When Oaktree Capital Management closed its European Principal Fund III in March last year, it had raised €3.2 billion – 20% more than its $2.5 billion target – to invest in what it saw as the excellent opportunities in the region.
What it hadn’t bargained for, however, was the impact that the ECB’s two long-term refinancing operations (LTROs) would have on the distressed investing environment. As the central bank flooded the banking sector with €1 trillion cheap money, the world’s largest distressed investor saw its European strategy all but washed away. “We all thought that we would get a deluge of selling by European banks that would overwhelm the available capital and force prices down,” admits Oaktree's chairman Howard Marks, ruefully. “Then the LTRO came along and the need for capital and liquidity was not what we thought it would be.”
Euromoney meets Marks at Oxford University’s Saïd Business School, where he is due to lecture on Uncommon Sense for the Thoughtful Investor, which is also the title of his latest book. Famed for his lengthy client memos, Marks is keen to dispense his investment wisdom that has been accumulated over four decades in the business.
Marks founded Oaktree Capital in 1995 with Bruce Karsh and three others from asset manager TCW Group. The firm had $77 billion assets under management at the end of last year and reported adjusted net income of $220.4 million for the fourth quarter of 2012 – a rise of 187%. Full-year income was $717.3 million, up 34% on 2011. While the firm distributed a record $12.7 billion to investors during last year, Marks himself was ranked 922 in Forbes Magazine’s global list of billionaires, with a net worth $1.65 billion.
Things are clearly going well, but developments in Europe seem to grate an investor with such a stellar reputation. “Macro developments can play havoc with what we plan to do,” he tells Euromoney. “All we can do at any point is make decisions based on our best judgement regarding the future. One thing that is not available at the moment is the investment opportunity that we thought that we would get.”
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| Howard Marks |
That opportunity is one that has so far eluded many of the distressed funds that have been raised in the region since the financial crisis. Oaktree’s European Principal Fund III is, however, the largest such fund raised so far in the region and it might struggle to achieve the return expectations it was predicated upon. (It has a tough act to follow: last year Oaktree’s 15 distressed funds had produced a 23% aggregate gross IRR since 1998). “We raised a lot of money for this a few years ago and thought we could make 25% to 30% in European distressed debt and distressed equity,” Marks explains. “We’re now faced with the choice of doing riskier things to make that return or doing what we were planning to do and make less. The former is simply chasing return so we are pursuing the latter."
He insists: "We aren’t going to climb out the risk curve. We would like returns in the teens. In 2002, 15% to 18% didn’t seem like a lot when treasuries paid 7%. I would be thrilled if we could make a return in the teens now.”
Banks might not be selling in the numbers that Oaktree expected, but when they do sell the firm is quick to seize the opportunity. In August, it closed the purchase of around 60 distressed regional UK properties from Lloyds Bank via the Project Harrogate portfolio sale. The discount on the £625 million face-value loans is thought to have been around 60%.
Oaktree is also understood to have bought $800 million of shipping loans from Lloyds in November at a substantial discount. It is pursuing further portfolio sales but will likely eschew the region’s riskier geographies. When asked whether the firm is looking at opportunities in Germany and Spain, Marks merely comments that: “Putting a lot of money into Spain could be a high risk/high return strategy.”
High risk, high return investing is something in which Oaktree has had much success in the US – particularly in loan-to-own strategies. This entails the investor building up a sizeable position in the troubled company’s senior debt to seize control in a debt-for-equity restructuring. The strategy might be win-win for the buyer, as even if it does not succeed in taking control of the company it can be paid out at par on debt that will have been bought at a substantial discount.
While loan-to-own strategies have a long history in the US, their adoption in Europe is relatively untested. Oaktree has been involved in several recent situations that highlight the challenges that can be embedded therein. Oaktree was part of a lengthy dispute between junior lenders to German plastics manufacturer Klöckner Pentaplast and Blackstone, which had bought the firm in a secondary buyout in 2007. Oaktree held a principal position in the firm’s €800 million senior debt and had proposed a debt-for-equity deal to take control of the firm with Blackstone.
In June, however, junior lenders led by Strategic Value Partners succeeded in gaining control of the firm. The senior debt was, however, repaid at par. In 2010, having built up a 46% position in the firm’s senior debt, Oaktree abandoned its restructuring plans for German aluminium company Almatis to Dubai International Capital – but was again paid out in full on its position.
“It is not easy to do loan-to-own in Europe as there are more moving parts,” Marks explains. “In the US we have done hundreds of restructurings where we were expecting a reliable outcome under the aegis of the court. But in Europe you can’t assign the same probability to that process working. In Europe I would expect to achieve outcomes not through the court but through a consensual restructuring."
He warns: "In such situations you may get less than you deserve and others get more than they deserve. But if you bought right you can come out well.”
Marks concedes that improving conditions in the European loan and capital markets will make a loan-to-own strategy in the region additionally unpredictable. “If a company whose debt we own is in trouble but has other capital avenues available then our leverage with them is reduced. The more alternatives the debtor has the less well the creditor will do,” he agrees – pointing out that the strategy can be regarded more favourably as conditions improve.
“In bad times, money from others can be called throwing good money after bad. In good times it is called rescue finance,” he says, smiling.
Oaktree raised $380 million in an IPO last April, which – like that of Blackstone, Fortress, KKR and Carlyle – suffered from market volatility. It had intended to sell 11.3 million shares at between $43 and $46 each but eventually priced 8.84 million shares at $43 in what Marks has described as a humbling experience. Indeed, he readily admits to finding these markets very tricky to predict.
Speaking to an audience of industry professionals and students later that afternoon, he states: “The world seems more uncertain today than at any time in my experience – and I have been in this business 45 years.”
Despite it being an unusually sunny, spring-like day for Oxford in March, in the crowded lecture theatre students are crouching along the stairs to hear Marks talk. “Is the world really less certain or do we just feel less certain?” he muses. “I don’t think that anybody really knew what they thought that they knew seven years ago, so which is worse?”
A recurring theme of his lecture is the resurrection of pro-risk behaviour in the face of persistently low interest rates. “There is no money to be made safely any more," he says. "You have to go out the curve and make risky investments. Low yields are forcing even wary investors into pro-risk behaviour. Risk aversion keeps the market honest.
"We have a world in which nobody is thinking bullish. Everybody is worried and there is an absence of bullish thinking but the presence of bullish behaviour. We see pre-crisis practices coming back into the market: it is easy to issue triple-C debt and it is easy to issue debt to pay dividends to shareholders.”
He describes his investment philosophy as 80% to 90% offence versus defence: the pursuit of high returns versus the avoidance of loss. “The answer is somewhere in the middle but biased towards the avoidance of loss,” he says. “Money and nerve are all that you have needed over the last four years – it didn’t really matter what you bought. All the asset manager selection in the world didn’t really make a difference.”
However, he now strikes a decided note of caution: “I see unsound practices creeping back into the credit markets. People are making investments not because they want to but because they have to – they are handcuffed volunteers. You need to keep your goal on buying value for less than it is worth.”
Marks is fond of reminding his audience that “this isn’t supposed to be easy”. But as someone who last year bought the most expensive co-op ever sold in New York City at 740 Park Avenue for $52.5 million and recently sold his California house to a Russian oligarch for a rumoured $75 million, he can make it look rather that way.
“Conditions in the world are not so bad and prices are not so high that it is unreasonable to move forward,” he tells Euromoney. “But conditions are not so good and prices are not so low that it is time to be aggressive. Some risk-tolerant practices have come back into the market so it is important to exercise caution.”
