The Exchanges

Q How important is that ability to look stupid? In terms of outperformance.

A It's essential. It is one of the most essential ingredients. And again, I wrote a memo back in, uh, well, in oh six, I think it was, I wrote one called dare to be great. Um, and I said, in order to be great, you have to dare to be great. And then in 14, I updated it, dare to be great too. Uh, and I said, everybody dares to be great. The question is not, do you dare to be great? The question is, do you dare to be different Because clearly by, you have to, to diverge from the, from the pack is required if you're going to be a superior. In anything. And number two, do you dare to be wrong? Number three, do you dare to be look wrong? Do you dare to look wrong? Because even things which are going to be right in the long run, maybe look wrong in the short run. So you have to be willing to live with all those three things, different, wrong, and looking wrong, in order to be able to take the risk required and, and the, and engage in the Idiosyncratic behavior required for success.

AI assessment note: “It's essential. It is one of the most essential ingredients.”

Q What's the, the government's role in the economic cycle?

A The most direct is the actions of the Fed, and of course that's in, in, in theory that is independent of government, but the, the Fed's central banks, which is what the Fed is, have for more than a hundred years basically been charged with controlling inflation. That is the number one job. Keep the economy on an even keel so that it grows But not overheats causing inflation that has to be reined in. In the more recent years, maybe 30, 40 years ago, the Fed was given another responsibility, which is to support employment. Now, this is problematic, because employment growth comes from economic growth. That's good. Too much economic growth , you get rising inflation. That's bad. So they, they, they have two goals, which are in opposition. And, of course, that requires, uh, particularly adroit management. Which is, by definition, not so easy. Um, and, um, so, well, you know, sometimes the Fed is too positive, and you might get inflation, or you might get, you know, I think, I think that in, in, in some ways, the Fed contributed to the global financial crisis by being too accommodating. And, you know, uh, I think that, uh, Greenspan was so accommodating of the need of the economy to grow that, uh, And, and kind of a, kind of a cheerleader that he permitted the perception of something called the Greenspan put. Which is, anytime the economy looks like it might have a problem, the Fed …

AI assessment note: “The most direct is the actions of the Fed”

Q Polarize everything. I want to come back a little bit just to investing. One thing we didn't talk about that I really want to get your thoughts on is, uh, what is risk? Like, how do you define risk? Not only in investing, but risk in general.

A Well, risk in general, what is it? It's the probability of bad outcomes. You know, in academic investment theory, they say it's volatility. The volatility of prices, the volatility of returns. Now, I believe, and that was a view basically developed in the new theory of investing, and I would say basically at the University of Chicago in the early sixties. And I was very, I talked before about my luck. One of the things I was lucky about is I went to Chicago in 67, and I was among the first classes taught the new theory. And anytime you're at the front of the line, it's an advantage. And that put me at the front of the line. But in the new theory, they, there are all these processes and equations which concern risk and return, and how you optimize risk, return relative to risk. And you have a formula, you need to plug something in for risk, and they plugged in volatility. Now, I don't think volatility is risk. I think, I think risk is the probability of bad outcomes. But Why did they use volatility? Because it exists. You can say, how volatile was this asset or, or, uh, asset class in the past, and we'll extrapolate to add to the future, and if, if you don't use volatility, there's no other number available, because there is, there is no number that you can observe historically for the probability of bad outcomes at, at various points in time, but I think that risk is the probab…

AI assessment note: “Well, risk in general, what is it? It's the probability of bad outcomes.”

Q How do you, how would you do things differently if you were sort of in charge of not only the, the sort of like US government and the economic cycle, but broadly, like how would you conceptualize how the world would best be maximized? How do we unleash that potential across the globe?

A Well, that raises a real interesting question, Shane, and you use the term maximize, and the greatest contributor to global economic maximization is globalization. You know, I mean, let's say you have two countries, mine and yours, and we're really good at raising sheep, and you're really good at turning leather into shoes. And so, we raise the sheep, and when they're ready, we send the hides to you, and you make the leather into shoes, and we, and this system produces a hundred pairs of shoes a year, and then some politician erects a wall. No more trade in sheep, leather, or shoes. Now, I have to I'm good at raising sheep, but I have to try to learn how to make shoes.

AI assessment note: “the greatest contributor to global economic maximization is globalization.”

Q What, what do you think that'll do for wages of blue collar sort of jobs?

A Well, you're seeing it already in, in this, in this rising income inequality. It, the people who have capital or technical education skills are doing very well. And the people who don't have those things are doing very badly. Don't you think that'll just continue? The people who can develop the personless bookstore or the robot will be in great demand, and the people who can create artificial intelligence will be in great demand and very valuable, and they'll all live in a small community just south of San Francisco. And the people who Can't do any of that stuff and get displaced from their jobs will be, will do very poorly, and this is dystopian, and I hate myself for thinking that way, but I'm not optimistic about a solution, and by the way, Let's be generous and say that there's a possibility that government could, could solve this or help. Not this government. This government, by, I mean, by which I mean the current state of affairs in Washington. I'm not talking about a, a person or a political party. This government can't solve any problems because they can't agree on anything. I think if, if there were a solution to this problem, it would be a big solution. There would be a national solution and revolutionary and would require Bipartisan support for something pretty radical. Hard to believe.

AI assessment note: “the people who don't have those things are doing very badly.”

Q sort of manage money, and very few, I think, have been able to act on that in the moment, and that's really interesting to me for a couple of reasons, right? One, you, you sort of overcame your evolutionary emotional programming, um, but two, I'm curious about how you test for that beforehand. How do you test how people will respond in a crisis before you actually have a crisis?

A We had lived through some lesser crises. You know, my partner, Bruce Karsh, and I, who Bruce runs our distressed debt funds, which is where most of this activity is centered. You know, we lived through, ah, a severe market downturn in 1991, and another one, you know, one oh two, so we had rehearsed. I, at, at the time of the financial crisis, I'd been working 40 years already. I've seen some of these things, and so you, hopefully, we learn from experience, you know. Hopefully, at some point, Our intellect, aided by dispassionate observation of our experience, can overcome our emotion. That's number one. Number two, maybe Bruce and I are more unemotional than most. Number three, our very activity of investing in distressed debt is inherently contrarian. You know, people say, well, how can you invest in companies that are bankrupt or destined to become so? So, you know, and at that point, we'd been doing that for 20 years. And If we succumbed to the normal view of distressed companies, we wouldn't be able to conduct that activity. And finally, I think we are unusually supportive of each other. And, you know, we've been doing, we've been partners for 31 years. Neither of us has ever said to the other one, Boy, that worked out badly. You did a stupid thing, you know. This is not an activity where you can bat a thousand, and hopefully it's better than baseball where the greatest bat…

AI assessment note: “We had lived through some lesser crises... so we had rehearsed.”

Q What are the other sort of like moral lessons that you would start with in our family?

A We, we respect others and we care for others and we, we want good for others. In our family, it's not about getting to the front of the line and it's not about succeeding at the expense of others. We want to be part of a team effort, be it in the house, in the community, in the country, in the, in the company, in the school. We want to be part of a team effort which brings success to everybody. And, uh, it's not about getting ahead of the others. And, you know, if you go out and do a great job, you'll be successful. And kindness, um, and, you know, the golden rule. Do unto others as you would have them do unto you is, is, is very relevant. And, uh, You know, the importance of, of being good people, and being liked, and uh, for good reasons, and respected, and uh, you know, when you get to be my age, you, Eric Erickson, the psychologist, wrote about the stages of man, and you, you think in terms of how are you thought of. It's very important to you, but when you get to be my age, it's too late to change how you're thought of. And then ultimately, how do you think of yourself? And, you know, you, when I think of people who get close to the end and are unhappy with how they led their lives, I think it's a terrible tragedy. And then the other thing is, um, I, I would advise young parents if there are, if there's a choice to be made, and the two choices, let's say, are both non-leth…

AI assessment note: “We, we respect others and we care for others and we, we want good for others.”

Q Is that one of the reasons that you read broadly across subjects?

A I, I do that mainly, I mean, my reading is not so purposeful. You know, I'm not reading at this point to become a better investor. Uh, I'm not making that many investment around this decisions around here. I'm really just trying to lead the organization, the people in the culture and, and, and, and relate to the clients and write and speak and that kind of thing. I'm not making investment decisions and I'm just trying to get smarter, you know, and, uh, no more and always challenge my thinking. And, you know, uh, as I said about risk and I now have a slightly different way of explaining risk than I did before. Uh, uh, three years ago.

AI assessment note: “I mean, my reading is not so purposeful. You know, I'm not reading”

Q of people with the same sort of logic, who identified an opportunity, but what was the difference? Because One of the things that I'm so impressed with is not only did you recognize it, but you actually took action on it. Um, so a lot of people seem to, um, perfect to understand what was happening, but they were, they had an inability to act. Where did that come from?

A Our emotions conspire at every turn to make us do the wrong thing. Maybe it comes from the fight or flight mentality, which is so deeply ingrained in us, but as the economy does well, and companies report good earnings, and the media reports turn positive, and the stock prices rise, and people become more enthusiastic, It becomes very hard not to buy. In other words, emotion causes people to buy more the higher prices go. Now, in most walks of life, people buy more when the prices go down during sales. On Wall Street, they buy more when the prices rise. And then, let's say, eventually, uh, things reach a top, which is not maintained. Now the economy turns down, and the company's reporting Decreasing earnings, or maybe losses, and the media put out scare stories, and, and the prices cascade down. Now people get depressed, and when they approach the bottom, they say, I just don't want to lose anymore. Get me out. I'm terrified. I don't know what to do. I feel so terrible about all the things I've owned, and so stupid, and so in other words, emotion tends to get people to sell at the bottom, just as they bought at the top.

AI assessment note: “Our emotions conspire at every turn to make us do the wrong thing.”

Q it as a nation state, but we also operate in this global economy where tax rates on businesses make it more competitive for one country over another, um, where interest rates make investment in one country more More prone than another. How do you think about that? Not only from the individual, like United States point of view, but then in the global sort of world that we live in.

A First of all, let me say, Oaktree is not what we call a macro investor. We do not invest in broad themes of economic growth and movements in currencies and interest rates. We, we are a micro investor. We invest in individual companies and situations and properties and so forth. Uh, so I don't do this for living, but I am out in the world and I do tend to have opinions on these things. Back in May of 2016, I wrote a memo Um, entitled Economic Reality. And basically what I said, you know, our, our presidential campaign was going on at the time. In campaigns, people always say things, uh, which, uh, do not comport with economic reality. You know, in real life, if we have 10 dollars, we can't have two 10 dollar hamburgers. In politics, during campaigns, people say, I'll, you, I'll give you two 10 dollar hamburgers, and it won't cost you anything. And you don't have to choose between having two hamburgers and, and, uh, and putting money in the bank or what have you. And so, yes, economic realities define the playing field and the rules. So, for example, a nation cannot or shouldn't set its tax rates without reference to the tax rates in the rest of the world. One of the reasons we had to reduce our corporate tax rate is that our corporate tax rate was high. Relative to the rest of the world, which meant, which gave businesses an, an incentive to establish themselves elsewhere or mov…

AI assessment note: “a nation cannot or shouldn't set its tax rates without reference to the tax rates”

Q Talk to me about that. Why do we conceptualize it as a market then?

A Because, you know, if you think of a, of a market, most people flash to a photo of the New York Stock Exchange, a building. Just as if most people, well, in my day, if you talked about a stock, people would think about a stock certificate. But the building is not the market, and the stock certificate is not ownership of a company. It's, these things are only signifiers. But, A market consists of a group of people who implement their views on value by transacting, and so it's all there is is people, and people have feelings, and so the emotions tend to get people to buy, buy, buy at the top until the last potential buyer has bought and spent all his money, at which point the, the top is reached and the second derivative goes negative, And sell, sell, sell at the bottom until the last person who's going to panic out does so. And so, number one, it's very difficult to take these contrarian actions in the face of sentiment. And I don't know, I'm sure we're not the only person who did it. I don't know who else did it. Most people don't report their transactions, and most investors don't write the memos like I do. So I don't know who was thinking what at the time. I think we were, Exceptional.

AI assessment note: “A market consists of a group of people who implement their views on value”

Q Talk to me about that, that sort of change with the, we'll call it technology and automation and AI and machine learning. How is that similar to other sort of, I want to use the term like revolutions, but, and how is it dissimilar in your mind?

A Yeah, I, I was, uh, I was invited down to Tulane University. They had a speakers program, and I think, uh, I was the first speaker at the business school after the school was repaired following the terrible earthquake, uh, hurricane they had down there. And, uh, my hosts took me to dinner in, um, Basin Street, and one of the things they told me about was that New Orleans and the environs were thriving metropolis, economically thriving metropolis in the days of agriculture. And, uh, Of course, millions of people had jobs in agriculture, and then, uh, agriculture became automated. Those people lost their jobs in agriculture, and they moved to the upper Midwest to make cars and appliances, and then they, that was, they thrived, and people who worked in those industries who really maybe, maybe only had a strong back as their main asset, Did very well. They had unions, they had strong unions, the unions got great, great, great packages for them, and they did very well. But then, of course, we globalized, and the manufacturing of cars and appliances moved overseas, and Since then, the unions have been in decline on the private sector side, and now what do you do if your only asset is a strong back? You know, I think President Obama on the, on the stump said, well, we'll give them all laptops, but not everybody can work a laptop enough to make a living, and number two, in the informat…

AI assessment note: “in the information age, by definition, we need fewer people to produce GDP”

Q Just for people listening, can we give context to?

A Well, in the, in the seventies, we had runaway inflation in America, not like, you know, some African nation that had a thousand percent a year, but we had 16% a year. I think it was at the peak. And makes it very hard to live and securities collapse and people have trouble keeping up with the cost of, of living and, um, you know, commodity prices get out of hand and so forth. And, uh, and of course, short term rates go up, which makes it hard to finance business and so forth. And everybody, you know, so, so the main point about inflation is I think it's very mysterious. It's hard to say what starts it. It's hard to say what stops it. Um, deflation they have in some countries like Japan, it's hard to know what starts or stops that, but obviously has a great impact on the economic cycle. And if you think about the economy, US economy grows, let's say for rounding purposes, uh, on average, two percent a year. Why doesn't it grow two percent every year? Why is it, why sometimes three and sometimes one and sometimes four and sometimes negative? Uh, and, um, I think that, you know, and unfortunately the book is already printed, uh, and as you, uh, keep thinking about things and, and talking about them, your, your thoughts come into better focus. So I, I would summarize it as saying that cycles happen because people, not electrons, but people commit excesses to the upside, usually ou…

AI assessment note: “Well, in the, in the seventies, we had runaway inflation in America”

Q Outside of the Fed, does the government play a wealth sort of redistribution role, and how does that affect the economic cycle? I mean, we talked about the tax cuts.

A Yeah. Well, of course, what people have to understand, maybe more than anything else, is that governments don't make anything. All they do is redistribute. All they do, you know, we have these millions of people working in Washington, and All these senators and all they really do is they collect money and they spend it. They don't make it. They don't have businesses which add value to our society. And so they make spending decisions and, and, and collecting decisions. These are policies. Taxation. How much from the rich? How much from the poor? How much from interest and dividends? And how much from Uh, salaries. And these, I've seen fluctuations in these things over the years, but this is policy. And then, you know, there are people who say that we have too much inequality and it should be fixed. And there are people who say that the way to fix it is to get the rich to pay their share. Now I kind of bridle at that, uh, because it seems like a religious or philosophical statement. It's not an economic statement. There is no such thing as a fair share. And, and the only question is who determines the fair share? And my feeling is that the fair share is by definition, when people say we're trying to get the rich to pay their fair share, what they mean is we're trying to get them to pay more than they pay now. But how do you define the fair share? Right. You know, right now, peopl…

AI assessment note: “governments don't make anything. All they do is redistribute.”

Q Like expected value is sort of like a model or a lens into making better decisions. One of the other ones that you've talked about is sort of second order thinking. Can you explain a little bit about that? And then what would be really interesting is to go into other sort of mental models you commonly use to conceptualize problems and think about them.

A Well, what I call second level thinking says this. The goal in investing, investing is a funny activity. It's really incredibly easy to be average, and, and average is usually not too bad, and if you're willing to settle for average, you can do it with very little risk and very little, very, excuse me, very little risk of being below average and very little cost. You buy what's called an index fund. If you say, I will be You know, that the S&P 500 stock index, it represents average stock market performance. I'll be happy with the return of the S&P 500. You invest in an index fund, which invests in all the stocks in the S&P 500 in a certain weighting. The cost is very low because there's nobody making any decisions.

AI assessment note: “Well, what I call second level thinking says this. The goal in investing”

Q I want to come back to something you said about thinking the same as everybody else. How does that change the information that you consume? And how do you, how do you go about the opportunity cost? I mean, you have a lot of things on your desk. There's a lot of books to read. How do you think about that?

A At some point in the process, and it's, it's probably a different point for everybody. You have to think about, again, this kind, this idea of, of counterintuitive. I think what most people think, who think about investing, is that if good things happen, you'll make money. Not necessarily so. It all depends on expectations. If the expectations are too high, then you could have a favorable out, a favorable event And it could disappoint people, you know. So, people think, last year the company made a dollar per share, next year they think they're gonna make two dollars a share, earnings doubling, that's exciting, they bid the stock up, and the earnings come out at a dollar 75. Now, earnings going from a dollar to a dollar 75 is certainly a good accomplishment, but most people are disappointed and the stock falls. And, and so, I think it's at some point, look, our, the people who work here spend all their time, time trying to figure out what is, and they try to know what is, that is to say, what is this company about? What will it be worth down the road? What will it accomplish? And so forth. And they try to know those things better than others.

AI assessment note: “You have to think about, again, this kind, this idea of, of counterintuitive.”