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I think that this decline in interest rates was the biggest single event of the last 45 years in the financial world most people wouldn't say that why because it was very gradual over a long period of time you could be criticized for buy quality that was too low and in fact under the right circumstances if a fiduciary bought 10 risky assets if nine of them were up 10x and the 10th one lost 5% the fiduciary could be charged for having bought a risky asset and and made to pay so the the job of the fiduciary was to avoid uh uh low quality then around 7778 Michael milin and others had the idea that the prohibition on issuing below investment grade debt was excessive and rather than consist of a blanket prohibition there should be an understanding that they're risky because they're risky they have to appear to offer a higher return as an inducement but if the promised return seems adequate for the risk then that's that's a reasonable thing for a fiduciary to do so this was a big change uh this was a c change you know uh you go from there are good assets and Bad Assets and you can't buy Bad Assets assets so you can buy any asset no matter how risky it is as long as the as as a as a prudent professional would say that the perspective return compensates for the risk big change risk return thinking and I I I dare say that it's risk return thinking that governs everything we do today um and nobody declines to buy anything just because it's slow quality but because it's it's it's too risky uh for the for the uh return that's that's that seems to be offered um big change big change and we wouldn't have hedge funds U Venture Capital um uh private equity and all the derivatives at the institutional level if the old uh fiduciary uh rules were still in in force so the the shifting to thinking about risk and return together really has made the investment Universe of today unrecognizable from 50 years ago the other C change I lived through uh came right around the same time not connected I don't think by anything under line but in 1980 I had a loan outstanding from a bank in Chicago and they sent me a slip of paper as they did when rates changed and they said the rate on your loan is now 22 and a qu% 1980 December 40 years later I was able to borrow at 2 and a qu % fixed for 15 years well this is a major change and first of all declining interest rates have a number of very strong impacts they stimulate the economy they make it easier for companies to make money um they make assets worth more and uh of course they uh reduce the cost of borrowing so the these events of those 40 years made it very very attractive for asset owners and for uh borrowers and people who borrowed money to buy assets got a double bonus and so this this was the overwhelming condition over this period and it's not a a coincidence that this is when private equity and uh in particular had its great success because that's what it does you borrow money to to buy assets the assets under the under as it happened turned out to be worth more than you thought they would and the cost of borrowing to buy them turned out to be less than you thought it would be what a great combination and I believe there's a couple things worth noting number one I think that this decline in interest rates was the biggest single event of the last 45 years in the financial world most people wouldn't say that why because it was very gradual over a long period of time kind of like the the the frog in the pot of water you know you put a you put a frog in a pot of boiling water he'll jump right out but if you put him in a cool water and you turn on the heat he'll just sit there while it gets hot and eventually he'll succ come because he doesn't notice that it's taking place so gradually and I think that's what happened with rates they change so so gradually that people I mean if if if you send out a a questionnaire what was the most important event of the last 45 years in the world of fin ask I don't think anybody would say they would say derivatives your bonds private Equity um very few I think would would say the declined in interest rates but and that that and so a couple other things worth noting number one that means that in order to uh have seen a a more normal period you had to be working in the 70s or maybe in the 60s in the 70s of course we had to battle against inflation so that wasn't a typical period the ' 60s may have been something we would call normal um and but that was obviously the 60s ended uh 53 years ago so not too many people who worked in the 60s are still working today um and I believe that the declining interest rates were responsible for the majority of all the money that's been made in the last 45 years so that's that's pretty important those are my candidates for sea changes obviously not just a normal uh cycal up and down not just a a correction an an access and corrections but a a repl pluming of the whole environment so the environment of borrowing money and buying assets at low interest rate period seems to be reversing so what is the opposite of that what is the c change we are entering into that you're foreseeing Trey I'd rather not say reverse because that implies that we're saying rates went down and now they're going to go up I think I would say they went down and now they're going to kind of hang around at this level I'm not predicting that they're going to go back up and in fact U you know you look at the FED funds rate which is four and three quarters today I'll bet you in a year and a half it'll be lower the the rates are high today to fight inflation I don't think they're going to stay this high or get high but if rates are are through coming down well two things number one they're through coming down and number two they're uh in any major way and number two they're through being ultra low you know the the FED reduced the FED funds rate to zero uh at the beginning of 09 to rescue us from the global financial crisis uh and it worked and it was it was a strong move and we we should thank Our Stars but interestingly do you know how long they kept it at zero 13 years no M signal don't know and the and the answer is seven years seven now zero rates are an emergency measure and an emergency measure was called for in late 08 or early 09 but clearly we didn't have an emergency for seven years clearly by 12 or 13 or 14 the emergency was over so why were rates left at zero and and the answer is you know I I I rather think it was a mistake but uh anyway way so if rates aren't going to be ultra low and aren't going to decline in the future then the things that worked in recent years uh should not be the things that work best in that new environment that's that's the essence of the memo change so I'm tempted to ask you know where if you think there's a vulker like uh you know uh hammer needed here with this current inflationary environment because you said they're not going to stay low for long they're not going to go high for long but inflation seems to be sticking around and and I'm yeah that Playbook exists I'm just curious if you're if you're agreeing that maybe that's not needed in this new environment well I think it's not needed to the same extent first of all inflation today is probably roughly half of what it was in the 70s so we by definition we don't need as strong countermeasures and secondly some of the inflation that we have is kind of a oneoff respon to the to the post uh pandemic measures that were enacted uh Distributing so much money uh to taxpayers uh and so forth and and and also the little crimping of the supply chain that and those two things should work themselves out over time so I think that the the the level of in inflation today is not so high and it will Abate naturally which was not necessarily the case in the 70s uh so but we still need to to wipe out inflation and inflationary psychology which tends to get embedded and sticky um and I think that you asked whether we're GNA have a a a vulker type treatment and I think we are getting it from J Powell I think he's being very reasoned but he's being Resolute and you know all the all the optimists uh who run the stock market would love him to say you know we we going to think about bringing rates back down starting uh in December or something but he hasn't said it and I don't think he's going to say it and all he has said so far is we're going to keep raising rates we may go slower than we were going we may end up higher than we thought we were going to go but we're going to keep Vigilant and he hasn't said a word well he has he has mostly said and we're not going to be cutting rates anytime soon which I think is very appropriate so I'm I'm optimistic uh that he'll that he'll do the right thing here then they've been coming up with all kinds of tools that I think will kind of abate them needing to lower rates as well which is kind of fascinating when when interest rates are low uh corporate defaults are also low and as rates rise defaults also rise or they tend to rise right so you've written about investing with caution in the past while we've had this uh pandemic Infuse uncertainty and this low return on cash environment I I'm curious how your opinion on investing with caution has changed in recent months is it the new definition of caution to a degree or or a different type of caution that you're you're uh now investing with well there are lots of kinds of caution um and for me caution means uh insisting on a margin of safety you know um not many of us are so dumb that we will not we'll make investments that would would suffer if things stay the way they are but if a cautious investor insists on margin of safety or margin of error whatever you want to call it what he's saying is I want to make sure that if things get worse than I think they will I'll still be okay and so I think that that's a very important part of being a cautious investor uh because you know from time to time things will be worse than you had thought how will you do that's that's a key question now when the Market's flying high and valuations are stretched and all opinions are loaded down with optimism clearly you need a lot of caution because there's so much potential for things to come in worse than expected when the Market's really low in its cycle there's not much risk of that there's no optimism in prices nobody thinks anything good is going to happen so you're not at risk of overestimating the situation and being disappointed to the same extent so the the thesis of mastering the market cycle is that your actions should be determined by where the market stands in its cycle to the extent you can figure that out uh and when it's high you should be cautious and when it's low you should be aggressive uh and you know I still feel the same about that at Oak tree we have I would say a a a cautious bias every investor and every Investment Portfolio embodies a mix of aggressiveness and defensiveness well you say I want to I want to be defensive so that if things go badly I would't suffer too much but on the other hand I don't want to miss all the opportunities so I'm going to have some aggressiveness and the question of how you strike the balance between aggressiveness and defensiveness for me is question number one in the short or me or intermediate term and and uh when the market is I think the Market's in moderate territory so I'd like to keep the same in their normal balance which for oak tree means a cautious balance um and um you know we we we ched our course many years ago as saying that we're what we're going to deliver is lots of good years maybe an occasion great year but hopefully never a terrible one and if you can just do that combination uh which I think we've done uh and you can do it for 40 or 50 years then I think you've really accomplished something
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