Howard Marks: No Screaming Bargains In European Credit, Not Planning To Hire

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Howard Marks spoke at the 2013 Goldman Sachs Financial Services Conference, below are some excerpts from his remarks.

Also see Howard Marks Latest Memo: The Race Is On

Goldman Sachs Group Inc (NYSE:GS) analyst Marc Irizarry question and answer with Oaktree Capital Group LLC (NYSE:OAK)’s Howard Marks.

Marc Irizarry – Goldman Sachs – Analyst

Thanks for joining us. So this year, I would imagine the single biggest question that you are hearing from folks is around the issue of tapering, what tapering means to rates, how high rates might go, and what folks ought to do about it. And I guess the questions that I have for you is what do rates mean, higher rates, and what is tapering? What does that mean for your business at Oaktree Capital Group LLC (NYSE:OAK)?

Howard Marks – Oaktree Capital Group, LLC – Chairman

First, I would like to commend you for asking about tapering without asking when it is going to happen, because this is a question I get most often and the question I think has the least relevance. If you thought it was going to rain tomorrow, you would carry an umbrella and you wouldn’t sit around saying, well, it’s going to rain at 12 or 2. And I think that’s what people are doing with tapering.

I don’t think tapering is that big a deal, only in the sense that I am convinced that it is probably going to happen. I think it should happen. I think that we need a free market in money in order for the free market to do its job of allocating resources, which it does so relatively well. And of course, we don’t have a free market in money now. So I hope we will taper, and I don’t think it is going to mean that much because I think rates, in part, have already adjusted. Before Bernanke said what he said about tapering in May, I think the 10-year was at 1.5%; now, it is at 2.8%. It went up to 3% and backed off to 2.8%.

And so, I think the world has had a chance to adjust to the idea. It is already acting in large part as if the tapering had started. The psychological impact has been there, and we can all sit around and say to ourselves, well, what would rates be today if the tapering weren’t going on? What would be the natural rate of interest today?

And I don’t think that business is so strong or the demand for capital is that strong, and I don’t think that inflation is that high, that the natural rate of interest today would be much higher than it is today. So maybe the 10-year would be between 3% and 4%. I don’t think it would be over 4%. So what that suggests is that if they start tapering, rates will go up some, but not so much.

The impact on Oaktree is — will not be great. First of all, we are not what I would call a bond house or a traditional fixed-income firm. We are an opportunistic credit investor, alternative credit. Interest rates are not the main determinant of value in the things that we traffic in. So, number one. Number two, where we have bonds, and the main place is in high-yield bonds where — which is probably about 20% of our assets or a little more, they have a very moderate duration, between 4 and 5, I think. So the price doesn’t change that much with a moderate change in interest rates.

And then, we have a lot of equity exposure. In many of our portfolios where we buy debt, after restructuring we convert it into equity. In many places, we buy equity; we do private equity — buy control of firms. We have some listed equity portfolios.

So basically, the traditional bondholder hates prosperity, because in prosperity, interest rates go up and he loses money. Oaktree likes prosperity, because the credit worthiness of our holdings goes up, the value of our equity type holdings goes up. So we are not — it is not something that preoccupies us or something we are very concerned about.

Marc Irizarry – Goldman Sachs – Analyst

And then, you mentioned Europe. I am curious where the opportunities — we hear a lot about capital being formed in Europe. I guess there is regulatory issues that are still uncertain and may be affecting lending on the continent or in the UK. How are you pursuing that opportunity? Is that a 2014 opportunity (multiple speakers)

Howard Marks – Oaktree Capital Group, LLC – Chairman

We have been in Europe for 15 years. We’re not starting it up now. We’re not trying to hire people today. We have been there a long time.

I spent much of my time in 2005 going around to, in particular, German financial institutions, meeting with the CEOs so that when they had assets to sell, they would think of us. Also, in London. And now, they are selling more than they had been. We raised a fund a few years ago for this reason; other people raised them, too. We felt there might be a deluge because they had too many assets. They had a small capital base. They were overlevered and, in particular, they had rules which would require them to get down to lower leverage levels. But the deluge never arrived, and, in fact, they pushed out the effective date of some of those rule

Marc Irizarry – Goldman Sachs – Analyst

Tell us how that (multiple speakers)

Howard Marks – Oaktree Capital Group, LLC – Chairman

There absolutely is a paucity of bargain-priced distressed opportunities. Most of the distress which is out there is in just a few pockets — shipping, power, nonprime real estate in Europe. And there, we find opportunities to put money to work.

However, even there, there is no deluge. And there are no forced sellers, and so there are no screaming bargains. And we’re investing at a moderate clip.

Marc Irizarry – Goldman Sachs – Analyst

And if I can ask that question, I guess, in a different way, where is — the term shadow banking, obviously, takes on all sorts of connotations. Where do you think there is regulatory changes that are potentially changing either market participants, or where maybe is there too much short-term funding chasing long-term opportunities in the markets that you look at?

Howard Marks – Oaktree Capital Group, LLC – Chairman

For a bargain hunter like us, the seven worst words in the world are too much money chasing too few deals. And we get that from time to time. We get that really when the race is on. We saw it in venture capital in 2000, and we see it from time to time cyclically. And the government has dislodged a lot of money from the treasury and high-grade market by bringing the yields down so low and forced it out the risk curve into areas including ours. So there is definitely lots of money sloshing around, wanting to do the things we do, and that is the reason why the race is on.

But this is the norm. The good news is that when people engage in the risky practices that I described here and that I described in the memo, it restocks the pond with bad deals, with deals that shouldn’t get done that then go bad in the next crisis. If everybody were prudent all the time, then the dumb deals wouldn’t get done which turn bad and give us the things to buy in the crisis. But it is very simple. What we have to do in our business, we have three jobs to do. We have to raise money, we have to invest it in attractively-priced securities, and we have to harvest when those securities appreciate. That assumes everything goes right. It is very unlikely that anybody — and I am not talking about Oaktree — it is very unlikely that anybody is going to be able to do the two latter things at the same time to an equal degree. It is very unlikely that we will be able to find great bargain purchases and sell highly appreciated securities atthe same time.

So today, we’re in the middle. We can buy some things. They are not great bargains, but they are okay, and we can sell a lot of things which are maybe not at mad prices, but are full prices. One of my pals was quoted earlier this year as saying we’re selling everything that is not nailed down. Does it really make sense to say we are selling everything that is not nailed down and we are buying incredible bargains today? It is internally inconsistent.

And so, that is why I say our mantra within Oaktree Capital Group LLC (NYSE:OAK) for the last three years, and I am pretty much the mantra man, I come up with the 30,000-foot stuff, and our mantra has been move forward, but with caution. You have to include caution today in your activities, or else you will have results which sully your reputation with your client.

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