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How I Invest with David Weisburd
E329: How Oaktree Is Positioning $223 Billion for a Credit Cycle Shift
00:23:34
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- [00:00]
A
Daniela, you're co portfolio manager of Global Credit at Oaktree which has $223 billion. Tell me about Global Credit. What is the strategy?
- [00:09]
B
Global Credit is really meant to provide our clients one stop access to Oaktree's credit platform, focus on income, total return in a diversified portfolio of our highest conviction opportunities. So Oaktree was founded in 1995 and the founding strategies at the firm were high yield and distressed. And over the years we did step outs in areas like private credit, leveraged loans, clos. And so we have a lot of different strategies and what we found is that our clients on average are invested maybe in four strategies. Some wanted us to be more strategic and think about allocating among those strategies as we saw shifting relative value. And so since the firm's founding we've been doing this kind of on a one off basis, more fund of funds. But it was really in 2017, with Bruce Karsh's guidance that I and others with him created Global Credit and as a single fund opportunity to participate in multiple credit strategies and benefit from our views on relative value.
- [01:05]
A
And you have a fun job of basically figuring out what's the best relative investment. So you get to go across multiple asset classes. How do you figure out which part of credit or fixed income is most opportune?
- [01:16]
B
It's a really fun job working with so many people at Oaktree. It takes a village. And we're really relying on our portfolio managers expertise across these different strategies to help us focus on those high conviction ideas. We get together on Tuesday mornings, 8am and we go around the table and we ask everyone what would you do with the dollar on the table? What would you buy? What does that look like? Walk us through that investment. Conversely, is there anything you would sell from your portfolio to fund that? And when you start hearing from everyone, you get a really good sense of where relative value is at any point in time. And that's how we decide as a committee. Maybe if we want to be more in bonds or loans or if we want to increase like the structured part of our portfolio, it's less about the macro and more about individual investments and themes that play through our portfolio. So at the end of the day, having diversification across all of these strategies I think is a benefit in itself. And our focus is sub investment grade. So we should be able to largely kind of outperform investment grade markets. But the power of being able to allocate to different areas depending on what's happening in the environment I think creates consistency of return and better outcomes over Time for investors.
- [02:21]
A
Your position is more defensive today than it was before. What's the strategy? If somebody wanted to be more defensive in the credit market, one of the
- [02:30]
B
ways is just having a lot of tools in your toolkit. So our global credit strategy at Oaktree was really designed to provide our clients one stop access to all that we do in credit in an all weather portfolio. So when we construct a portfolio of our liquid credit strategies, we kind of think about core and alpha. And the core we've got high yield bonds and senior loans and then the alpha we've got some strategies that have the potential to provide attractive yields but they require more expertise. That's structured credit, clos, real estate, debt, emerging markets, convertibles. So when we're thinking about being more conservative, sometimes it's focusing on the core, on safe income streams and kind of doing what we do best, underwriting credit, where we're going to get paid back the income. So we have more in the core to death.
- [03:13]
A
What metrics are you looking to determine how aggressive you want to be in the market?
- [03:17]
B
The health of underlying borrowers. We've been in an interesting environment. We saw interest rates spike 500 basis points. That has increased the debt burden for a lot of borrowers. And so we are looking at leverage levels, how their free cash flow generation is going, are they spending that on capex, how much of that is going to paying back interest? We're looking at that. We're also looking at some of the behavior in the market when it comes to lending. Right now there, in my opinion, is too much capital chasing too few deals. There's a huge need for capital just given how much debt needs to be refinanced. Over a trillion in the high yield and senior loan markets by 2028. Huge capital expenditures for data centers, AI et cetera. So there's a lot of need for capital and a lot of managers have raised big funds to deploy. And there hasn't been the issuance in the M and A that we've inspected. And so that has created, I think some exuberance in lending. So you're seeing lower lending standards, less covenants. And that's the type of behavior that also gets us a little bit worried.
- [04:11]
A
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- [05:51]
B
As a credit investor, AI is evolving. It's still unknown. We're seeing rapid advancements. It's one of the reasons why we've approached the space very conservatively. We've had an underweight, strategic underweight to the technology sector and in particular software, kind of worried about these types of risks, which are unknowns. And so we are coming into it with a lower allocation, looking to maybe find potential opportunities. As such, some of the sell off may be overdone. When you are underwriting for AI risk, there are certain things that you can focus on that may be more resilient within the software sector. So things like security of record or in a potential future environment where we have AI agents running around doing things for us, requiring our Social Security number and driver's license, you're going to need security with that data and so there could be winners in that sector. So it's just one more thing that we have to underwrite for. We're really focused on underwriting individual companies more than a sector. But you have to be mindful of what's going on a sector and how that could impact your thesis on an individual name.
- [06:49]
A
The devil's in the details. Software companies might become riskier, but security companies in theory could actually become less risky if there's more demand for them.
- [06:56]
B
That's right. We love an unloved sector. Right. That's where some of the best opportunities often are. They call it, you know, baby out with the bathwater. And I think we're probably seeing that right now with the broad sell off in the software space. There's probably some good companies that are going to be able to repay their debt because a lot of these advancements won't materially impact their businesses within kind of the window of the debt maturing. This seems to be a longer term problem for companies. But that said, when you have such a broad opportunity set like we do, we don't need to go chasing those types of deals. We can find really attractive things to do in other sectors and other parts of our portfolio.
- [07:30]
A
Double click on that. You see a sector that's been hurt, that's weaker than it was the previous year, and you want to find the core companies that are still good to lend to. What's the framework around that and how do you go about finding, I guess, the baby in the bathwater?
- [07:44]
B
It's interesting. Maybe chemicals right now is a good example, is a sector that got beat up really badly in high yield. And you're kind of seeing it roar back because oftentimes, as Howard Mark always says, there's the pendulum of risk, right? Things swing one direction and then they swing back. And so we want to catch things on the swing back and be more conservative kind of in those more challenged environments. It's all about the security analysis, fundamental research. We've got over 160 credit research analysts at Oaktree that are focused in individual asset class and then individual sectors. So they know their sectors, they cover all of the credits. They're really in the weeds to be able to spot those types of opportunities.
- [08:20]
A
Tell me about the K shaped economy. What does that mean?
- [08:24]
B
K shaped I think is a good kind of illustration, right? You think about the K and you think about what's happened in the economy, especially since COVID with top income earners continuing to see their percentage of wealth increase. And you've seen lower income consumers fall into more challenged times. I mean, dare I say that some are already in a recession in this market. They have not kept up with wage growth, largely are not participating in the same way in the equity market as higher income consumers. Higher income consumers are really driving this economy forward right now. But that creates challenges. Not only wealth inequality, social unrest and other things, but it makes the economy more fragile if equity markets falter. And I think we can all agree Valuations are pretty high, they're pretty stretched. If you see a hiccup in that market, all of a sudden this group that's so heavily invested in equities is less likely to be spending as much, keeping the economy going. It means that we could have dislocations more quickly. And so as an investor, it just makes us think we need to be more conservative in this type of a market given those types of risks. And we need to be mindful of spending patterns between those two groups and how that could continue to play out.
- [09:30]
A
So I want to move forward to best practices. Whether you're endowment, pension fund, single family office, what should a credit portfolio look like that's complementing their equity portfolio? What are some best practices gets to
- [09:42]
B
what you're trying to achieve. When we launched the global credit strategy in 2017, rates were very low. And so a lot of our institutional clients were looking for a return that was better than cash, preserving some liquidity in terms of funding, other kind of closed ended private opportunities. And so we were able to build a business around an active liquid fixed income allocation that included kind of higher alpha opportunities like structured credit, real estate, emerging markets that would create some additional yield. Constructing that core alpha, I think was a best practice for us and knowing when to lean into the core, when to lean into the alpha. And that was the time to lean into the alpha, to kind of outperform what you could do in more traditional markets as kind of the cycle shifted. Flash forward to 2019 when we felt markets were pretty fully priced, we became more conservative in our posturing. And then that allowed us in 2020 to go much more on the offense as the market was selling off. Reallocate to sectors like convertibles that were impacted by equities clos that saw spreads widened to a thousand. That's Oaktree's DNA. Being one of the largest distressed managers is kind of knowing when the cycle changes, knowing when to go on the offense. And so I think having diversification across a number of strategies key best practice. But two is that toolkit being able to flexibly reallocate when it makes sense in the market.
- [11:01]
A
It's that Warren Buffett quote, be fearful when others are greedy and greedy are when others are fearful. That's the way to basically operationalize that.
- [11:08]
B
That's exactly right. I mean we've deployed the most capital and had the best results for our cl. There's periods of dislocation, whether it's Covid or if it's the announcement of tariffs, Liberation day. Those pockets provide an opportunity for us to outperform our stated yield.
- [11:21]
A
Perhaps this is a dumb question, but how should investors think about private credit versus fixed income? It seems on a on the outside similar, but they're obviously very different. They play a different role in the portfolio. Talk to me about each role of those two aspects.
- [11:33]
B
It's timely because we're seeing a lot of convergence in the industry between public and private. Just this last year there was roughly an equal amount of capital that refinanced from public to private and private to public. So now you have companies that are tapping into both markets, which is somewhat of a new trend over the last few years. But when I think about constructing a portfolio with publics and privates, I think about it twofold. I think you should be paid to
- [11:57]
A
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- [15:28]
B
And so private credit should offer you excess yield, excess spread. And by and large it does. Today though, some parts of the market those spreads are thinner, right? So if we look at traditional sponsor backed direct lending, you're still getting a small premium, but maybe not as much as you once were because of the convergence. And so we're doing less in that space today because we can find attractive comparable yields within the public markets where we can get really, I think interesting opportunities for income that are higher than both of those markets is in parts of the private market like asset backed finance in particular where you have diversified income streams, cash flowing, you can tap into other sectors maybe that we wouldn't include in the portfolio and get maybe 200 to 600 basis points of excess spread return. So in an environment like this, if we're going to add privates to a portfolio of publics, they need to be giving us good compensation for the underlying risk and give up of liquidity. So that's kind of where incremental dollars are flowing now when markets become more challenged, right. And you have a freeze up of lending, banks get hung with things on their balance sheet and kind of the syndicated markets close. That's when you want to go in as a direct lender and do sponsor backed financings and other things and really serve as a provider of capital where you can command not only better terms but you can get protection in the form of covenants.
- [16:46]
A
So another way you want to be liquid when everybody's liquid and you could give up that liquidity when people need liquidity and you get a pretty high multiple, pretty high premium. I want to talk about the DNA of the firm mentioned it was started in 1995. Howard Marks and co founders. What did they instill in the DNA that made it grow to 220 plus billion today?
- [17:08]
B
Howard penned an investment philosophy when the firm was founded in 95 that still unchanged and in use today by all of these strategies. It's a unifying investment philosophy and we really kind of live and breathe it. Risk control is the number one tenant and that's our focus on avoiding defaults. It is supported by all of our credit research and our focus on bottom up credit research which should then lead to consistency. The second tenet, Howard has a saying at Oaktree that if you invest with us, it's kind of like his favorite restaurant. We're always good, we're sometimes great, but we're never terrible. And that's been really important to the DNA is focusing on avoiding loss, downside protection that should lead to consistent results over time. And then the other tenants really speak to not being a macro forecaster, not timing markets, knowing that macro forecasting is very hard to do with any level of consistency and that if we really focus on the underlying companies and their fundamentals, that should lead to more consistent performance. So that's been really key, a key teaching. And he always reminds us about that investment philosophy as well as how to think about where we are in the market cycle in terms of kind of our risk posturing. That's really the DNA of the firm.
- [18:18]
A
And you run a $20 billion portfolio within the $220 billion firm AUM. Is it not difficult to invest $20 billion? And how do you find opportunities with such A large amount of capital.
- [18:31]
B
We've grown over time as the markets have grown. So I think the size today is perfectly suitable for this environment. And I see the pot even more capital. We launched the strategy in 2017 with a paper portfolio and then eventually $100 million seed from Oaktree and then over time the capital has followed. So it's been Oaktree's fastest growing strategy as you mentioned, up to 20 billion in assets since the time we launched. But importantly the growth has been staged, it's been steady. One of the things I'm most proud of is that we've never had a quarter of net outflows in the strategy. Even in more challenging periods like Covid. You know, given our focus at the firm on distressed, it tends to be in those types of environments where actually investors are looking to increase their exposure to Oaktree. So it's allowed us to have capital at the right times when there's good opportunities to deploy. So being measured I think has helped that. And then again having a lot of different strategies and areas at the firm, there's so many different areas that we can invest in. A lot of multi strategy funds are more focused, invest in high yield and loans. We do so much more outside of that. Tapping into structured credit, real estate, convertibles.
- [19:38]
A
Give me a sense of the market. So you're 20 billion investing in how big of a pool of capital or opportunity set is there?
- [19:43]
B
We've calculated anywhere between $8 to $13 trillion addressable market just given the size. And that continues to grow. But look, we are mindful that you shouldn't be deploying into markets such that you're moving the market. Right. We always try and be reasonable with our portfolio managers. If I think there's a great opportunity in European senior loans because of the yield advantage. But our portfolio manager there says yes, but if you deploy this much capital immediately, I'm not going to be able to transact at those levels. That's an important dialogue to have. And so we're not trying to force things. We feel like our size is appropriate for this type of market and that we have ample kind of growth ahead.
- [20:22]
A
Speaking to the CIO of Mubadala Capital and they actually use their capital as a strength. They found out that if you have a couple billion dollars to invest in a deal, there's actually a few competitors there. Is there a place where the amount of capital you're managing is offensive? Could be used as an offensive weapon, could lead you to less, less competitive situations?
- [20:44]
B
Yes. I'm so glad you brought this up. Because a lot of the conversation is around capacity. You're too big to access these niche opportunities. But in these niche markets, being a player of size, being able to speak for an entire deal, and being one that's well known and established with a trading desk that speaks on behalf of all of Oaktree is a huge advantage. So I do think it allows us to see the best opportunities to take more than our fair share of deal allocation as well.
- [21:09]
A
Is there such a thing as first call alpha in credit where you're one of the first people that somebody calls
- [21:14]
B
likely, you know, but if you're the first call, that means you really need to be the one that's leading the diligence efforts. And there's no substitute for doing your homework in credit. It's a really rigorous bottom up approach that our credit analysts use at Oaktree. There's something called the credit scoring matrix that's been around at Oaktree since our founding where each analyst needs to underwrite an individual borrower's creditworthiness using eight different success factors. And nowhere on that page is the terms of the deal in terms of yield or spread or price. It's all about is this company going to repay us? What are the covenants look like, what's our downside, are we secured, et cetera. And oftentimes we will pass because the credit gets a negative score. And we'll call up the bank and we'll tell them we're passing for these reasons. And sometimes you may hear back, oh well, what if we increase the sweetness of the deal? What if the yield's higher? Well, that's just going to increase the interest rate burden for that company and make it more risky in our view. So like actually sticking to that is how you avoid defaults consistently over time. I'm very proud of the performance of the strategy, but the avoidance of default allows us to deliver that type of performance.
- [22:19]
A
I'm an equities guy, I'm a venture guy, so I get to always ask, what if this goes right? What if this goes 100x1000x? You're a credit person, I've gotten to know you. You're such a lovely person. Do you ever get tired of looking at everything through the credit lens and always looking to the downside?
- [22:31]
B
This is my biggest conundrum in life.
- [22:33]
A
Right?
- [22:33]
B
So we know each other now and I think I'm a serial optimist in life, but at work you have to be a serial pessimist. You have to look at the downside and what can go wrong. Building the business, working with our clients. That's where I've been able to really express that optimism and the growth in the markets and the power of credit for our clients and their beneficiaries. But when it comes to the day to day, it's all about risk control and managing to the downside. So we share that entrepreneurial spirit in building something and spotting opportunities, listening to trends. That's been really the privilege of working at Oaktree, getting to have a startup within the firm, with a firm's founder.
- [23:07]
A
When I imagine a credit firm, I think of a lot of very pessimistic people sitting around the table. Is it more like a team construction where different people are looking at from a different lens and you have different personalities? Not everyone just thinking about the downside or is it just an asset class where everybody just needs to focus on the downside?
- [23:21]
B
Diversity of thought is really important and that's why we have those committees where we hear from everyone and their perspectives. Alignment of interest through incentives is also important. So one of the things that we do at Oaktree is we have our form of deferred compensation. It invests alongside global credit for the majority of our employees. So all those portfolio managers are really incentivized to make the right decisions for the strategy. So they won't be paid more if they're managing more capital in a certain strategy. Everyone wants the fund to do well and I think it allows us to come up with the best decisions. But I'll tell you, if someone has concern among a group that doesn't, we focus mostly on that concern. Because the downside is so much larger, things are skewed to the downside. So having a voice that says no, these are the reasons why I wouldn't do something is important. I'll give you an example. Emerging market debt. Our focus is on corporates. We tend to go into areas maybe that are undergoing stress. The sovereign has a lower rating. The company, if it was based in the US might be investment grade rated. So we had a very large emerging market debt exposure in the portfolio in 2016, 2017, 2017, when we launched the strategy, it was our highest returning strategy that year, up maybe 20%. And our portfolio manager said, we've got to get out of this area. Spreads and the SEMBI High Yield Index are now tighter than in the US High yield index. This has only happened a few times. It doesn't end well. You should always be compensated going into emerging markets. That was our top performer in the strategy and we had some really interesting Opportunities with high yields that we didn't want to remove from the portfolio. And he told us, let me walk you through those 20 credits or so that are out yielding this MB index, and for all the reasons why I wouldn't invest in that on a fundamental basis. And of course, we listened to him and his expertise and guidance, despite the rest of the committee thinking, wow, the growth trends are in the favor of em. This is a big alpha driver. So we took a strategy down to zero. And then in 2018, local currency markets got roiled. It spilled into corporates. We were able to buy back some of that exposure. So that's why listening to those that are focused on risk control, that really know those markets and have concerns, is key, because it then leads maybe potentially to opportunities in the future, more buying life opportunities. That's kind of how the committee works.
- [25:29]
A
If you could go back to when you first started, before you were managing $20 billion, what is one piece of advice you'd give a younger Danielle that would have either accelerated your career or helped you avoid cost influence?
- [25:39]
B
Great question. I think I would say that the power of compounding is important in investing, but it's also very important in one's career. Building trust, relationships, always doing the right thing, caring about people. Those are principles that Oaktree was founded on. It's been a privilege to work with people that share those principles. But I think this is a people business and you want to be focused on relationships and things that are going to compound over time, not just the actual investments themselves, which compounding is also very important.
- [26:10]
A
A lot of people also underestimate. You start something in 1995, like Oak Tree, what 31 years of compounding looks like. It looks like $220 billion.
- [26:18]
B
You've said this before on my favorite podcast that you did, where you were actually interviewed, that sometimes you know the best investment outcomes. They're doing the things that other people aren't. They're looking different. Maybe they're not looking right at the time they're doing the unsexy. That's compounding right in credit and earning that income over time and building a business over time. I think that also can be applied to the people and the relationships. And it's a joy to work at Oaktree. We have a fantastic culture and fantastic people.
- [26:47]
A
Well, Danielle, thanks so much for jumping on. Thank you to Iconnections for hosting and looking forward to doing this again soon.
- [26:54]
B
Thank you so much, David. It's been a pleasure.
- [26:55]
A
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