How the Game Should Be Played

One of the questions asked most often in connection with our leaving to form Oaktree - - perhaps second only to "where'd the name come from?" -- is “why did you do it?"

The answer is that we concluded we had an opportunity to create our own investment management firm, all of which would run our way, according to our philosophies, beliefs and standards.

But what do we mean when we say "our way?"

Well, an article about sports in the April 2 New York Times Sunday Magazine provided an excellent metaphor through which to illustrate the point. In it, the author wrote of Babe Ruth that he represented . . . The Credo of the Home Run: A man can never be faulted, even if he's wrong, for the bold, aggressive action in pursuit of victory; a real man must be willing to strike out, to go down swinging.

I believe this is the way much of the investment world thinks, but it's U the opposite of what we believe in. U In fact, I wrote a memo in 1990 to take issue with a money manager who justified his poor recent performance by saying "If you want to be in the top 5% of money managers, you have to be willing to be in the bottom 5%, too."

"Our way" is U never U to tolerate poor performance, and certainly not to consider it an acceptable side-effect of swinging for the fences. While we strive to be somewhat above average each year, our philosophy mandates that we put the greatest emphasis on trying to avoid losing our clients' money.

And that brings me to what I feel is a much more appealing sports metaphor, which I clipped from the Wall Street Journal in 1992 but never had occasion to cite until now: the story of golfer Tom Kite. The article was about Kite's having won a major tournament, but the part that interested me dealt with his record up to that time: The bespectacled 42-year-old had won ... over the past 20 seasons some $7.2 million in official prize money, more than any other golfer -- ever. But [he had never before won] one of the sport's "majors" (the U.S. and British Opens, Masters and PGA Championship).

That's the way we think it should be done: by consistently finishing in the money, but with no need for headline-grabbing victories. What we think matters isn't whether you hit a home run or win the Masters on any given day, but rather what your long- term batting average is.

Many money managers, it appears, believe either (a) that they really can predict what's in store for the markets and which issues will do best, or (b) that their clients expect them to be able to, and to act as if they can. Thus they swing for the fences each year with a portfolio which will earn big rewards if their forecasts are right ... and vice versa.

The record suggests very few managers truly know what the future will bring, and yet many keep trying to make money through stock picking and market timing in even the most efficient markets. When their holdings appreciate, they recount their insights and take credit, never admitting when they've been right for unforeseen reasons. When they're wrong, they complain about the circumstances that conspired against them and explain that they were fundamentally right but just off in terms of timing or betrayed by chance. Then they go on espousing new predictions without ever publishing a scorecard from which to judge their record as forecasters.

Our response on this subject is simple: (1) We accept that we're among the many who do not know what the big-picture future holds. (2) It is for this reason that we choose to work in inefficient markets where specialization, skill and hard work can add value and lead to above-average performance over time. (3) Lastly, we feel that because we're not clairvoyant, it's important to acknowledge our limitations and U put the highest priority on avoiding losses, U not executing bold strategies.

I was raised on an adage which had good things to say for "he who knows and knows he knows" but warned about the danger of following "he who knows not but knows not he knows not.” Or, as expressed in my favorite quotation, from Stanford behaviorist Amos Tversky, . . . It's frightening to think that you might not know something, but more frightening to think that, by and large, the world is run by people who have faith that they know exactly what's going on.

We never forget how risky it is to join that group. Thus our "game plan" is directed at avoiding strikeouts and building a high batting average over time, not at hitting a home run each trip to the plate.