The worst of the subprime crisis may not be over

Howard Marks and William Kerins from Oaktree Capital discuss the firm's global investment strategy and explain why subprime contagion could still spread.
ôIf we avoid the losers, the winners take care of themselves,ö says Howard Marks, chairman of Oaktree Capital Management, describing the firmÆs motto. Marks is categorical that an investment management firm needs to stand for something other than amassing assets, thus OaktreeÆs focus is on avoiding risk while targeting markets which provide opportunities for high returns.

Marks says that the firm chooses not to employ an economist because macro-forecasting is not critical to the 18 distinct investment strategies it employs.

Oaktree positions itself as a multi-strategy asset manager. Around 80% of its $51 billion in assets under management (as at September 30) comes from pension funds and endowments. And 10% of the firmÆs capital is available for investments in Asia where the company employs 48 people. It has 430 employees worldwide and around 85 of these have an ownership stake in the firm.

Oaktree has about $15 billion currently dedicated to distressed debt opportunities. Marks says that the firm has been buying distressed debt for 19 years now and has lived through two cycles when markets have provided attractive returns on the product - 1990 and 2002. He is cautious about suggesting that the present environment might constitute a third such opportunity, and comments that current default rates, in contrast to the earlier periods, are at still very low.

Oaktree uses the nomenclature ôevergreen fundsö to characterise what the world calls hedge funds and has about $2.8 billion under management in this category. Marks says that the only leverage Oaktree employs is in this category and, on an aggregate basis only, about $1 billion of OaktreeÆs funds are leveraged at the fund level.

William Kerins, OaktreeÆs Hong Kong-based managing director, says the firmÆs $1 billion investment in Fu Sheng, the Taiwanese manufacturer of golf club heads, exemplifies OaktreeÆs cautious philosophy about raising leverage. Oaktree and its partners have contributed $700 million of equity while only $300 million has been raised by way of debt for the deal.

ôPeople took leverage to buy assets and the assets turned out to be illiquid,ö says Marks, commenting on the subprime situation. While Marks says the firmÆs distressed debt specialisation could provide an opportunity, he says it is unwise to take action on the assumption that the worst is over.

Marks admits that the firm may not have anticipated the degree of the subprime crisis, saying that on July 16 he issued a firm-wide memo titled: ôItÆs all goodö. In the memo, Marks outlined that, in the prevailing ôperfect world where all was hunky doryö, the challenge was sourcing deals. He says that since that memo was issued, there has been a sea change in the risk/return equation. While risk premiums remain low, staying disinvested and holding cash is a reasonable option.

On Asia specifically, Kerins says that although the direct impact of the subprime situation has been minimal, the indirect impact can be seen in the fact that spreads have widened, in what is primarily a term-loan market.

Marks elaborates on this theme to say that a further tightening in the market could occur, and that a heightened risk consciousness could impact confidence and sentiment. This could spill-over, affecting economic growth worldwide.

However, Marks is categorical that this is not the only scenario that could arise and there is no certainty to how things will turn out.

Cautious optimism might well sum up the tone underlying Marks' comments. Oaktree is obviously hopeful that its strategy of risk avoidance will stand it in good stead in a time when others who have chased high returns, while taking on high risks, are stumbling.
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