Howard Marks’ Oaktree Capital Group LLC (NYSE:OAK) presentation on Investing In A Low-Return World at Morgan Stanley Financials Conference via OakTree. Click here for the webcast. See our notes on the speech here.

Howard Marks Oaktree Capital - Risk

Howard Marks: The Investment Environment: A Mixed Bag

A slow, gradual, unsteady economic recovery in the U.S.

  • Less economic vigor and bigger problems elsewhere
  • The U.S. economy is clearly “the best house on a bad block”

Serious long-term issues

  • Debt reduction vs. stimulating growth
  • Globalization and competitiveness
  • Less-than-constructive politics
  • Job growth
  • Geopolitics

Low central-bank-mandated interest rates

  • Free markets do a good job of allocating capital; there’s no free market in money today
  • Borrowers are being subsidized; lenders and savers are penalized
  • Low-risk investments offer ultra-low returns
  • Therefore investors are forced up the risk curve in pursuit of return

Most assets priced “on the high side of fair”

  • Equity valuations are reasonable
  • Yield spreads on bonds are reasonable
  • But interest rates are historically low – dragging down all fixed income prospects, and other returns by contagion

Howard Marks: The Cycle of Investor Behavior

As markets rise, participants become increasingly euphoric and optimistic

  • Thus they want to invest more, even at high prices
  • They compete for investments by accepting lower prospective returns, weaker structures and greater risk
  • The quantity of issuance rises to meet the demand
  • The quality of issuance declines simultaneously
  • This is “the race to the bottom”
  • This is a time for caution

As markets fall, participants become depressed and afraid

  • They want to invest less, and to sell, and eventually to sell at any price
  • There are few buyers for the things that are for sale
  • Market participants reject deals, even good ones
  • The quantity of issuance declines and eventually can go to zero
  • Low-quality issues cannot be done
  • Asset prices are very low
  • This is the time for aggressiveness

Where are we today?

Howard Marks: The Temperature of Today’s Markets

  • The economic news is good, or at least improving. There may be a positive wealth effect as 401-Ks and home prices rise
  • The capital markets are accommodating, making it easy to refinance debt and feasible to do risky deals
  • Consequently distressed situations, defaults and bankruptcies are few
  • Because central banks have brought interest rates low, investors can’t get the returns they want in Treasurys, money market instruments or high grade bonds. Thus they are forced out the risk curve
  • The demand for risk assets is high; cash flow into mutual funds is strong
  • There are many buyers and few sellers. There’s no distress among holders, and thus no forced sellers
  • Bargains are few, especially in easy-to-access areas
  • Investors moving out the risk curve often drop their caution
  • Issuers and sellers are holding the cards today, not prudent investors or bargain hunters

“The less prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own affairs.” – Warren Buffett

See full “Howard Marks: Investing In A Low-Return World” in PDF Format here.

Howard Marks: Investing In A Low-Return World