuitive & Perverse
Shares two real-world examples showing risk perception affects behavior in counterintuitive ways:
Drachten, Netherlands: Removing traffic signs/lights reduced accidents because drivers became more cautious.
Mountain climbing: Better safety gear has not reduced fatalities because climbers take riskier routes.
Key insight: Risk depends not just on the activity itself, but on how participants behave.
When people believe something is safe, they take more risk, increasing actual danger.
In markets:
When prices rise, people think an asset is safer, but higher prices actually increase risk.
When prices fall, people perceive more risk, yet lower prices often mean less risk.
This perversity makes risk difficult for most people to understand — it’s often hidden and only revealed in downturns (“when the tide goes out”).
Here is a summary of 12:00–18:00 from Howard Marks' talk:
12:00–14:00 – Risk Is Hidden and Deceptive
Risk is only revealed in times of stress — like construction flaws in a house only appearing during an earthquake.
Similarly, investments can appear safe for long periods in favorable environments, but their true risk is exposed only during downturns.
"Improbable disasters" (Black Swan events) may be rare, but their infrequency can lead investors to underestimate risk.
This creates the illusion of safety — the longer something goes well, the more people think it’s risk-free.
14:00–16:00 – Risk Is Not About Asset Quality, But Price
A critical mistake: believing high-quality assets are always safe and low-quality assets are always risky.
Reality: A high-quality asset can be overpriced and risky (example: Nifty 50 stocks in 1969–1974, where even great companies lost 90%+ from excessive valuations).
Conversely, a low-quality asset can be undervalued and safe (example: high-yield bonds in the late 1970s–1980s could be profitable if bought cheaply enough).
Key lesson: “It’s not what you buy, it’s what you pay.”
Investment success comes from buying things well, not just buying good things.No asset is too good to avoid being overpriced, and few assets are too bad to be attractive if priced low enough.
16:00–18:00 – The Real Relationship Between Risk and Return
The traditional academic graph shows a linear upward slope — higher risk supposedly leads to higher return.
Marks disagrees: if riskier assets reliably produced higher returns, they wouldn’t actually be riskier.
Better explanation: Riskier assets must offer the prospect of higher returns to attract investors — but there’s no guarantee they’ll deliver.
Marks presents his own version: as you move toward higher expected return, the range of possible outcomes widens — including worse potential losses.
This means the “worst-case scenarios” become more severe even as the expected return rises — that’s the true nature of risk.
Here is a summary of 18:00–24:00 from Howard Marks' talk:
18:00–20:00 – Risk as a Probability Distribution
We can think of potential outcomes as lottery tickets in a bowl — only one ticket (one actual outcome) will be drawn from all the possibilities.
Superior investors have a better sense of what proportion of tickets are winners vs. losers — they better understand the probability distribution.
This skill allows them to decide whether to participate and how much to bet.
20:00–22:00 – How to Assess and Manage Risk
Risk is best assessed through subjective expert judgment, not precise quantitative measures like past volatility.
Peter Bernstein’s insight: The challenge is not when things go as expected, but when they turn out differently — are we prepared for unexpected outcomes?
For Marks, risk emphasizes negative outcomes — the chance that an unfavorable result occurs from the range of possibilities.
Balancing two risks is key:
The risk of losing money.
The risk of missing gains by not investing.
Decisions cannot be made in one dimension — both potential gains and losses must be weighed.
22:00–24:00 – Continuous Risk Management, Not On/Off Switches
Risk management should be continuous, not sporadic (“risk-on/risk-off” mentality is flawed).
We never know exactly when bad events will happen, so risk control must always be in place.
Analogy: Investing is like soccer (football), not American football:
In soccer, the same players are always on the field — there’s no clear stoppage to switch between offense and defense.
In investing, you must constantly balance offense (seeking return) and defense (managing risk) without being told when to shift.
Best model for risk management: Car insurance — you maintain it constantly because you don’t know if or when an accident will occur.
Intelligent risk-bearing means being aware of risks, analyzing them, diversifying, and ensuring you are well-compensated for the risks you take.
Here is a summary of 24:00–30:00 from Howard Marks’ talk:
24:00–26:00 – Intelligent Risk-Taking for Profit
Using life insurance companies as a model for intelligent risk-bearing:
They take risks they are aware of and expect (people will die).
They analyze risks (e.g., medical checks).
They diversify across many people with different risk profiles.
They charge a premium that compensates for the risk plus a margin for uncertainty.
Similarly, skilled investors:
Take calculated, analyzed risks.
Diversify portfolios.
Ensure they are adequately compensated (risk premium).
Superior portfolios aim for asymmetry — good returns if things go well, but resilience if they don’t.
26:00–28:00 – Risk Control vs. Risk Avoidance
Risk control is indispensable, but risk avoidance is counterproductive — avoiding risk means avoiding return.
Will Rogers quote: “You’ve got to go out on a limb sometimes because that’s where the fruit is.”
Risk control means building portfolios that can withstand downturns while still capturing gains.
The value of risk control is often invisible in good times, but essential when adversity hits.
28:00–30:00 – The Bottom Line: Key Takeaways
You can’t expect return without bearing risk, but bearing risk alone doesn’t guarantee return.
Risk is best handled through experienced, qualitative judgment — not just quantitative models.
The great challenge: limit uncertainty while maintaining meaningful upside potential.
Outstanding investors excel because they have a superior sense of the probability distribution of future outcomes.
They can identify whether the potential return compensates for the risks, especially the “left-tail” bad outcomes.
This enables the asymmetry that defines skillful investing: strong participation in gains, but protection from severe losses.
Final thought: Superior investing is about understanding the tickets in the bowl — the full range of possible outcomes — and positioning the portfolio to benefit from favorable ones while limiting damage from unfavorable ones.
Here is a summary of 30:00–37:00 from Howard Marks’ talk:
30:00–35:00 – Closing Summary
Marks delivers his final concluding thoughts:
Outstanding investors excel because they have a superior sense of the probability distribution governing future events.
They can better assess whether the potential return compensates for the lurking risks in the "unattractive left-hand tail" of outcomes.
This skill enables the asymmetry that characterizes superior investing: participating strongly in gains while avoiding many losses.
35:00–37:00 – Final Reflection
36:00: Marks expresses hope that his discussion will help listeners join the ranks of superior investors who understand and manage risk effectively.
Key Takeaway from This Segment:
The final minutes reinforce Marks' core thesis – that exceptional investing isn't about predicting the future, but about understanding probabilities, demanding adequate compensation for risk, and building resilient portfolios that can achieve asymmetry (favorable upside participation with limited downside).
No comments:
Post a Comment