Did you read my article yesterday?
If you haven’t yet, I’d click here. Because I am now officially predicting a real estate recession.
Not a bad one. Not a long one. But a recession nonetheless.
As I also stated, this doesn’t mean I’ve given up on my larger economic enthusiasm under the upcoming Trump administration. Not for real estate investment trusts (“REITs”). Not for the general stock market. Not for the economy or the nation.
A recession isn’t going to change that long-term growth. But it’s still something to plan for all the same.
That means taking a page out of Howard Marks’ book. Or, more specifically, from his memos.
Marks, the co-founder and co-chairman of Oaktree Capital Management – the world’s largest investor in distressed securities – has been writing memos for his shareholders since late 1990. They apparently stemmed from a meeting with David VanBenschoten, then the head of the General Mills pension fund.
Here’s what Marks wrote about it while reminiscing in a September 2023 memo:
Dave told me that, in his 14 years [on] the job, the fund’s equity return had never ranked above the 27th percentile of the pension fund universe or below the 47th percentile.
And where did those solidly second-quartile annual returns place the fund for the 14 years overall?
Fourth percentile! I was wowed. It turns out that most investors aiming for top-decile performance eventually shoot themselves in the foot. But Dave never did.
Marks also mentions how “a prominent value investing firm reported terrible results” around the same time – results its president shrugged off as just part of doing business. “If you want to be in the top 5% of money managers,” this man rationalized, “you have to be willing to be in the bottom 5% too.”
To Marks, that was unacceptable. He knew the caliber of his clients. They weren’t the type looking for fast fortunes.
They wanted reliable wealth.
And the way you achieve that is by properly managing risk. Or, to put it in Mark’s words, “If you can avoid losers… the winners will take care of themselves.”
Growth Is Only Good if It’s Sustainable
Since I’ve built Wide Moat Research around that very concept, I have to assume most of you are here for the same reason.
Really, I wish everyone was. Because, despite my predictions – and all the analysis behind them, including input from economic greats like Homer Hoyt – we never truly know when a downturn is going to hit.
All we know is that good times eventually end, sometimes suddenly.
Fortunately, that doesn’t mean you have to take recessions lying down. What Marks meant with his losers-and-winners comment is that smart investors commit to finding sturdy investments. And then they let those assets run for as long as they can.
I wish I had gotten that concept through my head 35 years ago when Marks first wrote about it.
In my last life as a commercial real estate developer, I was too much like the investment firm president he mentioned: the one who shrugged off his very bad year as a normal part of doing business.
Oh, I wouldn’t have been so easy about such a loss. But I had no problem taking on the kinds of risk that led to such consequences.
For instance, I personally guaranteed millions of dollars in loans to build shopping centers for companies like Walmart, PetSmart, and Barnes & Noble. And I signed less-than-wise contracts with engineers, architects, contractors, and tenants in hopes of creating future value.
While I took my reputation seriously, always making sure to select the best sites and approve solid construction material for my projects… I guess I didn’t take that same long-term approach to my finances.
I was all about building up wealth quickly. Factoring in risk would have slowed me down too much.
Then again, it also would have saved my portfolio from falling apart when the housing market crashed in 2008.
Risk Is Inevitable, but Rewards Are Still Possible
Look, there’s always risk, even if just in the slightest amount. There are no guarantees in life, and that’s especially true of the stock market.
Excellent company executives step down, are ousted, or pass away. Competitors rise up, and unexpected negative events happen, including recessions.
That’s something we have to acknowledge if we’re going to be successful.
Yet there are ways to minimize risk. Or, to quote Marks again, “You want to bear risk intelligently.”
He drew the distinction between “risk avoidance” and “risk control” in his 2023 memo. The latter “basically consists of not doing anything where the outcome is uncertain and could be negative.”
Which, we’ve already established, is extremely difficult. That’s why Marks went on to say:
For this reason, risk avoidance usually equates to return avoidance. You can avoid risk by buying Treasury bills or putting your money into government-insured deposits, but there’s a reason why the returns on these are generally the lowest available in the investment world. Why should you be well paid for parting with your money for a while if you’re sure to get it back?
Risk control, however, “consists of declining to take risks that (a) exceed the quantum of risk you want to live with and/or (b) you wouldn’t be well rewarded for bearing.”
That latter approach allows you to make money during the best market conditions… and then protect that money when things go south, which they always eventually do.
I’ve seen it for myself. Ever since 2008, when I had to recalculate my mindset and my money (what was left of it, anyway), I’ve been much more respectful of the concept of risk.
And I’ve made sure to carry this mantra over into Wide Moat Research’s services.
Stacking the Odds in Our Favor
In The Wide Moat Letter, for example, we identify solid, blue-chip companies trading at a discount to our assessed fair value. This provides a margin of safety and limits our risk.
It has also paid off very nicely.
I recently asked one of my analysts, Nick Ward, to do a review of our portfolio for last year. Here’s what he found:
[We] took advantage of the strong market conditions throughout the year, making 17 sales or trims across our portfolios… locking in gains in 15 of them (an 88%-win rate). Our average gain across these 17 sales/trims was 73.1%.
That isn’t to say we were perfect (we weren’t). Or that we didn’t have some losers (we did). But by following our mantra of finding sleep-well-at-night (“SWAN”) investments – while respecting risk – we stacked the odds in our favor.
That’s why I don’t fear the recession I expect in the next 15 months. Regardless of whether it’s mild or not.
Regards,
Brad Thomas
Editor, Wide Moat Daily
MAILBAG
Do you agree with Brad that reliable wealth comes from properly managing risk? Write us at feedback@widemoatresearch.com.