Q. What are the key messages?
Investing (like economics) is more art than science and that means things cannot be made fixed and mechanical - things can get messy -and that it requires one to be adaptive and intuitive.
Getting above average returns, versus average returns that could be achieved via index funds, would require one to have superior insights.
“In basketball they say, “You can’t coach height,” meaning all the coaching in the world won’t make a player taller. It’s almost as hard to teach insight.”
In investing the key trait required is perceptive thinking, in other words second level thinking.
Consistently above-average results would require, superior insight, intuition, sense of value and awareness of psychology. Howard Marks thinks that one could achieve consistent above average results by applying second-level thinking.
Since other investors may be smart, well-informed and highly computerized, you must find an edge they don’t have. You must think of something they haven’t thought of, see things they miss or bring insight they don’t possess.
Example of second level thinking
“First-level thinking says, “I think the company’s earnings will fall; sell.” Second-level thinking says, “I think the company’s earnings will fall less than people expect, and the pleasant surprise will lift the stock; buy".
“First-level thinking says, “It’s a good company; let’s buy the stock.” Second-level thinking says, “It’s a good company, but everyone thinks it’s a great company, and it’s not. So the stock’s overrated and overpriced; let’s sell.”
Howard Marks urges the investor to go deeper than the simplistic first level thinking to find a variant view.
“Second-level thinking is deep, complex and convoluted.”
Second-level thinking requires one to take a lot of considerations into account: some excellent questions are provided as a sample…
What is the range of likely future outcomes?
Which outcome do I think will occur?
What’s the probability I’m right?
What does the consensus think?
How does my expectation differ from the consensus?
How does the current price for the asset comport with the consensus view of the future, and with mine?”
“Is the consensus psychology that’s incorporated in the price too bullish or bearish?
What will happen to the asset’s price if the consensus turns out to be right, and what if I’m right?”
First-level thinkers are looking for simple formulas and easy answers.
Second-level thinkers know that success in investing is the antithesis of simple.
“First-level thinkers think the same way other first-level thinkers do about the same things, and they generally reach the same conclusions. By definition, this can’t be the route to superior results. All investors can’t beat the market since, collectively, they are the market.”
“The problem is that extraordinary performance comes only from correct nonconsensus forecasts, but nonconsensus forecasts are hard to make, hard to make correctly and hard to act on.”
“If your behavior is conventional, you’re likely to get conventional results—either good or bad. Only if your behavior is unconventional is your performance likely to be unconventional, and only if your judgments are superior is your performance likely to be above average.”
“Joel Greenblatt: The idea is that agreeing with the broad consensus, while a very comfortable place for most people to be, is not generally where above-average profits are found.”
“Those who consider the investment process simple generally aren’t aware of the need for—or even the existence of—second-level thinking.”“Thus, many people are misled into believing that everyone can be a successful investor. Not everyone can. But the good news is that the prevalence of first-level thinkers increases the returns available to second-level thinkers. To consistently achieve superior investment returns, you must be one of them. (second level thinker ).