Practical analysis for investment professionals
11 September 2014

Weekend Reads for Investors: Howard Marks on Risk and the “Zone of Imprudence”

Posted In: Weekend Reads

Equity fund managers are underperforming their benchmarks again this year, continuing a trend that started sometime shortly after the Big Bang. As it often does, the year began with the promise of a “stock picker’s market,” a thinly-veiled and empirically lacking pitch for active management. But with the finish line in sight, nearly 80% of large cap fund managers in the US find themselves trailing the S&P 500 Index. Some of these fund managers may be tempted to break free of their index-hugging ways in an effort to overtake their benchmarks in the remaining months of the year. They would do well to heed the warning of Oaktree Capital’s (OAK) Howard Marks, CFA, who thinks investor behavior has “entered the zone of imprudence.”

Marks’ thoughtful “Memos from the Chairman” are widely considered required reading for serious investors and his latest missive, “Risk Revisited,” is no exception. While he believes that today’s market conditions “are creating a degree of risk for which there is no commensurate risk premium,” Marks is an advocate for risk control rather than risk avoidance, which he likens to “return avoidance.” To this end, he warns of the risk of over-diversification, whereby a portfolio has so many positions the impact of any one stock is so muted as to be inconsequential. Warren Buffett, an admitted fan of Marks, has said that you can get all the diversification you need in six businesses, adding “very few people have gotten rich on their seventh best idea.” Of course, given its enormous size, Buffett’s Berkshire Hathaway by necessity owns more than seven stocks — it owned 46 at last count — but its top seven positions constituted over 75% of its portfolio at the end of June. It’s a concentrated portfolio by almost any measure.

Before swinging for the fences, however, investors would be advised to consider a recent report from JP Morgan Asset Management, which takes a close look at the risks and rewards that come with a concentrated portfolio. Examining the Russell 3000 Index, they found that the median stock since its inception underperformed the index by 54%. It’s a minefield out there. But, as Buffett’s partner Charlie Munger once said, “It’s not supposed to be easy. Anyone who finds it easy is stupid.”

Below are some other stories that caught my eye in recent weeks.

Strategic Thinking


  • Alibaba founder Jack Ma. (The New York Times)

Big Business

The Future of Finance

Disruptive Innovation in Education

In Remembrance


Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

About the Author(s)
David Larrabee, CFA

David Larrabee, CFA, was director of member and corporate products at CFA Institute and served as the subject matter expert in portfolio management and equity investments. Previously, he spent two decades in the asset management industry as a portfolio manager and analyst. He holds a BA in economics from Colgate University and an MBA in finance from Fordham University. Topical Expertise: Equity Investments · Portfolio Management

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