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Howard Marks is a market legend. Don't just take our word for it. Everyone says so 👇

And now he's making moves behind the scenes to repeat his 2007/8 trick...

Marks' firm Oaktree raised just under $11bn to buy 'distressed assets' before the crisis really hit. They saw it coming. When Lehman was collapsing, they were buying. The bet paid off and by 2011, high yield bonds had gained around 50%, which Marks then described as 'fairly valued'. But he wasn't worried about more returns. There are always more opportunities. HM: I think opportunities like this last one will recur, though probably not to the same extent and probably not for the same reason. Since we started doing this in the 1980s, this was our third episode like this. And there will be more, because people go to excess. It's the excessive booms that lead to the busts, and it's the busts that give us an opportunity to buy -- I don't think that will ever change. In June 2022 Marks gave an interview, covered by the FT. He was starting to see opportunity and better value in debt markets 👇 “Today I am starting to behave aggressively. Everything we deal in is significantly cheaper than it was six or 12 months ago,” he added, highlighting drops in the prices of high-yield bonds, leveraged loans, mortgage-backed securities and collateralised loan obligations. This is all run of the mill stuff for Oaktree. Far more interesting is how Marks questioned private equity funds and if they'd be able to keep generating strong returns. “Maybe the best private equity funds really do outperform, or maybe the rest do so in brief periods,” “But you can’t talk about private equity outperformance over the long term based on the average private equity firm and the research that I’ve seen. Yes, private equity has produced very good returns in the last few bullish years. But given their leverage, shouldn’t that be expected in such a period?” Later in 2022, Marks laid out his theory that we're going through a sea change "from a low-return world (2009-21) to a full-return world..." In this context, the news that Oaktree is moving into leveraged buyout lending is intriguing. The plan is to raise and invest the$10bn within the next two years. Which raises the question... Why now? Why does Oaktree see an 'exceptional' opportunity here?

Marks and Harrington explained in a letter to clients 👇

“While the need for this type of lending is enormous, we believe the competition to lend is limited,”
“Moreover, we believe many are facing legacy portfolio issues because they aggressively deployed capital in sponsor-backed loans between 2019 and 2021, a period when heightened competition caused financing for leveraged buyouts to become increasingly borrower friendly, to the detriment of lenders.”
“The leverage employed in these deals spiked to pre-2008 levels, and loan covenants providing lender protection mostly disappeared,”

Basically, the competition lent too much at extremely low rates, mispriced the risks, and now they'll be stuck sorting out the defaults/restructuring mess and unable or unwilling to repeat the process.

Oaktree can fill that void, but with better terms for themselves as lenders and more of a focus on quality.

It's no small thing either. The FT notes that "If Oaktree hits or exceeds the \$10bn fundraising target, it will rank among the largest US direct lending funds ever raised, close to vehicles by HPS and the investment management arm of Goldman Sachs, according to Preqin data".

If you're not familiar with Direct Lending, Oaktree has an excellent explainer on their site here. In December 2020 they noted an impending maturity wall, heavily stacked across 2023-25.

The timing of the capital raise makes a lot of sense. It's no secret that plenty of risk has been transferred from the banking sector to private debt markets over recent years.

Given the uncertainty in the world, it would be no surprise to see Oaktree raise the full amount either.

Where are the returns likely to come in the net few years?

Bonds? Sure you can get 5% for a year, but if the economy isn't so hot in 2024 and the Fed starts cutting, you won't get that again.

Stocks? Sure. Maybe. But they're hardly screaming bargain at current prices given the macro backdrop of higher rates and slower growth.

So why would (responsible) direct lending appeal to investors?

The typical characteristics of Direct lending investments according to Oaktree 👇

• Floating-Rate Coupons: Interest rates are normally quoted as a spread above a reference rate, such as LIBOR or the Secured Overnight Financing Rate (SOFR).
• Short Terms to Maturity: The average term to maturity on these loans is between five and six years compared to over seven years for high yield bonds, and the loans’ average lifespan is between three and four years.
• Strong Covenants: Loan contracts usually include negative and affirmative covenants that limit the borrower’s ability to reduce the value of the loan. These include maintenance-based covenants, which are tested at regular intervals throughout the life of the loan. These lender protections require companies to meet certain financial conditions, such as keeping their ratio of debt to EBITDA below a specific level.
• Less Liquidity: Lenders can’t move in and out of these investments as easily as investors can normally buy and sell broadly syndicated loans (BSLs) and high yield bonds; however, lenders are typically compensated for this risk with the possibility of additional return – the so-called illiquidity premium.
• Low Correlation with Public Markets: Because of the bespoke nature of direct lending deals, returns are normally not highly correlated with those of public debt and equity markets.

Is Oaktree going to repeat the trick when the inevitable credit crunch hits? I woudn't bet against them.