Oaktree 4Q16 Earnings Call Notes

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Howard Stanley Marks

Define a good year as high absolute or relative return

“I’ve traditionally defined a good year as one in which we achieve a return that is either high in the absolute or superior to the benchmark, or both. By that standard, for example, our 31-year-old record in high-yield bonds includes only one bad year, 2014, when the benchmark was up 1.9% and we were up 1.7% before fees, neither absolute high nor benchmark-beating. All the other years’ gross returns either exceeded 9% or beat the benchmark.”

The world is unusually uncertain

“Looking forward, our continuing view is that the world is unusually uncertain, and perhaps even more so given the regime change in Washington and the questions surrounding the administration’s proposed agenda. We still face some of the lowest prospective returns in history as well as asset prices that I generally describe as being, “on the high side of fair or the beginning of rich.” Lastly, we are still witnessing pro-risk behavior on the part of investors pursuing traditional returns in a low-return world. These four factors when combined with a generally sanguine economic environment result in the presence of lots of buyers and few sellers, an absence of desperate sellers, and thus a paucity of bargains.”

Corporate default rates will remain limited

‘As we begin 2017, it seems that corporate default rates in the U.S. will remain limited and the supply of public opportunities will be low relative to early 2016. As a result, our current distressed debt funds focus will likely continue to be on energy-related opportunities and buying bargains from European sellers.”

Interest deduct-ability isn’t the only reason that people use leverage

“Jay, I think that the comment about taxes and the implications for distressed debt supply suggest that if interest payments are not tax deductible, people won’t use as much debt and thus won’t overburden companies with leverage and the overburdened companies won’t as often fall into distress. I think that there’s probably some truth in that in the margin, but the most important thing is to remember that the deductibility of interest is not the only reason to use leverage. And I think that the private equity funds, for example, will still be doing highly leveraged buyouts because the supplier of debt capital does not participate in the gains. So regardless of the tax treatment, his capital will continue to leverage the returns on the equity capital, which is very important.”

Eventually there will be an uptick in defaults but the question is when

“We think and the reason we raise a lot of money for Xb was that we thought by 2017 or 2018 maybe we’d be seeing some increase in defaults. Every year that goes by logically increases the probability, but there are times, like today, when people say, oh, you know, we’re in a virtuous circle. We have an accommodative Fed, we have expanding – well, the Fed’s accommodative, but not too much, and the economy is expanding, but not too much that it has to be reined in, and corporations are doing well in piling up cash, and debt has been refinanced and paid down, and they’ll give you a hundred reasons why there’s not going to be another down cycle again, but invariably there is. And the question is does it come after 12 years, like the gap between 1991 and 2002 or does it come after six years like the gap between 2002 and 2008 or – these subjects are not subject to science and statistics.”