The Rational Investor #013: Howard Marks on the Most Reliable Path to Above-Average Returns

Happy Saturday to you,

Welcome to the 13th edition of The Rational Investor Newsletter.

Today’s quote comes from the very first memo that Howard Marks ever wrote wayyyyyy back in 1990. His first memo was titled, “Re: The Route to Performance.” While this first edition is much shorter in length than most of the memos he puts out today, it includes a thought that still guides my investing beliefs today. After the quote, I’ll share some very brief commentary.

Onto the main event…

Here’s Howard Marks on the Most Reliable Path to Above-Average Returns (Emphasis is Mine):

I would like to cite the approach of a major mid-West pension plan whose director I spoke with last month. The return on the plan's equities over the last fourteen years, under the direction of this man and his predecessors, has been way ahead of the S&P 500.

He shared with me what he considered the key:

“We have never had a year below the 47th percentile over that period or, until 1990, above the 27th percentile. As a result, we are in the fourth percentile for the fourteen year period as a whole.”

I feel strongly that attempting to achieve a superior long term record by stringing together a run of top-decile years is unlikely to succeed. Rather, striving to do a little better than average every year—and through discipline to have highly superior relative results in bad times—is:
— less likely to produce extreme volatility,
— less likely to produce huge losses which can't be recouped and, most importantly,
— more likely to work (given the fact that all of us are only human).

Simply put, what the pension fund's record tells me is that, in equities, if you can avoid losers (and losing years), the winners will take care of themselves.

While Mr. Marks finds this to be a helpful thought for those pursuing market-beating returns (to which I agree), I found it to be just as supportive of the indexing approach.

So much so that I want to share the exact note that I wrote in the margins for myself when I read this passage probably five years ago as I think it’s the appropriate commentary for this week’s note. Please forgive the redundancy in my thoughts. :)

“This is actually an incredible argument in favor of indexing and the math works out remarkably close as well. Average performance year-over-year-over-year will yield an incredibly above-average performance over the long term.

It’s an irony of investing that the purposeful avoidance of single-year greatness, which is the default position of indexing—while also providing the equal avoidance of single-year disasters—virtually guarantees decades-long greatness.”

I stand by this statement today.

Thanks for reading. I’ll be back again next week with more timeless wisdom from great investors.

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