Avoid the Losers and the Winners Take Care of Themselves

Howard Marks released a new investor letter—sharing his thoughts on investing, markets, and whatever else on his mind.

He usually doesn’t put these out with a regular cadence—he tends to write when inspiration strikes.

His recent letter focused on a concept he has written about in the past, but remains relevant today.

The concept? A very simple one: if you have less losers, you’re more likely to have more winners.

Eureka!

He shared a story—one he’s shared before—to drive this point home.

The story is a meeting he had with Dave VanBenschoten—General Mills pension fund manager—many years ago.

In Mark’s telling:

“Dave told me that, in his 14 years in the job, the fund’s equity return had never ranked above the 27^th percentile of the pension fund universe or below the 47^th percentile. And where did those solidly second-quartile annual returns place the fund for the 14 years overall? Fourth percentile! I was wowed. It turns out that most investors aiming for top-decile performance eventually shoot themselves in the foot, but Dave never did.”

He contrasted this story with an opposite view he observed shortly after:

“Around the same time, a prominent value investing firm reported terrible results, causing its president to issue an easy rationalization: “If you want to be in the top 5% of money managers, you have to be willing to be in the bottom 5%, too.” My reaction was immediate: “My clients don’t care whether I’m in the top 5% in any single year, and they (and I) have absolutely no interest in me ever being in the bottom 5%.”

Marks went on to summarize why he thought the former was the ideal strategy.

His thought was attempting to do a little better than average every year—while optimizing for much stronger results during bad times—is:

• less likely to produce extreme volatility,

• less likely to produce the huge losses that are difficult to recover from and, most importantly,

• more likely to work (given the fact that all of us are only human).

This year is perfect example of that final point—we’re only human.

It’s been discussed at length, but the U.S. stock market is effectively being dominated by seven companies this year—coined the Magnificent Seven.

These seven stocks have rallied 66% this year (on average) while the remaining 493 companies in the S&P 500 have an average return of 5%.

If you don’t own these seven companies—or at least a few of them—you’re performance is lagging.

Could you imagine optimizing for that every day?

I have to own the best performing stocks or else…

Impossible. Even if you did it once, there’s no chance of repeating it.

Take Cathie Wood—nobody’s star shined brighter a few years ago. She was dominating.

In February of 2021, her fund—Ark Innovation—was beating the S&P by ~600% since the fund’s inception in 2014.

Fast forward to today: Poof, gone.

The market had an attitude change and her really big winners became really big losers.

The intention is not to dunk on Cathie Wood, either—though I acknowledge it comes off that way.

So, let’s make it clear: the reason the investment world became so fascinated with Cathie Wood is because of her unique views, high conviction, and how much success came her way during the 2020 time period.

BUT IT WAS A BUBBLE!!

Who cares. Still happened.

Especially when you consider much of the active management world is full of closet indexers (translation: if Apple’s a 5% weight in the index, you hold it in equal proportion), so her ability to be truly different warrants her active fee—good, bad, or otherwise.

That ability to be different will likely bring her more success in the future.

Ok, hopefully the point is clear—I’m not trying to be a hater.

But there’s a reason it’s hard to outperform an index: the biggest returns come from only a few stocks. And if you don’t own the few mega-outperformers, there’s almost no chance you’ll beat it.

Some may think this is specific to 2023. It’s not. It’s been true in other years. The FANG’s (Facebook, Amazon, Netflix, Google) in 2017 being another recent example.

But it goes deeper than that—you can see it depicted below.

See that crappy circle on the far right I drew? Those are stocks that went up more than 1,000% over the last 20 years in the S&P 500.

Some of the companies you know: Nvidia, Google, and so on.

But that list also includes boring (or less exciting) companies like Old Dominion Freight Line, Monster Energy, and Constellation Brands.

In short, it’s not obvious ahead of time what stocks will do the best … which is why indexing works. (Disclaimer: you don’t only have to index. I own plenty of stocks. Simply advocating that indexing is a practical thing to do and it works.)

You can pick any great investor—Buffett, Marks, Peter Lynch—they were not at the top of the performance tables year-in and year-out.

Rather, it was lots of consistent above-average performance that pushed them to the top. And that’s the obvious advice that most people should keep in mind, which is:

If you earn average returns for a long amount of time, you’ll do much better than average.

They don’t teach that in business school. You don’t have to make macro calls, hold near-term market direction opinions, or dial up the risk in a single asset class, industry, or stock.

Simple over complex tends to work best for most. Not sexy but will get you where you need to go—and avoids the brain drain.

Regardless, the entire Marks memo can be found here and is worth reading in full.