Volatility is the academic’s choice for defining and measuring risk; but Oaktree Capital’s Howard Marks warns Bloomberg TV’s Stephanie Ruhle that “while volatility is quantifiable and machinable… it falls far short as ‘the’ definition of investment risk.” In fact, he berates, “I don’t think most investors fear volatility. In fact, I’ve never heard anyone say, ‘The prospective return isn’t high enough to warrant bearing all that volatility.’ What they fear is the possibility of permanent loss.” With $91 billion under management, perhaps it’s worth listening to (and reading) his perspective: “In brief, if riskier investments could be counted on to produce higher returns, they wouldn’t be riskier. Misplaced reliance on the benefits of risk bearing has led investors to some very unpleasant surprises.”
STEPHANIE RUHLE: Surely you’ve heard this line before. If you want to make more money investing, take more risk. Fine. Great even, if you understand what risk actually means. Howard Marks says most people don’t, and he should know. He’s the chairman of Oaktree Capital and one of the greatest investors in distressed debt. Howard, welcome back. Your newest letter is out. Tell us, what don’t people understand?
HOWARD MARKS, CHAIRMAN, OAKTREE CAPITAL MANAGEMENT: The main thing people don’t understand is that it’s wrong to say if you want to make more money, take more risk. This is what people say. Higher — riskier — riskier investments have higher returns. So if you want to make more money, take more risk. It can’t be right, Stephanie.
RUHLE: Why?
MARKS: Because if riskier could be counted on to produce higher returns, they wouldn’t be riskier. It’s at simple as that. There’s got to be something wrong with that formation. What we should say is that investments that appear riskier have to appear to offer higher returns or nobody will make them. But that doesn’t mean it has to come true. And lots of things other — lots of things can happen other than what you hope will happen.
ERIK SCHATZKER: Is it also true that investing in riskier instruments increases your chances of higher returns but also of higher losses?
MARKS: Exactly, exactly. That’s — that’s the thing that people have to understand. Yes, when you take on more risk you expect a higher return, but you should also understand —
SCHATZKER: Hope for a higher return.
MARKS: You hope, yes, but you should also understand that the range of possible outcomes becomes wider. With T-bills there’s no uncertainty. With the five-year there’s a little uncertainty. With corporates there’s a bunch. With stocks there’s more. The more risk you take, the more uncertain the outcome is, and the worse the bad ones are.
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