Oaktree Capital Memo, September 2014
The thing I most want to make clear is that it's impossible to produce superior performance by doing what everyone else does. If your behavior is conventional, you'll get conventional results—good or bad. Only if your behavior is unconventional is your performance likely to be unconventional.
But here's the hard part: unconventional behavior doesn't guarantee success. Most people who dare to be different end up being different and wrong. To achieve great results, you must be different and right. That's a very difficult combination.
I find it helpful to think about investing as a two-by-two matrix:
| Conventional Behavior | Unconventional Behavior | |
|---|---|---|
| Favorable Outcomes | Average good results | Above-average results |
| Unfavorable Outcomes | Average bad results | Below-average results |
The first column—conventional behavior—gives you average results by definition. You cannot beat the market by doing what everyone else does.
The second column—unconventional behavior—gives you the chance to be above average but also exposes you to the risk of being below average. You must accept this asymmetry to have any shot at greatness.
First-level thinking says, "This is a good company; let's buy the stock."
Second-level thinking says, "This is a good company, but everyone thinks it's a great company, and it's not. So the stock is overrated and overpriced; let's sell."
First-level thinking is simplistic and superficial. It sees what's obvious and reacts. Second-level thinking considers the full range of possible outcomes, the probability of being right, what the consensus thinks, and how the current price compares to the intrinsic value.
The relationship between first-level and second-level thinking is similar to the relationship between checkers and chess. Both involve thinking, but the depth is entirely different.
Here's what makes this genuinely difficult: doing the right thing almost always feels wrong at the time.
Buying when everyone is selling feels terrible. Selling when everyone is buying feels like you're missing out. Holding when everyone is panicking requires almost superhuman conviction.
If it felt comfortable, everyone would do it, and it wouldn't work. The discomfort IS the edge.
This is why the best investors I know share one trait above all others: they are comfortable being uncomfortable.