Some Thoughts on Howard Marks’ Most Recent Memo

By Jack Forehand (@practicalquant) —  

Howard Marks’ memos provide some of the deepest and most thought provoking insights in the investing world today. They are on par with Warren Buffett’s annual letters as one of the few must reads in investing today. Marks just recently posted a new memo, and the topics he covered were very close to home for me as someone who believes in quantitative and factor-based investment strategies.  The memo was titled Investing Without People and covered three main areas.

  1. The impact of the rise of passive investing on the market and asset prices
  2. His thoughts on quantitative investing relative to a qualitative approach
  3. Artificial intelligence and machine learning and their potential impact on markets


As is always the case with his memos, this one was a very deep and interesting read. These topics are among the most important for the future of investing, so regardless of which side of them you are on, it is important to consider their implications for the future.

I tried to tackle the issue of the impact of passive investing on stock prices in a past blog post and reached a similar conclusion to Marks; that flows into passive funds have likely not led to overvaluation of certain stocks relative to others within indexes. I also took a look at artificial intelligence in a separate article.

Can Factor Strategies Work When Everyone Knows They Do?

In this article, I want to take a look at his second point because I think it is a very important one and is likely to impact the investing landscape for many years to come. Those who read my posts regularly know that I am a big believer in quantitative investing using factors. In his memo, Marks takes the opposite side of that argument. He argues that the rise of quantitative models will lead to diminishing returns for those following them. Marks frames the issue this way.

He then argues that as more people follow a particular quantitative strategy, its effectiveness will be reduced and eventually go away.

I think that argument holds true for short-term quantitative strategies, but when it comes to long-term factor-based strategies, he may be missing one major point – factor-based investment strategies don’t work all the time. If you could invest in a factor like value and outperform the market every year, he would be right because investors would flock to value approaches and bid up the stocks to the point that they would no longer offer attractive prices, and the strategy would no longer be effective.

But in the real world, following strategies that emphasize selecting value stocks (i.e. stocks with low P/E or P/B ratios) involves much more pain than that. As anyone who uses a value approach is all too aware of today, value stock investing involves multi-year periods where the strategy trails the market. It also involves periods where that underperformance can be dramatic. That will shake out all but the strongest followers of the approach. The fact that most investors won’t be able to consistently follow a value approach will allow it to continue to work long-term even though everyone knows it works. In essence, a value investor can give everyone their secret formula and it wouldn’t matter because very few would have the stomach to follow it.

Will the Rise of Factor Strategies Shift the Pendulum Toward Human Stock Picking?

Toward the end of the paper, Marks argues that although most active managers will not add value that exceeds their fees, the ability of humans to analyze things that computers cannot will afford an opportunity for the best investors to continue to add value.

Marks explains it in the following way.

I can’t disagree with that. There will likely always be great investors who can use qualitative strategies to beat the market. The issue, however, is not do these people exist. The issue is can an average investor identify them in advance.  The data so far indicates that the answer to that is no in most cases.

So many of the star investors of the past decade have seen the wheels come off in the current one. It would have been very difficult to see that coming in advance. Also, studies have shown that using past performance data for mutual funds to pick managers for the future has been a futile exercise.

This is where I think factor investing can improve things. As it is in all areas of investing, the caveat that past performance does not guarantee future results is true for using factors as well. But with factor strategies, you can know that the strategy that produced the historical track record you are looking at is the same one being used today. That consistency in the approach increases the odds it will continue to work. It certainly isn’t perfect, and some factor strategies that have worked historically will not continue to going forward (or won’t work as well), but that consistency makes it easier to use the past to predict the future in quant than it is with human managers.

In the end, I am not sure there are any right answers here that apply 100% of the time. Trying to beat the market is incredibly tough no matter how you do it. It requires an incredible amount of discipline and ability to regulate emotion. That is why most people should just index. But for those who do want to attempt to generate outperforming returns, I think long-term quant strategies offer the best opportunity. While I agree with most of what Marks writes in his memos and much of what he says in this one, I would respectfully disagree with him on that point.

Photo: Copyright: Dzianis Rakhuba – Belarus / 123RF Stock Photo


Jack Forehand is Co-Founder and President at Validea Capital. He is also a partner at and co-authored “The Guru Investor: How to Beat the Market Using History’s Best Investment Strategies”. Jack holds the Chartered Financial Analyst designation from the CFA Institute. Follow him on Twitter at @practicalquant.