Emma Wall: Hello and welcome to the Morningstar Investment Conference in Europe. I'm Emma Wall and I'm joined by Howard Marks, Co-Chairman of Oaktree Capital Management.
Hello, Howard.
Howard Marks: Hello, Emma.
Wall: So, it has become fashionable to associate volatility with risk. In fact, the two words have almost become interchangeable. Investors think volatility is risk, but you don't think that's the case. What's risk by your assumption?
Marks: Risk is the probability of losing money, I mean, that's the main risk. There are other risks. There is the risk of falling short of your goals or your needs. There is the risk of being forced to sell at the – on a downward fluctuation and that interestingly is related to volatility, but volatility is not risk. Risk is the chance of losing money.
Wall: And I think because people have this idea about volatility and risk, they think that passives – by investing purely in passives totally negates risk, because of course then you just have the benchmark and the standard deviation away from that, whereas actually investing in any type of structure does have risk.
Marks: That's right. You know, investors get sloppy and don't look deeply into the meaning of things. People say I'm going to invest in an index fund and get rid of the risk. Well, the risk they get rid of is the risk of underperforming, of course, to the price of giving up the risk of underperforming is giving up the risk of over-performing. But let's say that's fine, they still retain significant risk, because every time if an index fund is guaranteed to emulate the market then every time the market goes down the index fund investor will lose money. Now may be the rest will lose money too but at least they are trying not to.
Wall: And you say about risk because people become very risk aware when the market goes kaput, but actually we should be thinking about risk constantly, make hay while the sun shines.
Marks: We should think about it all the time and we should think about it more when the market is doing well. When the market goes kaput to use your technical terminology, and prices go low, the market actually becomes safer.
Of course nobody thinks it's safer, nobody acts like it's safer, most people tend not to rush in at the bottom, that's why we have bottoms, but it's safer because prices are lower. But I think that you should think about risk all the time, you should – a portfolio should incorporate risk control all the time because risk is the potential for loss. Loss is what happens when risk collides with a bad environment and we never know when that's going to happen.
Wall: And you have quite nice analogy about car insurance and risk.
Marks: Well that's right, or home insurance. Everybody has a home, everybody has insurance on their home against fire and nobody curses themselves at the end of the year that they had fire insurance and the house didn't burn down. It is part of prudence. Similarly, investing should incorporate risk control all the time. It's an essential part of prudence.
Wall: And then to call up another analogy that you've just given at the Morningstar European Conference; you say that it's not actually the components of the market that are risky; it's the people who are interacting with that market.
Marks: That's right. The risk is not in the stock certificate. It's not in the exchange. It's not in the company fully. I mean, most companies are much steadier than their stocks are. The risk is in the behavior of the investors. And if investors are behaving prudently, that's good. If investors are panicked and dumping their securities then as I said then the market becomes safer and if investors are buoyant and overconfident then that's dangerous and we should recognise that.
Warren Buffet says the less prudence with which others conduct their affairs the greater the prudence with which we must conduct our own affairs.
Wall: And if we could all do it like Buffet then we're doing it right?
Marks: That's right.
Wall: Howard, thank you very much.
Marks: Pleasure, Emma.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
