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Oaktree Capital

Howard Marks says time to relax defensive stance

By Apr 14, 2020 (Gmt+09:00)

Courtesy of Oaktree Capital Management
Courtesy of Oaktree Capital Management

The global economy is bracing for unprecedented negative impacts of the coronavirus pandemic in the short term, but now is the time to hunt for bargains rather than waiting for further market declines, said Oaktree Capital Management’s co-founder and co-chairman Howard Marks.

“There is a chance of negative but there is a chance of positive. I would recommend being less defensive today. Not aggressive but less defensive,” he told the Korean Investors in a telephone interview last week.

The interview was conducted after he sent a memo to Oaktree clients on April 6, in which he said: “Given these new conditions, I no longer feel defense should be favored. ... Thus, I feel it’s a time when previously cautious investors can reduce their overemphasis on defense and begin to move toward a more neutral position or even toward offense.”

His memos are widely read among Wall Street investors, including Berkshire Hathaway chairman and CEO Warren Buffett.

In a rare case, Marks, known as a contrarian investor, wrote four memos for Oaktree clients in March alone. For the entire 2019, he sent five memos to his clients.

Oaktree Capital, the largest investor in distressed securities in the world, manages $125 billion in assets, of which US distressed investing and high-yield bonds account for two-thirds.

Q: Would you say the uprising market cycle has ended with the coronavirus pandemic?

“In the recent years the world was a very risky place as asset prices were high. Now everyone knows about the catalyst and people are not doing risky things and prospective returns are higher.”

“Now I don’t think you have to be so defensive. We were highly defensive one or two years ago, but today the tendency is not as bad and you don’t have to be so defensive. We are buying high-quality assets at discounted prices. I still don’t know how the world is going to go in the short term. But I think these are investments that will be successful in the long term.”

Q: It is not the normal type of the end of the boom and bust cycle? Can we still understand tendencies and invest as we did in the past?

“Obviously, the coronavirus is a one-off event. Have you seen my book about cycles? What it says is where we stand in the cycle determines our tendencies and where we stand in the cycle determines whether the world is riskier or less risky. I have been feeling for the past several years that the world was a risky place. We were in the late in the cycle in which people were engaging in risky behavior and tried to make high returns and these things make the world vulnerable.”

“Now I didn’t know what would happen. When the upcycle is old and prices are high and people are doing risky things, the world is vulnerable. That’s where we were in the cycle. Now we had a freaky event which you have (in) your risky conditions and something that sets them off, that’s the catalyst. If we were at a different place in the cycle and the world was not so risky, then maybe it would not have the same effect. But because we were high in the cycle, we were vulnerable.”

Q: Do you think the pandemic will not last long?

“This cycle is similar to the global financial crisis, in that we had a virus at that time which were the sub-prime mortgages. The sub-prime mortgages were dangerous and uncontrolled and too many people invested in them using too much leverage and that set off the crisis and during the crisis we were all afraid of the downward spiral in the financial industry.”

“This experience is similar, now we have the coronavirus. It has affected the whole world and business world. And now we are scared of the effect of the virus and its effect on the economy. It is similar in the sense that it is huge and has a broad effect.”

“It is of course scarier, because we are talking about life and death. Then the immediate damage was limited to the financial system and now the damage is broad and affects the entire economy. The damage to the economy is unprecedented.”

“Three weeks ago unemployment claims was 280,000. Two weeks ago it was 3.3 million, last week 6.6 million. Prior to that the worst on record was 695,000. This is almost ten times as bad as the worst in history.”

“Similarly people are talking about GDP in the second quarter being down 20-30%, I think Morgan Stanley reported 34%, and historically a very bad quarter would be about 8%. We are talking about the worst economy that anybody alive has ever seen and the complication of the disease. So incredibly negative short-term possibilities.”

Q: Despite such gloomy economic forecasts, any reason to recommend investors stop playing defense?

“The point is, if the market goes up from here you will be glad you bought it and if it goes down from here hopefully you will buy, we will buy more. We don’t know which way it is going, but now the possibilities are better balances when a year ago or six months ago the possibilities were mostly negative. But now ... there is a chance of negative but there is a chance of positive. I would recommend being less defensive today. Not aggressive but less defensive.”

Q: The problem is that we don’t know where the bottom is.

“If you read my memo, I have a whole section about the bottom and waiting for the bottom. The answer is that you never know where the bottom is and when it will come. I believe that the investor should always assume that he is ignorant and that he does not know what the future holds.”

“The old saying goes: the perfect is the enemy of the good. Likewise, waiting for the bottom can keep investors from making good purchases. The investor’s goal should be to make a large number of good buys, not just a few perfect ones.”

Q: Some Korean investors are continuing to buy stocks, when foreigners and institutional investors are selling. They say it is a once-in-a-lifetime opportunity to buy blue chip stocks like Samsung. Do you agree with them?

“Number one, I am not an expert on Korea. Number two, I do not know how much the stocks have gone down, but if they have gone down a great deal, then I think they are probably right. I am in favor of buying here.”

“In one of the memos I said there is no argument for spending all of your cash now, but I don’t think there is no argument for not spending any of your cash now. If you are like me and admit that you do not know how much the future holds, and it’s cheaper, you buy some. If they get cheap you will buy more.”

“I do agree with a great company like Samsung. We know what Samsung will be in the future. The cheaper the stock, the more you want to own. It’s just like in the stores: when things go on sale you buy more. And right now there is a sale, and you buy more. ”

“I think the idea of the average Korean to buy some stocks because it is cheaper is a good idea as long as they only spend some of their money.”

Q: US stocks are cheap enough to buy now?

“The US market is not down so much. I think it’s down 20% and bad markets have the tendency to go down 40% or 50%.”

“I think, based on traditional valuations, stocks are (at) fair today and reasonable (prices). We normally look at the PE ratio. Before this crisis, the PE ratio of the S&P 500 had been 19. The post-war PE ratio was 15 or 16 on average. Today earnings (per share) are about $170 and price is about $2,600. Divide that by 170 is 15 times which is average. But earnings will collapse this year. I saw in one forecast that they will earn $110 and not $170. So if they earn $110 it will probably be about 24 times which is very high."

“Most people think the earnings will be up next year, a V-shape recovery. The optimist is assuming that the economy will be better in 2021 than in 2019. But that assumes a very good outcome. The truth could be worse than that.  The point is the great buying opportunities are when everyone assumes the worst and stocks are still cheap. Now I don’t think everyone is assuming the worst. Stocks are reasonable but I don’t think they are being given away, at least in the US.”

(In his April 6 memo, Marks said markets rarely rally in a straight line. He concluded the memo saying that "the bottom line for me is that I’m not at all troubled saying (a) markets may well be considerably lower sometime in the coming months and (b) we’re buying today when we find good value. I don’t find these statements inconsistent.")

Courtesy of Oaktree Capital Management

Q: In your last book and last memo you mentioned we can’t predict but we can prepare? Is Oaktree prepared?

“What I would say is that we were not totally prepared. The only way we would be totally prepared is to have a pile of cash with no investment. But of course if we had not invested in the past 3-4 years, we would have been out of business by now. So we have investments, but we have been investing cautiously.”

“This year, in most of our strategies, we have been doing better than our benchmark. We have not increased our assets as a firm in the last five years. No change. Many have been adding and adding to their assets and debt. One of our flagship areas is distressed debt and we have shrunk from $25 billion in 2010 to $11 billion today."

"As we say in English our decks are clear, we have the ability to move forward in the affirmative way and we don’t have to worry too much about problems. In many of our strategies we are now raising new funds. I think we can get cash now and the ability to invest cash now is a very good thing. Everybody in the financial world has suffered the past month but I think we are in good shape.”

Q: What instruments have you been purchasing?

“We have different strategies and we are buying different things. But you know, we are buying distressed debt and in the month of March there was pretty urgent selling and we were glad to be able to buy and we bought extensively."

"Quality companies, senior debt at discount prices which is a very good opportunity for us. And we have found companies and investment entities who were at risk of melting down because they needed cash to satisfy their obligations and we were able to make some very large private deals. Those were the two main things we were doing. Working with corporations and their debt and also real estate debt.”

Q: Korean investors had invested a lot in US middle market loan for the last several years. What’s going to happen in the market?

“Warren Buffett in 2009, ‘only when the tide goes out we can find out who has been swimming naked.’ The point is, when we get into a bad environment, we find out who made good lending decisions and who didn’t. There is not just one answer to your question. Some investors make good credit decisions and make loans to companies who will make it through. Some companies used too much leverage and some did not. So there is not one answer for everybody. Other companies probably did not make good decisions and their company will not make it. Some investors use too much leverage.

“If you and I talk in Seoul two years from now, we will be able to talk about the loan funds that made it through and the ones that didn’t. But today we can’t tell. The lending decision is a judgement. You look at a company and ask if this company will make it through and if conditions get worse, will they still be okay. That requires judgement. And some managers make that decision better than others. And we will find out who.”

Q: Is there a specific tranche or product you are worried about right now?

“No, some industries are doing very bad. Now anything that has to do with travel or entertainment or anything in leisure is doing very badly. In the area of real estate, anyone who invested heavily or loaned money in real estate and right now hotels and things like that are doing very badly right now. Some have the ability to get through and some do not."

Q: For the last several years, a lot of loans have been made in Covenant-lite which are highly unlikely to default. In the short term they would be okay. But if they do default it is going to be more serious than the past, isn't it?

"Yes, that’s right. With covenant, there is a time when the lender gets control and stops the bleeding. Without it, it is harder for the lender to get control and the bleeding goes on longer and that’s when they default. You are right the longer it goes on, the more money the borrower goes through and the less there is for the lender at the end.”

“We talked about recoveries and now that there are fewer covenant and recoveries will probably be lower. (On top of that) it used to be if you lend money at the senior level and there was not much senior debt than anything below you gave you comfort. But if there is a lot of senior debt and not much below you, then you have less protection. Again the recovery will be lower.”

Q: You are worried about this situation?

“Well on the one hand I am worried about it but on the other hand there are more opportunities. The more problems people have, the more opportunities. If we have cash and we have nerve, then we benefit and Oaktree has been a distressed debt investor for 32 years.”

Q: Is the system in risk right now?

“I am not an economist and I don’t know the numbers. My sense is the problem is not systemic, because we could not have the banks go down. I think some of the non-bank lenders can go bankrupt and it wouldn’t ruin the country.”

Q: Some industries are doing bad and some good. Which industries can grow the most with the latest events?

“There are very few industries who will be able to grow form this. Zoom conference call, other than that, maybe Netflix because more people will watch movies from home? But I think the real question is who is going to be okay in two years. Business will come back in two years. The question is who can last through two years from now."

"Maybe companies will receive government support. Large companies for the most part will be okay. What I worry about is the small companies who may not have received government aid in time. So I hope that is helpful.”

Q: Is the US government's stimulus package enough for small companies?

"I don’t think I’m smart enough to know. It’s a lot of money. It’s like water in the river. Will it find its way through to the small businesses. Will the money reach the small companies in time before they have to close?

Q: What about inflation? Are you worried about inflation?

"I do worry about it you know. In theory, if you print too much money it will cause inflation. So far the government behavior has not caused inflation. Many countries in the world want inflation but haven’t been able to produce it. So I don’t know. So many people have been wrong about inflation for so long, but that would be my guess and we will see. I cannot make any assumptions about inflation and I will not do anything about it in our investments."

Q: Do you have any message for Korean LPs?

"I feel very close to the Korean people, we have good clients in Korea and I always respect the Korean work ethic and efficiency and economy. I think the idea of the average Korean to buy some stocks because it is cheaper is a good idea as long as they only spend some of their money. And don’t borrow money and not so much debt where they can’t get through the low spot."

Write to Chang Jae Yoo at

Yeonhee Kim edited this article

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