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Howard Marks' Rule No. 1 and Rule No. 2 are Now as Important as Buffett's

Oct 28, 2016

In this issue:
» Non-Convertible Debenture issues highest in seven years
» Finally, a decision on sale of loss making PSUs!
» Market updates
» ...and more!
00:00
Tanushree Banerjee, Co-Head of Research
  • Rule No.1: Never lose money.

    Rule No.2: Never forget rule No.1.

You'd never regret making Buffett's two rules for investing the cornerstone of your investment strategy. They can be applied to almost any investment, in any market, by any investor.

But unfortunately, investors often do regret their investment decisions. And in the markets, our biggest mistakes tend to be the psychological ones.

Psychological mistakes are at the same time our biggest source of danger and our biggest source of opportunity. If you can keep your head calm when everyone else is losing theirs, you'll beat the market.

Howard Marks, founder of Oaktree Capital, has his own two rules for investing. And these rules, more than Buffet's, could help investors avert psychological mistakes and profit from market anomalies.

Buffett himself is a big fan of Marks:

  • When I see memos from Howard Marks in my mail, they're the first thing I open and read. I always learn something.

Howard Marks' rules do two things for investors: First, they help protect capital. Second, they help find the best contrarian bets. You will know why when you read them. Here they are:

  • Rule No. 1: Most things will prove to be cyclical.

    Rule No. 2: Some of the greatest opportunities for gain and loss come when other people forget Rule No. 1.

A lay investor reading these rules might wonder if you need an economist to determine cycle turns. But Marks, known for his humour as well as his common-sense investment philosophy, has a wry response:

  • Well ... we fired our economist!

Despite having a good ear for jittery financial markets, Marks isn't in the game of following economic data to draw conclusions on the cyclicality of stocks.

As he recently noted in one of his widely followed memos....

  • As Ben Graham pointed out, the day-to-day market isn't a fundamental analyst; it's a barometer of investor sentiment. You just can't take it too seriously.

But many do. Entire populations of market strategists, fund managers, and economists are employed to try and intuit which stocks to bet on for cyclical changes each year or quarter.

Fortunately, at Equitymaster, we know how to make the most of Mark's cyclicality ideas without the need of an economist. The strategy, inspired by Benjamin Graham's price-conscious investing, does an outstanding job of profiting from cyclical anomalies.

So it's hardly a surprise that the stocks we've recommended have beaten the market returns hands down. During the most the most bullish and bearish phases.

The only way to know how the average return on closed recommendations is as high as 92% is to try Microcap Millionaires yourself!

02:35 Chart of the Day

There is a lot of interest in the corporate debt market these days. One such instrument that has gained prominence these days is Non-Convertible Debentures or NCDs. NCDs are loan-linked bonds that cannot be converted into stock and usually offer higher interest rates than convertible debentures.

The total funds mobilised by Indian companies through NCDs during the first six months of this fiscal is just mind boggling. The loans raised have increased multifold times in just the first six months of FY17. It's the highest in at least seven years.

Loans Raised Through NCDs Highest in Last Seven Years


So what makes NCDs so popular among corporates? With bond yields falling in line with policy rate changes, raising funds via NCDs has become a cheaper source.

However, we believe that potential investors should not get carried away by the euphoria. They should assess the issue structure and the risk return considerations beforehand. Also, these NCDs are not risk free. Their ability to pay interest is dependent on the financial health of the issuer. Hence, credit rating of the issue and parentage of the issuing company must be assessed before subscribing. One would do better to look into the past track record of interest payments. Also one should see whether the issue is secured or unsecured. An unsecured issue may have a higher return but it also carries a higher risk of default. Lastly, one should assess the liquidity of such issues. If the investor is unable to lock in capital gains due to poor liquidity should interest rates fall, his return expectations could go for a toss.

The bond yields could further come down if the Reserve Bank of India takes more rate cuts, thus making the NCD route look attractive. But one should take decision on case to case basis keeping the risk of the issue into consideration.

03:30

The government has finally laid out an ambitious plan to sell loss-making state-owned companies, subsidiaries and manufacturing plants to strategic buyers. The government's decision comes after much criticism and nearly a 12-year hiatus.

Now, we have been extremely vocal with our views on these companies that are draining taxpayers' money.

Vivek Kaul, has time and again raised this issue in his Diary. Here is an abstract from his article - Modi Govt Has Made a Start, But More Loss Making Companies Need to Be Shutdown.

  • The good part is that now that it is shutting down, the government will no longer have to bear the losses of the company. The government bears losses of the loss making companies in two forms. One is by putting money into the company every year to keep it going. Or it ultimately has to take on itself the entire debt that the company takes on to keep itself going. And the financial system lends to the company despite it not making any money because it knows ultimately they are lending to the government.

The government is taking steps in the right direction, to bring a resolution to these chronically sick companies. Doing so in a speedy manner would benefit all the stakeholders alike. But the sale of PSUs will surely attract agitation from the employee unions. However, India is at a stage when tough reforms cannot be delayed to make the best use of resources and ensure profitability in public sector enterprises.

04:40 Investing Mantra

I don't pay any attention to what economists say frankly. Well, think about it, I mean all these economists with 160 IQs and spending their life studying it. And can you name me one super wealthy economist who's ever earned money out of securities? No. - Warren Buffett

Editor's note: There will be no issue of The 5 Minute Wrapup on 29th and 31st October 2016. We wish all our readers a very happy Diwali!

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst) and Bhavita Nagrani (Research Analyst).

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4 Responses to "Howard Marks' Rule No. 1 and Rule No. 2 are Now as Important as Buffett's"

SRINIVASAN CHANDRASEKHARAN, BAHRAIN

Nov 6, 2016

Well said and lucidly portrayed by Tanushree. Readers like me have to read such good recommendations (Rule No.1) and follow them religiously (Rule No.2). I often fail in Rule No. 2 on the influence of fear and greed. Having lost quite a bit in investments, I am now determined to follow Rule No.2 too religiously. Thanks a lot.



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VAN SHARMA

Nov 5, 2016

I entirely agree.Very practical.But being an economist myself,did not like blaming economitsts..Are doctors.engineers or any other professionals super rich? Sharma

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Prem Prekash Khattar

Nov 3, 2016

How to get guidance and support for creating abilities is matter of great concern in the present condition of unemployment.

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Prem Prekash Khattar

Nov 3, 2016

Without proper knowledge and experience not possible?

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Equitymaster requests your view! Post a comment on "Howard Marks' Rule No. 1 and Rule No. 2 are Now as Important as Buffett's". Click here!
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