This action might not be possible to undo. Are you sure you want to continue?
Howard Marks Presentation to UCLA Anderson Student Investment Fund Capturing Efficiencies in Distressed Debt • Introduction o No investments are good or bad intrinsically o It all depends on the timing and the price
Fashion fads come and go In 2010, the fad was safety What Marks does to determine the quality of the investment is to project himself into the future • What kind of scenario would have to play out for the return to make sense? o In terms of buying Swedish gov’t bonds at .9% yield, depression and deflation are the only outcomes that would make the decision prudent
• o Distressed debt
Investing successfully surrounds buying assets for less than they are worth
What is distressed debt? • Debt for which the markets do not believe the bonds will pay principle and interest
Generally, distressed debt investors want a creditor claim on the company Restructuring is the event that comes about after a default • Trigger (such as restructurings) are important in investing
3 questions that Oaktree asks itself in determining whether to make an investment What is the pie worth? How will it be split up among claimants? How long will it take? • If you can get all of these right you can determine the IRR with certainty
com/ You might want to buy a piece of each of the different classes of debt to hedge the uncertainty of how the pie is going to be split up o Sub debt for example has nuisance value and its holders can often extract more than they should when the pie is being divided Oaktree has bought the sub debt even when it believed the chances of making money were not great in order to hedge against weird outcomes of the pie splitting o Determinants of supply and demand of bonds Lowering of credit standards • • These are the logs that provide fuel for the fire There is a correlation between the level of issuance of HY bonds and the subsequent likelihood of default Onset of economic weakness • Put a match to the logs and ignites the crisis • General cycle dynamics o Build Up o Start off with a hospitable environment Risk taking is profitable Credit standards decline as risk aversion declines Issuance balloons Quality of issuance declines Potential factors that can combine to trigger a crisis Recession Credit crunch War o Consequences Prices fall .The Inoculated Investor • http://inoculatedinvestor.blogspot.
The Inoculated Investor o Holders engage in panicked selling Supply overwhelms demand Price collapse gains momentum Losses snowball http://inoculatedinvestor.com/ High prospective returns become available Subsequent Events Economy recovers Defaults spike Capital markets reopen Psychology improves Prices snap back Super high returns are realized o Cycle continues Default rate recedes Supply of mainstream debt recedes Capital for investment swells Investment opportunities and prospective returns contract Investors lower their sights and pursue special niches • First distressed debt cycle Marks lived through was 1980-1993 o People were averse to these bonds in 1980 and1981 The entire universe of high yield (HY) bonds was very small in that time with yearly issuance of only about $1B Pension funds and endowments did not buy these Moody’s said B rated bonds were bad ideas in general • This statement was “crap” o They ignored price completely .blogspot.
it is usually accompanied by a willingness to buy lower quality bonds Leads to increased willingness to buy. it is not because issuers want to issue more debt necessarily It has to do with Wall Street demand • It is not driven by supply from companies o Supply is elastic o What is hidden is that when there an increase in quantity. and decreased skepticism o What went wrong in this particular cycle? . decreased risk aversion.blogspot.com/ How could HY bonds be bad investments at every price? People’s prejudice and bias creates opportunities for Oaktree • • • • Market efficiency theory is inaccurate Securities become mispriced and people who figure that out can make money At very least smart investors can know enough to refuse to fall in line with the herd mentality What is inefficiency? o Very simple: a mistake Smart investors take advantage of such mistakes Perception of HY began to change in the mid-1980s • • Issuance went from $1B a year to $7B Psychology is very cyclical o In 1981. low issuance and low defaults were due to high credit standards People saw low defaults and thought that HY bonds were fine in general • o But this was self-selecting because people only bought high quality HY bonds then When you see issuance increase.The Inoculated Investor o http://inoculatedinvestor.
blogspot. => high prospective returns become available because debt can be bought cheap • Low issuance starts again Recovery begins then prices come back up and super high returns are realized • But then then cycle begins again What about what is going on now? • • Egypt: The situation is cataclysmic No one know what the impact of the Egypt situation will be on the world and on the US o o But the stock market continues to go up When one thing happens the market can retain its equanimity But when a bunch of things go wrong.com/ Milken goes to jail and Drexel gets shut down Prices fell => panicked selling => losses snowball. 2nd with a clean slate o Marks doesn’t believe in macro forecasts We know rather little about the future .The Inoculated Investor Exogenous and endogenous events • • • Collapse of LBOs Iraq War http://inoculatedinvestor. the market is prone to a crash—contagion effect • 1990-2002 Cycle o o A number of events caused another downturn and started the cycle over again Lesson: It is never over The cycle always begins again • Marks even uses the same slides—just adds new data Oaktree’s business is like a basketball game with an infinite # of quarters • If you have a good year and you come back again Jan.
blogspot.com/Most-Important-Thing-ThoughtfulPublishing/dp/0231153686/ref=sr_1_1?ie=UTF8&qid=1297973638&sr=8-1 o Comes out in May (according to Amazon) Galbraith was one of his main influences Shortness of memory is one of the amazing thing about financial markets.amazon.The Inoculated Investor o http://inoculatedinvestor.com/ The people who are great investors are the ones who understand the cyclical nature of things Henry Kauffman from Salomon: There are two types of people who lose money: those who know nothing and those who know everything Amos Tversky: It is frightening to realize that you don’t know something but it is even more scary to realized that the world is run by people who think that they do • Current environment in high yield o People are now saying that what happened in 2008 was sunspot In 2008 you could buy HY bonds with a yield of 22% and now the yield is more like 7% People are going back into high yield bonds • Standards are lower and of course issuance is up • Soon to be released book: The Most Important Thing o Pre order the book: http://www. But why? • • Either people die off or retire People’s memory tells them to not do something because it is clearly too good to be true but that restraint is often overtaken by greed o o o You want that free lunch You want to make big returns when others are Willing suspension of disbelief overcomes memory and prudence This is why the cycle is the same over and over • Memos from Marks that address this topic: “You can’t predict but you can prepare” and “Happy Medium” .
blogspot.com/memo.oaktreecapital. from willing to lend to unwilling to lend. for example If on the day the bonds mature the credit window is closed then you are bankrupt If the window is open then people allow you to take on more debt • It all depends on psychology and where the pendulum is o The pendulum swings between optimistic to pessimistic. from greedy to fearful This is what happens to cause things to go crazy and leads to pendulum to swing away from the middle o • On average the pendulum is in the middle but it spends very little time there in reality Have to think about whether or not the average means anything o o Momentum towards one extreme actually causes the swing to the other direction Example: Average returns for stocks is about 10% How many years has the return been between 10% and 12%? • Not enough to rely on the average: the average deviates from the norm • The never ending credit cycle: 2003-2010 and the current recovery o Risk averse investors limit quantities and demand high quality .aspx Combination of micro knowledge about companies and markets is important But you also have to understand cycles o We never know where we are going but we sure as hell should know where we are now • What is debt? o General rule: debt is never repaid Countries.com/ Available on Oaktree’s website: http://www. consumers and companies never pay off their debts: they just can’t • Think of California.The Inoculated Investor • o http://inoculatedinvestor.
sell them when they are rich • These are the things Oaktree has to do to be successful o But. making investors risk averse once more The cycle then repeats Where are we now? We are in between bullets three and four You can do things in the credit markets that you couldn’t do two years ago • The Buffet quote most often used by Marks seems to apply now: o “The less prudence with which others conduct their affairs. all three cannot be done at the same time People aren’t that stupid: either everything is rich or everything is cheap In Q4 2008 they knew where they were • Raised $11B in March 2008 o o Between September 15th. 2008 and the end of the year they deployed most of that money If you missed that window you basically missed the entire opportunity .The Inoculated Investor o o o o o o o High quality issuance produces good results http://inoculatedinvestor. buy things cheap.com/ Good results cause investors to become complacent and risk-tolerant Risk tolerance opens investors to increased issuance and reduced quality Lower quality issuance eventually is tested by economic difficulty and failures High defaults have a chilling effect.blogspot. the greater the prudence with which we should conduct our own affairs” People are becoming aggressive (not back to 2006-07 levels) but they are getting back to 2008 levels People are getting complacent o What is Oaktree doing? Goal: understand where they are in the cycle and act accordingly Process: raise money.
strongly held estimate of intrinsic value The relationship between price and value Being mindful of cycles (and where we stand within them) . Lehman.com/ Oaktree was buying senior debt on great companies with yields in the 30’s and prices in the 50s and 60s o Now they are scraping to find deals that safely produce 13-15% Could get higher returns if they take on risk • But that is not their game • Wisdom from Marks o 3 stages of a bull market Stage 1: Few intelligent people see improvement • Q4 2008 o AIG.blogspot. the fool does in the end o Oaktree Mantra If you can avoid the losers. WAMU gone World was going to end and a few people bought bargains then Stage 2: Most people accept that improvement has occurred Stage 3: Every idiot thinks that things will get better forever • Current view in the markets: the world ending was just a head fake o People are worried about being left behind o The greatest adage of investing: What the wise man does in the beginning.The Inoculated Investor http://inoculatedinvestor. the winners will take care of themselves o There are old investors and there are bold investors But there are basically no old and bold investors o The 4 most important things according to Marks (also the title of his new book) A solidly based.
blogspot. etc. dollars.com/ Each of these is a chapter in the book Gold has worked for 2000 years because people put store of value in it That will probably continue People like gold in times of uncertainty • When you have inflation or collapse of the value of currencies then sentiment turns toward gold o What could prick the bubble is increased confidence Usually leads to a decline in interest in gold • People no longer feel as though they would rather hold gold than Euros. o Gold looks like it is becoming more expensive But actually the dollar is getting cheaper It is not true in Australia that gold is appreciating • Gold appreciation may be most indicative of a loss of respect for the dollar o The trouble with inflation is that governments inflate their currencies to get through crises Classic example of hyperinflation is Weimar Germany • Have to ask yourself: will the gov’t debase the currency by printing more money? o There is nothing intelligent to be said about the value of gold because it cannot be valued No way to determine intrinsic value No estimate of what a buyer should play because of the lack of cash flow • Only worth what people will pay for it .The Inoculated Investor Contrarian behavior • Q&A • Question #1: Would he elaborate on his views on gold? o http://inoculatedinvestor.
things were going to go badly • He never got credit for that If he had made the statement in 2005 that he was going to stop dancing then he would have lost his job March 2007 note: “Race to the Bottom” addresses this topic • For real products the best way to gain share is not to lower the price but to increase the quality .blogspot. We're still dancing.000-17. the higher rating o Chuck Prince quote: “As long as the music is playing. you've got to get up and dance.000 AAA ratings on subprime securities • Meanwhile there are only 4 AAA corporate ratings in the US Most people were not smart enough to know the folly of their ways I-banks tried to get the highest rating they could • • They did not intend to defraud Young MBAs without ethical and moral standards or training thought this was a game and tried to get the highest possible rating o Knew they could sell more. Were the actions fraudulent or due to stupidity? o Marks does not think that there was much fraud There was much more stupidity Creating securities that can be bet against was not necessarily fraud Most people are stupid around money But. there always is some fraud • • Most people can’t walk by a pile of money without picking some of it up Greed overcomes logic o o CLOs Rating agencies issued 16.com/ Question #2: I asked Marks what he thought of the actions of financial institutions in the US before and during the crisis.'' Prince knew that the when the liquidity went.The Inoculated Investor • http://inoculatedinvestor.
The Inoculated Investor • http://inoculatedinvestor. he lost half of his business It is hard in this business to do the right thing • But it is almost impossible to do the right thing at the right time o o The only way to never look wrong is to do what everyone else is doing To be good in this business you have to be comfortable with being wrong for a period of time .blogspot. it had to cut its prices o Banks lower their interest rates to lend more o They can’t make their products better People stopped being skeptical. risk averse If other people are making those loans then there is a race to the bottom o If you win an auction all that it means is that you paid more than anyone else was willing to pay In certain times in the cycle you don’t want to win auctions • But in the fall of 2008 it would have been OK to win an auction o But not right now or in 2007 o Second greatest adage of investing: Being too far ahead of your time is indistinguishable from being wrong Jeremy Grantham of GMO became negative on tech stocks in 1995-96 and he went into cash • As a result from being early.com/ Commodities are goods in which there is no differentiation is quality o • Only way to sell more is to cut your price For the financial community to lend out more.
This action might not be possible to undo. Are you sure you want to continue?
We've moved you to where you read on your other device.
Get the full title to continue reading from where you left off, or restart the preview.