Oaktree Capital Management is one of the largest distressed debt investors in the world. Its founder, Howard Marks, is also known as the master of value investing. His books (The Most Important Thing in Investment) and (Mastering the Market Cycle) are It is regarded as an introductory bible to investors around the world. Recently, Howard Marks also published his latest investment memorandum, spending a lot of space talking about the so-called asset allocation and debt. This article will focus on the income curve recognized by Oaktree Capital and its impact on the currency circle. It is recommended to read the previous article beforehand to understand Howard Marks' basic arguments on ownership and debt.
Review of the previous article: Analysis of the latest memo from value investing guru Howard Marks: Thoughts on asset allocation (Part 1)
In efficient markets, beta is more important
All our discussions are based on the assumption of efficient markets. Howard Marks gave three statements about efficient markets:
As risk increases in efficient markets, expected returns increase proportionally. Perhaps the opposite is better: as the expected return increases, so does the accompanying risk (uncertainty of the outcome and the possibility of worse). Therefore no position on the curve is "better" than any other position. It's just a matter of what level of absolute risk you want to achieve, or what level of absolute return you want to achieve. The risk-reward ratios at all points are basically the same. The lower the return rate on the left, the higher the return rate on the right.
Furthermore, at each position on the curve, the symmetry of the vertical distribution around expected returns is similar from one position to the next. This means that the ratio of upside potential to downside risk at one location on the curve is not significantly better than at another location.
Finally, if you want to further reduce risk, you can consider doing so by (a) investing in higher-risk assets or (b) using the original strategy but adding the attribute of leverage (amplifying expected returns and risks). Also in efficient markets, neither strategy is better than the other.
These three statements reflect something important about the assumed efficiency of markets, from which the only thing that matters is finding a risk position that suits you. The reason is that academic opinion holds that in an efficient market:
(a) All assets are priced relatively fairly so there is no bargaining or overpricing to take advantage of
(b) There is no such thing as alpha. Howard Marks defines alpha as "the benefits derived from superior personal skills." There are therefore no benefits to active investing, and no asset class, strategy, security or manager is superior to any other. They differ in terms of risk and the rewards that come with that risk.
Also in an academic perspective, since there is no such thing as alpha, the only thing that differentiates assets is their beta, or their relative volatility, i.e. how well they reflect market movements. In theory, expected returns are proportional to beta.
There is no alpha in this market
Howard Marks pointed out that from the perspective of "always correct" in the academic sense, the market is not efficient. The market can efficiently complete the following tasks:
(a) Quickly integrate new information
(b) Accurately reflect the consensus opinion on the correct price of each asset given all information, but this opinion may be biased. So you can reap the benefits by cleverly choosing the following options:
Certain assets, markets or strategies may offer better risk/reward trading than others
Some managers can operate within a market or strategy to generate superior risk-adjusted returns.
The latter idea raises a key question in asset allocation: whether one should consider moving away from the sweet spot of risk levels (i.e., leaving the original risk-reward curve) in order to invest in riskier assets with an investment manager who is believed to have alpha. category? There is no easy answer to this question, and investment managers who are thought to possess alpha probably don't have an answer either.
Most people misjudge the relationship between risk and reward. If you read this article, you may change your strategy.
Howard Marks pointed out that every investor should consider his or her investment horizon, financial situation, income, needs, desires, responsibilities, and ability to withstand ups and downs. to set a baseline for risk taking. This is the basics, and then they can maintain this strategy or choose to deviate from it occasionally in response to market movements. When the market is down, choose a more active investment strategy, and when the market is up, focus more on capital preservation.
(Calling it a Ponzi scheme in 2017, Howard Marks’ latest memo: Thanks to my son for holding considerable Bitcoin)
Then Howard Marks mentioned the ancient problem: the risk-reward curve. As we all know, when moving from left to right, the expected risk increases and so does the expected reward.
Traditional risk and return curve Source: Oaktree Capital
But he disagrees with the traditional risk and return curve. He believes that this representation is very inadequate because the linearity in the chart makes the relationship between risk and return appear too certain. This obscures the nature of risk, so in a 2006 memo, Howard Marks superimposed some bell curves representing probability distributions on the same line. This was done to show the uncertainty of returns on risky assets.
Adjusted risk and return curve Source: Oaktree Capital
Then he put several asset allocation ratios into this return curve
Blue curve: 2/3 debt and 1/3 ownership
Red curve: 1/3 debt and 2/3 ownership
The performance of different asset allocations on the risk reward curve Source: Oaktree Capital
When expected returns increase, expected risk also increases (that is, the range of possible outcomes broadens). Howard Marks thought this way of presenting options might be more intuitive and clear. And pointed out that if you believe the traditional risk-reward curve picture, "the greater the risk, the greater the reward" and adopt a high-risk strategy. Then, knowing the true impact of increased risk (on an adjusted risk-reward curve), they may choose a more modest strategy.
Has your annualized return exceeded 7%? If not, why not embrace bonds?
At the end of the article, Howard Marks reviews the key points again
Fundamentally, the only asset classes are ownership and debt, and there are huge differences in their nature.
You should combine ownership and debt assets to put your portfolio in a suitable position. This is the most important decision in portfolio management or asset allocation, the other decisions are just a matter of execution.
Asset allocation depends on how you evaluate your strategy and your ability to access senior managers.
Howard Marks then talked about the reasons why Oaktree Capital invests in debt. As mentioned before, thanks to changes in interest rates, the expected returns in the bond sector are now much higher than in 2009-21.
Returns of approximately 7% on public credit and approximately 10% on private credit are competitive with historical returns on stocks and can help many investors achieve their overall investment goals. And because of the contractual nature of debt, returns on credit are likely to be more reliable than returns on ownership (after all, basically no one wants to default).
The thought process set out in this memo leads to the conclusion that in fact most (but not all) investors will (a) be attracted by returns around 7-10% (b) want uncertainty or volatility then large, and (c) willing to give up upside potential beyond current yields. And that's exactly the same return that the bond market can provide.
The advice he gave was that investors should conduct the necessary research on credit to increase their credit allocation and develop a plan for this. While today's potential returns are definitely attractive, the reality is that credit returns were higher a year or two ago. But if the market becomes less optimistic, we may see them again. And Howard Marks believes there will be such a moment.
Can teacher Howard Marks start a national debt craze?
Finally, we all know that most of the current stablecoins are still backed by real-world assets as reserves. Although everyone knows that this matter has always been a potential conflict, after all, centralized reserves are contrary to the spirit of decentralization. But the general trend is that the industry chooses to accept and wait to see how this conflict develops. After all, after experiencing runs and the collapse of algorithmic stablecoins, excess reserves are regarded as the most stable method. However, this problem seems to be erupting in recent times.
(Founder of Curve: Geopolitics and regulation are still the biggest problems for over-collateralized stablecoins, and algorithmic stablecoins are the right way to go)
As Howard Marks said, thanks to changes in interest rates, the profitability of investing in the debt market will continue to rise after 2021. Tether has also benefited from this and its profits have repeatedly hit new highs. However, after the United States moves to cut interest rates, the subsequent development is still worthy of attention (if it is not raided by the United States). At the same time, we have also noticed that in the RWA (Real World Asset) market, the largest commodity is still tokenized treasury bonds. It is also worth observing whether the views of well-known investors like Howard Marks will trigger a treasury bond boom.
This article analyzing the latest memo from value investment guru Howard Marks: Thoughts on asset allocation (Part 2) first appeared in Chain News ABMedia.
