Sunday, June 19, 2011

Howard Marks Is Selling: Should You Be Buying?



Surely it was all coincidental: Howard Marks, probably a top three favorite manager of mine, recently released a book ("The Most Important Thing: Uncommon Sense for the Thoughtful Investor"). A chapter from the book was the front page story in last month's Institutional Investor magazine. In March there was a lengthy Fortune/CNNMoney feature on him. Then on Friday 6/17/11, Bloomberg Markets ran a long profile with details all the way to his diet and parental occupation, casually mentioning that Oaktree is... going public. The Bberg article was time-stamped at 17:43, while the S-1 filing was stamped at 16:25. A marketing professional might call this "generating buzz around the brand": turns out, the sudden burst of publicity had a reason.

Mr. Marks is a true legend: according to the S-1, his distressed debt funds have averaged a gross IRR of almost 24% since 1986 with Sharpes above the benchmarks. This is nothing short of phenomenal: remember that we are talking about credit here! Very few equity equity managers can claim a record like his, let alone managers in the fixed income space. Interestingly, Oaktree was an early investor in Jeffery Gundlach's DoubleLine, a new but already stellar fixed income fund family, despite Mr. Gundlach's "difficult" separation from TCW.

Unlike many other investors, Mr. Marks has been very generous with his insights. His "Memos From Our Chairman" are available on Oaktree's site, and I strongly recommend that people read them all. There was also a 700-page pdf collection floating around with many of the letters combined: between Mr.Marks and his colleagues, we are talking about hundreds of years of investing experience all distilled for you. He really drives a few points: the primary job is to control risk. An investment cannot be viewed as more risky or less risky without discussing the price: at the right low price, nothing is too risky. Mr. Marks is known for returning capital to investors when the opportunities are not there, and for putting money to work when the window is open ($6 bn late 2008, just like Warren Buffett, except that you never read about Howard Marks riding on a white horse in the GS boardroom and asking for usurious preferred stock). There are a few other insights in the letters that you should discover on your own, including a few from an "earlier" version of Michael Milken.

So here is a guy who was buying during the biggest liquidation in a generation, and now he is selling a piece of his management business (not in the funds themselves): should you be buying? In a word, no. Here's why:

(1) Just common sense: don't be seduced by explanations such as "liquidity needs", "permanent capital", "estate planning" and the like. Another professional seller partnership, called Goldman Sachs, went public in 1999: you all know what happened to the market soon after.

(2) Are we at the end of the bull market for credit? The economics of the fund management business are driven by the fund results and the AUM. The two are inter-connected: good results beget higher AUMs. We have had a 30-year bull market in credit, and the phenomenal results we have seen might not be repeated by anyone at any time when the credit cycle reverses upwards. If you look at the 10-year yield chart since 1980, you are seeing a series of lower highs and lower lows. This means that a high yield loan might be at 10% initially, 25% in distress (when Oaktree buys it), and then at 8% when things stabilize ("lower low"). The IRRs would not be there if the credit cycle were going the other way, i.e. 10% new/25% distress/15% stabilized.

(3) Unfavorable structuring for the investors: the units do not have voting control, lose some of the tax benefits, generate peculiar income tax liabilites, and a few other things that make them differ substanitally from a "normal" stock

(4) Generally poor performance by investment manager LP units in the market. Oaktree is not the first partnership to go public. AllianceBernstein has been public for a number of years. In more recent history, Blackstone, Ochs-Ziff and Fortress all marked the top with IPOs in 2007, and proceeded to tank 85-95% off the IPO price (!) in 2008, and they are still at 50-85% off. AB, too, was $92+ in 2007, and is at $19 now. In recent months, we've had the IPOs of PE titans KKR and Apollo, and a recent bake-off by The Carlyle Group: again, remember that these are professional sellers. This, and the record of unit performance post IPOs, make me unenthusiastic about the offering. That said, to channel my inner Howard Marks, if the price is low enough...

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