Вы находитесь на странице: 1из 12

The Inoculated Investor http://inoculatedinvestor.blogspot.

com/

Howard Marks Presentation to UCLA Anderson Student Investment Fund

Capturing Efficiencies in Distressed Debt

• Introduction

o No investments are good or bad intrinsically

 It all depends on the timing and the price

o Fashion fads come and go

 In 2010, the fad was safety

 What Marks does to determine the quality of the investment is to project himself
into the future

• What kind of scenario would have to play out for the return to make
sense?

o In terms of buying Swedish gov’t bonds at .9% yield, depression


and deflation are the only outcomes that would make the
decision prudent

• Investing successfully surrounds buying assets for less than they are
worth

o Distressed debt

 What is distressed debt?

• Debt for which the markets do not believe the bonds will pay principle
and interest

 Generally, distressed debt investors want a creditor claim on the company

 Restructuring is the event that comes about after a default

• Trigger (such as restructurings) are important in investing

o 3 questions that Oaktree asks itself in determining whether to make an investment

 What is the pie worth?

 How will it be split up among claimants?

 How long will it take?

• If you can get all of these right you can determine the IRR with certainty
The Inoculated Investor http://inoculatedinvestor.blogspot.com/

• You might want to buy a piece of each of the different classes of debt to
hedge the uncertainty of how the pie is going to be split up

o Sub debt for example has nuisance value and its holders can
often extract more than they should when the pie is being
divided

 Oaktree has bought the sub debt even when it believed


the chances of making money were not great in order to
hedge against weird outcomes of the pie splitting

o Determinants of supply and demand of bonds

 Lowering of credit standards

• These are the logs that provide fuel for the fire

• There is a correlation between the level of issuance of HY bonds and the


subsequent likelihood of default

 Onset of economic weakness

• Put a match to the logs and ignites the crisis

• General cycle dynamics

o Build Up

 Start off with a hospitable environment

 Risk taking is profitable

 Credit standards decline as risk aversion declines

 Issuance balloons

 Quality of issuance declines

o Potential factors that can combine to trigger a crisis

 Recession

 Credit crunch

 War

o Consequences

 Prices fall
The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Holders engage in panicked selling

 Supply overwhelms demand

 Price collapse gains momentum

 Losses snowball

 High prospective returns become available

o Subsequent Events

 Economy recovers

 Defaults spike

 Capital markets reopen

 Psychology improves

 Prices snap back

 Super high returns are realized

o Cycle continues

 Default rate recedes

 Supply of mainstream debt recedes

 Capital for investment swells

 Investment opportunities and prospective returns contract

 Investors lower their sights and pursue special niches

• First distressed debt cycle Marks lived through was 1980-1993

o People were averse to these bonds in 1980 and1981

 The entire universe of high yield (HY) bonds was very small in that time with
yearly issuance of only about $1B

 Pension funds and endowments did not buy these

 Moody’s said B rated bonds were bad ideas in general

• This statement was “crap”

o They ignored price completely


The Inoculated Investor http://inoculatedinvestor.blogspot.com/

o How could HY bonds be bad investments at every price?

 People’s prejudice and bias creates opportunities for Oaktree

• Market efficiency theory is inaccurate

• Securities become mispriced and people who figure that out can make
money

• At very least smart investors can know enough to refuse to fall in line
with the herd mentality

• What is inefficiency?

o Very simple: a mistake

 Smart investors take advantage of such mistakes

 Perception of HY began to change in the mid-1980s

• Issuance went from $1B a year to $7B

• Psychology is very cyclical

o In 1981, low issuance and low defaults were due to high credit
standards

 People saw low defaults and thought that HY bonds


were fine in general

• But this was self-selecting because people only


bought high quality HY bonds then

o When you see issuance increase, it is not because issuers want to


issue more debt necessarily

 It has to do with Wall Street demand

• It is not driven by supply from companies

o Supply is elastic

o What is hidden is that when there an increase in quantity, it is


usually accompanied by a willingness to buy lower quality bonds

 Leads to increased willingness to buy, decreased risk


aversion, and decreased skepticism

o What went wrong in this particular cycle?


The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Exogenous and endogenous events

• Collapse of LBOs

• Iraq War

• Milken goes to jail and Drexel gets shut down

 Prices fell => panicked selling => losses snowball, => high prospective returns
become available because debt can be bought cheap

• Low issuance starts again

 Recovery begins then prices come back up and super high returns are realized

• But then then cycle begins again

 What about what is going on now?

• Egypt: The situation is cataclysmic

• No one know what the impact of the Egypt situation will be on the world
and on the US

o But the stock market continues to go up

o When one thing happens the market can retain its equanimity

 But when a bunch of things go wrong, the market is


prone to a crash—contagion effect

• 1990-2002 Cycle

o A number of events caused another downturn and started the cycle over again

o Lesson: It is never over

 The cycle always begins again

• Marks even uses the same slides—just adds new data

 Oaktree’s business is like a basketball game with an infinite # of quarters

• If you have a good year and you come back again Jan. 2nd with a clean
slate

o Marks doesn’t believe in macro forecasts

 We know rather little about the future


The Inoculated Investor http://inoculatedinvestor.blogspot.com/

o The people who are great investors are the ones who understand the cyclical nature of
things

 Henry Kauffman from Salomon: There are two types of people who lose money:
those who know nothing and those who know everything

 Amos Tversky: It is frightening to realize that you don’t know something but it is
even more scary to realized that the world is run by people who think that they do

• Current environment in high yield

o People are now saying that what happened in 2008 was sunspot

 In 2008 you could buy HY bonds with a yield of 22% and now the yield is more
like 7%

 People are going back into high yield bonds

• Standards are lower and of course issuance is up

• Soon to be released book: The Most Important Thing

o Pre order the book: http://www.amazon.com/Most-Important-Thing-Thoughtful-


Publishing/dp/0231153686/ref=sr_1_1?ie=UTF8&qid=1297973638&sr=8-1

 Comes out in May (according to Amazon)

o Galbraith was one of his main influences

 Shortness of memory is one of the amazing thing about financial markets. But
why?

• Either people die off or retire

• People’s memory tells them to not do something because it is clearly too


good to be true but that restraint is often overtaken by greed

o You want that free lunch

o You want to make big returns when others are

o Willing suspension of disbelief overcomes memory and


prudence

 This is why the cycle is the same over and over

• Memos from Marks that address this topic:


“You can’t predict but you can prepare” and
“Happy Medium”
The Inoculated Investor http://inoculatedinvestor.blogspot.com/

• Available on Oaktree’s website:


http://www.oaktreecapital.com/memo.aspx

o Combination of micro knowledge about companies and markets is important

 But you also have to understand cycles

o We never know where we are going but we sure as hell should


know where we are now

• What is debt?

o General rule: debt is never repaid

 Countries, consumers and companies never pay off their debts: they just can’t

• Think of California, for example

 If on the day the bonds mature the credit window is closed then you are bankrupt

 If the window is open then people allow you to take on more debt

• It all depends on psychology and where the pendulum is

o The pendulum swings between optimistic to pessimistic; from


willing to lend to unwilling to lend; from greedy to fearful

 This is what happens to cause things to go crazy and


leads to pendulum to swing away from the middle

o On average the pendulum is in the middle but it spends very little


time there in reality

• Have to think about whether or not the average means anything

o Momentum towards one extreme actually causes the swing to the


other direction

o Example: Average returns for stocks is about 10%

 How many years has the return been between 10% and
12%?

• Not enough to rely on the average: the average


deviates from the norm

• The never ending credit cycle: 2003-2010 and the current recovery

o Risk averse investors limit quantities and demand high quality


The Inoculated Investor http://inoculatedinvestor.blogspot.com/

o High quality issuance produces good results

o Good results cause investors to become complacent and risk-tolerant

o Risk tolerance opens investors to increased issuance and reduced quality

o Lower quality issuance eventually is tested by economic difficulty and failures

o High defaults have a chilling effect, making investors risk averse once more

o The cycle then repeats

o Where are we now? We are in between bullets three and four

 You can do things in the credit markets that you couldn’t do two years ago

• The Buffet quote most often used by Marks seems to apply now:

o “The less prudence with which others conduct their affairs, the
greater the prudence with which we should conduct our own
affairs”

 People are becoming aggressive (not back to 2006-07 levels) but they are getting
back to 2008 levels

 People are getting complacent

o What is Oaktree doing?

 Goal: understand where they are in the cycle and act accordingly

 Process: raise money, buy things cheap, sell them when they are rich

• These are the things Oaktree has to do to be successful

o But, all three cannot be done at the same time

 People aren’t that stupid: either everything is rich or


everything is cheap

 In Q4 2008 they knew where they were

• Raised $11B in March 2008

o Between September 15th, 2008 and the end of the year they
deployed most of that money

o If you missed that window you basically missed the entire


opportunity
The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Oaktree was buying senior debt on great companies with


yields in the 30’s and prices in the 50s and 60s

o Now they are scraping to find deals that safely produce 13-15%

 Could get higher returns if they take on risk

• But that is not their game

• Wisdom from Marks

o 3 stages of a bull market

 Stage 1: Few intelligent people see improvement

• Q4 2008

o AIG, Lehman, WAMU gone

 World was going to end and a few people bought


bargains then

 Stage 2: Most people accept that improvement has occurred

 Stage 3: Every idiot thinks that things will get better forever

• Current view in the markets: the world ending was just a head fake

o People are worried about being left behind

o The greatest adage of investing:

 What the wise man does in the beginning, the fool does in the end

o Oaktree Mantra

 If you can avoid the losers, the winners will take care of themselves

o There are old investors and there are bold investors

 But there are basically no old and bold investors

o The 4 most important things according to Marks (also the title of his new book)

 A solidly based, strongly held estimate of intrinsic value

 The relationship between price and value

 Being mindful of cycles (and where we stand within them)


The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Contrarian behavior

• Each of these is a chapter in the book

Q&A

• Question #1: Would he elaborate on his views on gold?

o Gold has worked for 2000 years because people put store of value in it

 That will probably continue

 People like gold in times of uncertainty

• When you have inflation or collapse of the value of currencies then


sentiment turns toward gold

o What could prick the bubble is increased confidence

 Usually leads to a decline in interest in gold

• People no longer feel as though they would rather hold gold than Euros,
dollars, etc.

o Gold looks like it is becoming more expensive

 But actually the dollar is getting cheaper

 It is not true in Australia that gold is appreciating

• Gold appreciation may be most indicative of a loss of respect for the


dollar

o The trouble with inflation is that governments inflate their currencies to get through
crises

 Classic example of hyperinflation is Weimar Germany

• Have to ask yourself: will the gov’t debase the currency by printing more
money?

o There is nothing intelligent to be said about the value of gold because it cannot be valued

 No way to determine intrinsic value

 No estimate of what a buyer should play because of the lack of cash flow

• Only worth what people will pay for it


The Inoculated Investor http://inoculatedinvestor.blogspot.com/

• Question #2: I asked Marks what he thought of the actions of financial institutions in the US
before and during the crisis. Were the actions fraudulent or due to stupidity?

o Marks does not think that there was much fraud

 There was much more stupidity

 Creating securities that can be bet against was not necessarily fraud

 Most people are stupid around money

 But, there always is some fraud

• Most people can’t walk by a pile of money without picking some of it up

• Greed overcomes logic

o Most people were not smart enough to know the folly of their
ways

o CLOs

 Rating agencies issued 16,000-17,000 AAA ratings on subprime securities

• Meanwhile there are only 4 AAA corporate ratings in the US

 I-banks tried to get the highest rating they could

• They did not intend to defraud

• Young MBAs without ethical and moral standards or training thought


this was a game and tried to get the highest possible rating

o Knew they could sell more, the higher rating

o Chuck Prince quote: “As long as the music is playing, you've got to get up and dance.
We're still dancing.''

 Prince knew that the when the liquidity went, things were going to go badly

• He never got credit for that

 If he had made the statement in 2005 that he was going to stop dancing then he
would have lost his job

 March 2007 note: “Race to the Bottom” addresses this topic

• For real products the best way to gain share is not to lower the price but
to increase the quality
The Inoculated Investor http://inoculatedinvestor.blogspot.com/

• Commodities are goods in which there is no differentiation is quality

o Only way to sell more is to cut your price

• For the financial community to lend out more, it had to cut its prices

o Banks lower their interest rates to lend more

 They can’t make their products better

o People stopped being skeptical, risk averse

 If other people are making those loans then there is a


race to the bottom

o If you win an auction all that it means is that you paid more than
anyone else was willing to pay

 In certain times in the cycle you don’t want to win


auctions

• But in the fall of 2008 it would have been OK to


win an auction

o But not right now or in 2007

o Second greatest adage of investing:

 Being too far ahead of your time is indistinguishable from being wrong

 Jeremy Grantham of GMO became negative on tech stocks in 1995-96 and he


went into cash

• As a result from being early, he lost half of his business

 It is hard in this business to do the right thing

• But it is almost impossible to do the right thing at the right time

o The only way to never look wrong is to do what everyone else is


doing

o To be good in this business you have to be comfortable with


being wrong for a period of time

Оценить