Memo to:Oaktree Clients

From:

Howard Marks

Re:

Uncertainty IIL.
P.

I’ve written a few times about the frequency with which I come across something additive just before
finalizing a memo. This time I wasn’t so lucky: my wife Nancy brought an important article to myattention two weeks after the publication of Uncertainty. The article’s appearance, along with asecond potential addition, prompts me to write this post-script to that memo. I have a few thoughts
to add, all generally related to the topic of foreknowledge.

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No One Knows What’s Going to Happen

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The above heading was the title of an excellent article by Mark Lilla, a professor of humanities atColumbia University, which appeared in The New York Times this past Sunday. (You may remember
my previous discussion of our tendency to think highly of people who agree with us. I readily admitthat the reason I like this article so much may lie in the fact that it confirms a great deal of what I saidin Uncertainty.) Here are some excerpts from that article:
The best prophet, Thomas Hobbes once wrote, is the best guesser. That would
seem to be the last word on our capacity to predict the future: We can’t.

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But it is a truth humans have never been able to accept. People facing immediate
danger want to hear an authoritative voice they can draw assurance from; they want
to be told what will occur, how they should prepare, and that all will be well. We are
not well designed, it seems, to live in uncertainty. Rousseau exaggerated onlyslightly when he said that when things are truly important, we prefer to bewrong than to believe nothing at all. . . .

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Apart from the actual biology of the coronavirus – which we are only beginningto understand – nothing is predestined. How many people fall ill with it depends
on how they behave, how we test them, how we treat them and how lucky we are
in developing a vaccine.
The result of those decisions will then limit the choices about reopening that
employers, mayors, university presidents and sports club owners are facing. Theirdecisions will then feed back into our own decisions, including whom we choose forpresident this November. And the results of that election will have the largest impact
on what the next four years will hold.
The pandemic has brought home just how great a responsibility we bear toward thefuture, and also how inadequate our knowledge is for making wise decisions andanticipating consequences. Perhaps that is why our prophets and augurs can’t keep
up with the demand for foresight.
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Follow us:At some level, people must be thinking that the more they learn about what ispredetermined, the more control they will have. This is an illusion. Human beings
want to feel that they are on a power walk into the future, when in fact we arealways just tapping our canes on the pavement in the fog.
A dose of humility would do us good in the present moment. It might also help
reconcile us to the radical uncertainty in which we are always living. Let us retire ourprophets and augurs. [Emphasis added]
Lilla’s article pulls together in one place several themes from Uncertainty and other recent memos:

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the very human hunger for forecasts to help us navigate the future,
the conditionality of the future on multiple future developments,
our own ability to influence the future through the decisions we make,the unpredictability of each development,
thus the futility of forecasting,the importance of accepting our ignorance of the future, and thus
the general importance of intellectual humility.

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ED M•••••••Articles like this one and those cited in my last memo should drive home these points to everyone’s
satisfaction. But rarely will people fully accept that we must make decisions regarding thefuture without knowing it.

The Future as Path-Dependent

OA

Forecasters seem to act as if the future already exists, and all we have to do is be smart enough todiscern it. But that ignores the fact that all of us – and many other influences – are constantly
creating the future through our collective activity.

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2020In his article, Lilla stated, “. . . the post-Covid future doesn’t exist. It will exist only after we havemade it.” I think this is a very important concept. We might predict the future today, and we mighteven correctly assess what today’s conditions and actions are likely to produce in the future. But thatprediction will be shown to have been right only if no one and nothing causes the future to become
different between now and the day it arrives. Thus I’ll repeat what I quoted from Lilla earlier:
How many people fall ill with [the coronavirus] depends on how they behave, how
we test them, how we treat them and how lucky we are in developing a vaccine.
Not only how will the virus behave, morph, travel, react to warm weather and infect, but also how
fast will we reopen the economy, how will people behave when we reopen it, and what will the virus
do at that time? Thomas Sowell, a Hoover Institution economist and social theorist, provided aglimpse at how these things work in another field:2© 2020 Oaktree Capital Management, L.P.

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Economists are often asked to predict what the economy is going to do. But
economic predictions require predicting what politicians are going to do – andnothing is more unpredictable.
The unpredictability of politicians is only one of the many variables complicating the future today.
Not only can’t we predict people’s actions and the many other things that will determine the courseof the virus and its impact on the economy, but we also certainly can’t predict when they’ll take thoseactions – and that will count just as much.

Which Expert to Follow?

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In the memo Uncertainty, I quoted at considerable length from an article by Erik Angner. One of its
most interesting points was as follows:KTR
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ENT,People who lack the cognitive skills required to perform a task typically also lack themetacognitive skills required to assess their performance. Incompetent people are ata double disadvantage, since they are not only incompetent but also likely unaware ofit. (Behavioral Scientist, April 13)
By definition, people who lack the expertise in a given field required for superior judgments also lackthe expertise required to assess their level of expertise. As I mentioned, they qualify as John Kenneth
Galbraith’s forecasters “who don’t know they don’t know.”

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While re-reading my memo, I realized I had left out an important further ramification. Not only domost people fail to possess superior expertise – as well as the ability to know it – but they also lackthe ability to figure out who does have it. That’s the catch: you may have to be an expert in afield in order to be able to figure out who the true experts are. That’s why research in most fields
is subjected to “peer review,” meaning a review by experts (not to be confused with “a jury of one’speers,” meaning other lay citizens).

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And yet, where does the buck stop on the biggest of questions, like those of today? The answer can’t
be “with the experts.” An article in The Wall Street Journal set out the dilemma:
To govern, at least at the level of the presidency, is to make hard choices among
competing options with incomplete information. Easier problems are resolved before
they ever reach the Oval Office. Neither scientific data nor public sentiments canproperly answer the questions that face elected officials. Both are important and must
be integrated into the judgments that political leaders make. But neither can
substitute for that crucial act of judgment. . . .
The president’s job, and not only in times of crisis, frequently involves listening toexperts disagree with one another and taking responsibility for choosing among them,plotting a course through opportunities and dangers. The capacity to do this wellinvolves its own sort of practical wisdom, an expertise in judging expertise. . . .
(“Experts Aren’t Enough,” May 16-17, emphasis added)3© 2020 Oaktree Capital Management, L.P.

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Nowadays, like everyone else, I’m bombarded with conflicting views regarding the wisdom of
rapidly reopening the U.S. economy. Yet I recognize that not only is my opinion on that topic oflittle value, but I also don’t have the expertise required to know for sure whose opinion does
count. What I do know is that the last thing I should do is choose an expert because his or her
opinions agree with mine, and allow confirmation bias to affect my decision.
Further, in considering expertise, we must be leery of some dangerous tendencies in our society:to confuse general intelligence with knowledge of the facts relative to a given field,
to confuse factual knowledge with superior insight,
to conflate expertise and insight with the ability to predict the future,
to treat experts in one field as if they’re knowledgeable about all others, andto credit rich and successful people with all of the above.

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ENT,Thus, as I’ve described in previous memos, when I travel abroad, I’m often asked what I think of myhost countries’ economies and their potential. “Why ask me?” I respond, “you live here.” Just
because I know something about investing and the U.S., why should I necessarily have meaningfulinsight into other fields and countries?
We see doctors or public health officials on TV who inveigh against quickly reopening the economy.
They may well know much more than most about the medical and public health aspects of thecoronavirus and how it should be dealt with, and their advice is likely to keep the most people alive.
But on the other hand, since they’re not economists, we should assume they’re only answering fromthe standpoint of minimizing deaths. They may not take into consideration the importance ofrestarting the economy or how to balance the two considerations.

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On the other hand, we see businesspeople and economists talking about the need to reopen in order tominimize the damage done to the economy by keeping it in a deep freeze. But what do they know
about the cost in human lives? And certainly there is no algorithm or accepted process for deciding
between the two. It’s a matter of judgment, not expertise.

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2020I recently read an article about an often-cited libertarian lawyer and legal scholar (unnamed here
because of my general practice of not criticizing individuals) who predicted in mid-March that nomore than 500 people would die from Covid-19 in the U.S. (revised upward to 5,000 when he later
found a statistical error in his analysis). While he admitted to having no medical expertise, he said he
did know more than the doctors about evolutionary theory and its applicability to the virus. His
opinion apparently carried great weight at the time in conservative quarters.
Reporters, not being experts themselves, have to consult experts in order to write their stories. But
how do they choose and vet the experts they cite? And to what extent are their selections a functionof the biases we all tend to confirm and the conclusions they want to justify? In my experience, themore I know about a subject, the less I’m impressed with related media coverage.
And likewise, elected officials are rarely expert in the fields about which they have to makedecisions. They, too, have no choice but to depend on experts. But how do they choose theirexperts? Would they ever consult an expert who belongs to the other party? I recently read a Wall4© 2020 Oaktree Capital Management, L.P.

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Street Journal op-ed piece by a conservative senator suggesting categorically that conservatives andliberals are different in how they weigh re-opening the economy versus minimizing infections. Is
such a sweeping (and probably unscientific) generalization more likely to be an appropriate
observation or an example of intellectual bias stemming from ideological division?
So (a) true expertise is scarce and limited in scope, (b) expertise and predictive ability are twodifferent things, and (c) we all should be careful about whom we listen to and how much weight wegive to their pronouncements.

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And one other thing: As Lilla wrote, “People facing immediate danger want to hear an authoritative
voice . . .” Thus they tend to put inordinate faith in a popular “prophet.” And when he or she turns
out to be a less-than-perfect forecaster, and thus only human, they go looking for the next one toanoint. They never say, “I guess forecasting doesn’t work.” I would say the same about people ingeneral, including those looking for help making money without risk or effort.

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ED MENA Living Example

Finally, in a related vein, I want to mention a May 19 article by Morgan Housel of Collaborative
Fund, an insightful commentator whose philosophical and behavioral observations tend to resonate
with me. In it, he told the story of two friends with whom he regularly took the risk of skiing out ofbounds at the resort they frequented as teens. One day, his friends went out for a second run while hebegged off for no particular reason, and a freak avalanche took their lives. Here’s his summation:
I don’t know if Brendan and Bryan’s death actually affected how I invest. But it
opened my eyes to the idea that there are three distinct sides of risk:
The odds you will get hit.
The average consequences of getting hit.
The tail-end consequences of getting hit.

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The first two are easy to grasp. It’s the third that’s hardest to learn, and can often
only be learned through experience.
We knew we were taking risks when we skied. We knew that going out of bounds
was wrong, and that we might get caught. But at 17 years old we figured theconsequences of risk meant our coaches might yell at us. Maybe we’d get our season
pass revoked for the year.
Never, not once, did we think we’d pay the ultimate price.
But once you go through something like that, you realize that the tail-end
consequences – the low-probability, high-impact events – are all that matter.
In investing, the average consequences of risk make up most of the daily news
headlines. But the tail-end consequences of risk – like pandemics, and depressions –are what make the pages of history books. They’re all that matter. They’re all you
should focus on. We spent the last decade debating whether economic risk meant the5© 2020 Oaktree Capital Management, L.P.

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Federal Reserve set interest rates at 0.25% or 0.5%. Then 36 million people lost theirjobs in two months because of a virus. It’s absurd.
Tail-end events are all that matter.

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This introduces one of the great conundrums associated with investing. Since we know nothing
about the future, we have no choice but to rely on extrapolation of past patterns. By “past patterns,”
we mean what has normally happened in the past and with what severity. And yet, there’s noreason why (a) things can’t happen that differ from those that happened in the past and (b) future
events can’t be worse than those of the past in terms of severity and thus consequences. While welook to the past for guidance as to the “worst case,” there’s no reason why future experience should
be limited to that of the past. But without reliance on the past to inform us regarding the worst case,
we can’t know much about how to invest our capital or live our lives.

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Many years ago, my friend Ric Kayne pointed out that “95% of all financial history happens
within two standard deviations of normal, and everything interesting happens outside of two
standard deviations.” Arguably, bubbles and crashes fall outside of two standard deviations, butthey are the events that create and eliminate the greatest fortunes. We can’t know much in advanceabout their nature or dimensions. Or about rare, exogenous events like pandemics.
In 2001, I wrote a memo titled You Can’t Predict. You Can Prepare. At first glance, that seems likean oxymoron. How can we prepare for something if we can’t predict it? Turned around, if thegreatest extremes and most influential exogenous events are unpredictable, how can we prepare forthem? We can do so by recognizing that they inevitably will occur, and by making our portfolios
more cautious when economic developments and investor behavior render markets more vulnerable
to damage from untoward events.

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That line of reasoning suggests a glimmer of good news: we may not be able to predict thefuture, but that doesn’t mean we’re powerless to deal with it.

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May 28, 2020

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This memorandum expresses the views of the author as of the date indicated and such views are subject tochange without notice. Oaktree has no duty or obligation to update the information contained herein.
Further, Oaktree makes no representation, and it should not be assumed, that past investment
performance is an indication of future results. Moreover, wherever there is the potential for profit there
is also the possibility of loss.

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This memorandum is being made available for educational purposes only and should not be used for anyother purpose. The information contained herein does not constitute and should not be construed as anoffering of advisory services or an offer to sell or solicitation to buy any securities or related financial
instruments in any jurisdiction. Certain information contained herein concerning economic trends andperformance is based on or derived from information provided by independent third-party sources.
Oaktree Capital Management, L.P. (“Oaktree”) believes that the sources from which such information
has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has
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