Howard Marks' Book: Chapter 12


Continuation of portfolio management highlights from Howard Marks’ book, The Most Important Thing: Uncommon Sense for the Thoughtful Investor, Chapter 12 “The Most Important Thing Is…Finding Bargains” Definition of Investing, Portfolio Management, Position Review, Intrinsic Value, Opportunity Cost

“…‘investment is the discipline of relative selection.’” Quoting Sidney Cottle, a former editor of Graham and Dodd’s Security Analysis.

The process of intelligently building a portfolio consists of buying the best investments, making room for them by selling lesser ones, and staying clear of the worst. The raw materials for the process consist of (a) a list of potential investments, (b) estimates of their intrinsic value, (c) a sense for how their prices compare with their intrinsic value, and (d) an understanding of the risk involved in each, and of the effect their inclusion would have on the portfolio being assembled.

The “process of intelligently building a portfolio” doesn’t end with identifying investments, and calculating their intrinsic values and potential risks. It also requires choosing between available opportunities (because we can’t invest in everything) and anticipating the impact of inclusion upon the resulting combined portfolio of investments. Additionally, there’s the continuous monitoring of portfolio positions – comparing and contrasting between existing and potential investments, sometimes having to make room for new/better investments by “selling the lesser ones.”

It’s worthwhile to point out that intrinsic value is important not only because it tells you when to buy or sell a particular asset, but also because it serves as a way to compare & contrast between available opportunities. Intrinsic value is yet another input into the ever complicated “calculation” for opportunity cost.

Mandate, Risk

“Not only can there be risks investors don’t want to take, but also there can be risks their clients don’t want them to take. Especially in the institutional world, managers are rarely told ‘Here’s my money; do what you want with it.’”

This type of risk avoidance is a form of structural inefficiency caused by mandate restrictions. It creates opportunities for those willing to accept that particular risk and/or don’t have mandate restrictions. A great example: very few investors owned financials in 2009-2010. Fear of the “blackhole” balance sheet was only a partial explanation. During that period, I heard anecdotally that although some institutional fund managers believed the low price more than compensated for the balance sheet risk, they merely didn’t want to have to explain owning financials to their clients.


“…the optimism that drives one to be an active investor and the skepticism that emerges from the presumption of market efficiency must be balanced.”