A cheap investment can still be the wrong use of your last available dollar. It may require money you will need soon, expose you to a risk you cannot judge, or duplicate a weakness in your portfolio. Howard Marks begins with suitability. Compare the investments you can responsibly own, then commit when their value and prospective return justify the risk. You need enough patience to reject poor terms and enough capacity to act when better ones appear.
Start with your return goal, tolerable loss and likely cash needs. Some investments fail that test at almost any price. Unclear accounts or a business vulnerable to technological change may put the risk beyond your ability to assess it. Among the remaining candidates, compare price with estimated underlying worth and consider what each holding adds to the portfolio. The best investment in isolation may displace something more useful or concentrate an exposure you already have.
Managers also owe clients the kind of investment they promised. Christopher Davis cautions that honoring those limits must still leave room to make decisions. Avoiding every potentially embarrassing purchase can become paralysis. Joel Greenblatt adds another comparison. Today's cheapest available investment may look less compelling beside bargains available in earlier markets. Relative cheapness alone need not make today's terms attractive.
When waiting helps
Sometimes doing little is sensible. Marks prefers responding to owners eager to sell over urgently pursuing a fixed shopping list. Their urgency can improve his terms. But waiting costs missed gains. Seth Klarman identifies two failures of selectivity. Impossibly strict standards leave money uninvested indefinitely; loose standards fill the portfolio before better opportunities arrive. You cannot eliminate both the chance of losing money and the chance of missing a winner. Which deserves more attention depends on the opportunities available.
A desired return cannot change those opportunities. When safe yields fall, reaching into riskier investments to restore a familiar return can produce losses that deepen the original shortfall. Accepting modest returns may be the reasonable choice. Holding cash preserves buying capacity but can miss gains and fail to meet spending needs. Investing for the long run requires tolerating interim losses. Searching for special opportunities requires skill, and a strategy may accommodate only limited capital. Each choice has a cost; borrowing cannot manufacture better underlying investments.
Who has to sell
Marks's account of senior bank loans during the final quarter of two thousand eight shows why available capital matters. These loans gave holders an early place in the repayment order. They had usually traded near one dollar for each dollar owed. Low yields encouraged investors to borrow to increase returns on their own money. In Marks's example of a typical financing arrangement, a loan price below eighty-five cents triggered a demand for additional collateral.
That arrangement connected the owner's survival to the loan's market price. When prices fell and new credit became unavailable, many owners could not supply the extra money. Their lenders took control of the loans and sold them. Numerous forced sellers faced few buyers with cash. A lender chiefly concerned with recovering its advance could sell below what a patient owner thought the investment was worth. The original holder's opinion no longer determined whether the holding stayed in the portfolio.
Loan prices reached the sixties, in cents on the dollar. Marks reports that much of the paper appreciated sharply the following year, but investors forced out had already lost ownership. Borrowing had magnified losses and shortened the time available for a judgment to work. It had done nothing to improve the underlying loans. The bargain available to a new cash buyer could be the investment a financed owner could no longer keep.
Cheap can become cheaper
Such selling also explains why pessimism deserves scrutiny. A frightening outcome being possible does not make it certain, and widespread fear can depress prices beyond what underlying value justifies. Waiting until buying feels comfortable can surrender that discount. Yet cheapness identifies no bottom. Prices can keep falling, and mispricing can last for years. Once prices recover, competing buyers return and owners become less willing to sell. For someone building a substantial position, attractive quantities may disappear too.
Nor does a falling quotation automatically justify buying more. The business itself may have deteriorated. Conviction must rest on a valuation that remains sound, with an explanation of why price has moved away from it. Stubbornly defending an old estimate can turn patience into an expensive refusal to learn.
Staying power therefore needs arrangements made beforehand: long-term capital, restrained borrowing, emotional endurance and, for managers, patient backers. Backers must understand why avoiding losses can take priority over joining every rise. Marks says Oaktree buys when value looks attractive and may buy more if prices fall. He also assumes the firm can raise additional capital. An investor with limited funds cannot assume that ability. Money committed today reduces the capacity to buy tomorrow; money held back may miss a worthwhile purchase. The book supplies no allocation formula that removes this tradeoff.
Standards must respond to changing conditions while commitments stay within actual resources. Sometimes the sound decision is to wait. Sometimes it is to accept an uncomfortable purchase or a modest return. More return stops being desirable when obtaining it would require risks you cannot afford.
Three things to keep
Choose investments that fit your risks, resources and existing portfolio.
Cheap prices justify investigation; they do not identify a market bottom.
Patience works when capital and buying standards leave room to act.