The Indispensability of Risk

Summary

• The author compares investing to chess, sports, and card games to clarify the role of sacrifice and risk.
• Chess grandmaster Maurice Ashley distinguishes between "sham" sacrifices, which offer calculated concrete benefits, and "real" sacrifices, which offer gains that are neither immediate nor tangible.
• Buying a 10-year U.S. Treasury note is described as a modest or "sham" sacrifice involving an opportunity cost for certain interest income.
• Most other investments involve real sacrifices where the risk of loss is borne in pursuit of gains that are not immediate or tangible.
• Ashley's mother left her children in Jamaica to travel to the U.S. to seek a better life, demonstrating the willingness to take risks required for real sacrifices.
• In chess, risk is both intuited and calculated due to the game's inherent complexity, making it impossible to assess with certainty whether a risky move will pay off.
• The saying "No risk, no reward" is considered true because skilled adversaries can handle conservative play and rob players of opportunities.
• Investors generally choose between avoiding risk with little return, taking modest risk for modest returns, or taking high uncertainty for substantial gain with the possibility of substantial permanent loss.
• Market efficiency usually precludes the possibility of earning big gains with little risk.
• Earning high returns requires bearing meaningful risk, either the possibility of loss in pursuit of absolute gain or the possibility of underperformance in pursuit of outperformance.
• The risk of not taking enough risk is real, as individual investors may fail to support their cost of living and professional investors may fail to meet client expectations or benchmarks.
• Backgammon requires players to calculate when to take risk and when to avoid it, with beginners often losing by playing too safely to avoid getting hit.
• Wayne Gretzky stated that you miss 100% of the shots you don't take, and Kenny Smith stated that you have to give yourself a chance to fail.
• Achieving a goal of having no losers requires not taking any risk, which likely results in return avoidance.
• Success in competitive arenas requires taking risk, but taking risk does not guarantee success.
• High rates of return over long periods usually result from a large number of well-reasoned investments where a subset works out well, rather than consistent success on every effort.
• Warren Buffett and Charlie Munger achieved great performance through a lot of decent investments, a relatively small number of big winners held for decades, and relatively few big losers.
• Investors must accept that success stems from making a large number of investments where some portion is known to potentially fail.
• The success of an investment strategy is a function of the ratio of winners to losers and the magnitude of losses relative to gains.
• Taking a chance does not require a successful outcome, but if the reasons are sound, the risk should be taken almost reflexively.
• The courage to take risks becomes a worthwhile end in itself as it builds confidence in decision-making capacity.
• Making money requires bearing risk, but making money does not result from taking risk alone; certainty must be sacrificed skillfully, intelligently, and with emotion under control.
• The memorandum expresses the views of the author as of April 17, 2024, and is subject to change without notice.
• Oaktree Capital Management, L.P. makes no representation that past investment performance is an indication of future results.
• The memorandum is for educational purposes only and does not constitute an offering of advisory services or an offer to sell securities.
• Information concerning economic trends is based on independent third-party sources, but Oaktree cannot guarantee the accuracy of such information.
• The memorandum may not be copied, reproduced, republished, or posted without prior written consent from Oaktree.