Howard Marks, Oaktree Capital — 2025-10-28
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Memos from Howard Marks 2025-10-28T07:00:00.0000000Z" pubdate title="Time posted: >10/28/2025 7:00:00 AM (UTC)">Oct 28, 2025
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Over the last 56 years, I've spent a lot of time making suggestions to clients regarding their investment processes and portfolios, and I've been on the client side as a member of various investment committees. But seldom have I been able to bridge the two, serving as an active participant in clients' investment processes. I had an opportunity to do just that the other day, when I met with the board and senior staff of a U.S. state pension fund. I was asked to listen in and provide feedback on the results of a board-member survey their consultant had recently conducted and would be reporting on during the meeting.
The content of the consultant's session impressed me so much that I decided to write a memo about it. I'm not disclosing the names of the state and its consultant, for obvious reasons, but I'm very pleased that they agreed to let me use the content of the meeting as raw material for this memo.
In the meeting, the consultant covered many of the things I consider "the most important thing" and often came down on the same side I would (admittedly, that might've contributed to why I was so impressed!). I'm going to sum up below the consultant's assessment of the board survey and my reaction. My hope is that this is as informative for you as it was for me.
Attitudes Toward Risk
As you can imagine, I was very glad to see the consultant start with a discussion of how the board members think about risk, and especially do it in a way that was new to me. They led off with a simple two-by-two matrix that I found thought-provoking and useful, as it put one of the most important decisions into perspective.
On the horizontal axis is the plan's ability to bear risk. When I first read that, I thought it referred to the skillfulness of its board and staff in managing risk. But then it became clear that the reference was to the plan's financial capacity to accept risk, defined by its financial health and that of its sponsor, the state.
On the vertical axis is the plan's willingness to bear risk – its attitude toward taking on risk and readiness to withstand the losses that might result. In other words, is the board relatively risk-tolerant or risk-averse? Will it assume more risk in pursuit of above average returns, or will it shun risk, knowing that doing so is likely to limit the returns it enjoys? Importantly, "more risk" and "less risk" are considered relative to the maximum amount of risk that the plan's "ability" might allow it to bear.
The labeling of the matrix's four cells is very informative:
If an investor has a high financial ability to bear risk and a high willingness, it is described as "capitalizing" on, or taking advantage of, its financial strength and risk-tolerance.
If it has a high ability to bear risk but a low willingness, it is said to be "defensive." It could take on more risk than it does, but it has chosen to operate at a lower risk level.
If it has a low ability to bear risk and a low willingness, it is described as being "protective," which seems appropriate given its circumstances. However, it should be recognized that this is likely to limit returns in the short run, and thus to create a need to shoulder more risk and/or increase contributions in the out years.
Finally, if it has a low ability to bear risk but a high willingness, it is described as "naive." I think that might be a generous description. What could be more foolish than taking risk that entails potential consequences you might not be able to survive?
The consultant's survey described the board as having a moderate willingness to accept risk despite the plan's above average ability to bear it (stemming from the plan's solid funding status and the state's strong economic performance). This suggests returns will be constrained, but also that the plan and its constituencies won't be exposed to the greater range of outcomes that increased willingness would bring.
I found this an organized way to approach risk bearing, in which the most important thing is that it's done explicitly and intelligently. It reminded me of the conditions that existed when I was asked to chair the University of Pennsylvania's investment committee in mid-2000. Penn's endowment performance had lagged that of its peers because of its having been severely underweighted in growth, tech, venture capital, and private equity investments in the roaring 1990s, and people were asking whether it should take on increased risk in an effort to narrow the gap. Penn ranked very low at the time in endowment per student, a crucial metric.
Should Penn turn aggressive to make up the shortfall, or should it remain conservative to safeguard the limited resources it had? In the spirit of the consultant's matrix, should it increase its "willingness" despite the limits on its "ability"? I convinced the people who mattered that (a) it was too late to start chasing a horse so long after it had left the barn and (b) the risk of continuing to underperform from such an elevated market level paled relative to the risk of participating in a bust after having missed the boom. The consultant's matrix might have been of help in that effort.
Moving on from the matrix, the consultant described some other interesting facets of the board's attitude toward risk:
100% of the board members agreed – half "strongly agreed" – that exposure to risk is necessary if the plan wants to meet its objectives.
The consensus among board members was that they would feel worse about adopting an aggressive strategy and experiencing a market collapse than they would about being conservative and missing out on strong gains.
The board expressed a strong preference for bearing the "normal" risks stemming from market participation as opposed to the risks associated with an innovative but opaque approach that is projected to deliver returns accompanied by risk below the normal level.
All board members recognized that having true diversification means there may well be some laggards within the portfolio at all times.
In my opinion, the consultant covered the most important aspects of risk bearing, and the board members' views were reasonable. Importantly, they recognize that their conservative bent may lead to underperformance in strong markets, but they explicitly prefer that to a more aggressive posture with its attendant risks. This is probably the most important real-world consideration under the heading of risk attitudes. Not everyone can live happily with the performance lags that conservatism can bring, but this board has had the opportunity to see that in action during the last two bullish years, and it seems to be sticking to the plot.
The board members accept that risk isn't something to be avoided. They're not looking for the illusive black box that others say will give them return without risk. And they understand that caution limits return potential – and that the staff shouldn't be criticized for the presence of underperformers when the board says it wants diversification. I found this discussion realistic and constructive.
Setting Objectives
The starting point for the consultant's discussion of objectives was the ranking provided by the board members: