In Occupational Hazard, we quoted from a memo to clients by Howard Marks, in which the Oaktree Capital chairman argued that, in trying to be right, investors had to be willing to bear “the inescapable risk of being wrong”. In other words, investors need to decide whether they want superior investment returns or to avoid looking foolish – because it is not possible to have it both ways.
The logical extension of this point, of course, is not only must investors be aware of their own feelings on the matter; they also need to have an idea of the primary motivation of any fund manager or other investment adviser whose services they may be using. Or, to put it more bluntly, how sure are you that your agent’s incentives are aligned with your own?
In the client memo, Dare to be different II, Marks highlights a recent news story about a pension consultant who expressed a reluctance to allocate further money to a high-profile US bond manager, who had been suffering some negative press, on the basis that “if it doesn’t work out, it looks like you don’t know what you are doing”.
This is probably not the sort of thinking one wants from one’s investment adviser but Marks admits he finds it “perfectly logical” people should feel this way since “the possibility of receiving an ‘attaboy’ for a few winners can’t balance out the risk of being fired after a string of losers”. “Only someone who’s irrational would conclude the incentives favour boldness under these circumstances,” he adds.
Marks suspects the unwritten rule for many institutional investment organisations runs ‘Never buy so much of something that, if it doesn’t work, we’ll look bad’. However, he goes on to warn: “People who follow this rule must understand that, by definition, it will keep them from buying enough of something that works for it to make much of a difference for the better.” Investors meanwhile must understand they may be employing people who follow this rule and perhaps ask themselves if it would be better if they did something different.