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Bram de Haas
Bram de Haas
Articles (252)  | Author's Website |

Why Oaktree Capital Is Positioned for Future Returns

Jay Wintrob commented on the position of Oaktree Capital and private equity in general in this economic environment

May 04, 2018 | About:

Often, guru Howard Marks (Trades, Portfolio) represents Oaktree Capital (NYSE:OAK) in the media but recently the Oaktree CEO Jay Wintrob appeared on Bloomberg. I'm invested in Oaktree, as well as several competing private equity firms, because they are attractively valued. Oaktree is currently one of my favorites among its peers. The firm has a market cap of around $6 billion while it manages about $120 billion of assets. Historically, they have been very succesful with their private equity and distressed debt funds:

First, I'll summarize some of the more important things Wintrob shared and subsequently dive into why I like these firms.

Wintrob stressed Oaktree is more than a distressed debt investor. There isn't much distressed debt around the world currently but the firm is expanding into other strategies: real estate, emerging markets and direct lending.

Synchronized growth around the world is real. Valuations are high. Impact from the tax cut and stimulus from the repatriation of profits still to come. This is real and positive. These are all tailwinds.

At the same time, there are headwinds out there like interest rates moving up and an enormous volume of global debt. There is more inflation than you'd think from the headline number. If you are trying to buy a house, you are feeling much more inflation compared to headlline inflation. Finally, there is a non-traditional president whose moves are hard to predict.

There are increasing flows going to alternative managers because institutions can't find the returns to meet obligations in liquid debt and equity markets. Institutions are moving towards private real estate, infrastructure and direct lending.

At different parts of the cycle, the supply of opportunities tend to trump the amount of available capital. When there are recessions, a lot of opportunities become available.

KKR conversion

Wintrob also comments on the recent KKR (NYSE:KKR) conversion to a C-Corp. Oaktree has been studying the possibility. The KKR transition has been expected. There are slight differences between firms and Ares Capital and KKR were most likely to try out the conversion. I've written about it several times before including recently:

It trades at 9x earnings because it can't be bought by indexes. KKR is also unique among private equity peers as it retains more of its earnings. It pays a lower distribution rate (it would be called a dividend if it weren’t a partnership) but it reinvests in investment opportunities alongside partners. Given that it generally attains a very high rate of return on investment, that’s a very attractive feature. Just like the other major private equity groups, it has a very high rate of insider ownership. Both founders and high-up executives have a lot of stock and don't like to give it up.

Oaktree isn't sure what it will get in return for accepting the double taxation imposed by the C-Corp structure.

Potential improvements could be that ETF's will have an easier time including the companies. Mutual funds will have an easier time investing in them. The tax treatment could be beneficial for private investors. As a result, multiples awarded to the space may expand.

According to Wintrob, the challenge for investors is that alternative managers are very hard to model. There are three types of income. At least two of those are cyclical. Over time, he expects the alternative management companies will generate strong returns and Oaktree and competitors over the long-term will deliver strong returns to investors.

I happen to agree to this view and own both Oaktree and KKR. 

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KKR doesn't return as much compared to peers but that's because KKR retains a uniquely large amount of capital to deploy it into their strategies. Oaktree's level of distribution is more typical for the space.

Oaktree also has a 20% stake in DoubleLine Capital, which is a fixed income focused firm with over $100 billion of capital under management. It is lead by the famous Jeffrey Gundlach.

Finally, the firm has quite a bit of cash that is undeployed, which means it isn't earning fees yet. In addition Oaktree increased its assets under management by 50% in 2008. When the next recession hits and the opportunity in distressed opens up, the firm will raise a lot of additional capital towards the strategies where it has historically enjoyed enormous success. Those forward earnings are impossible to model but I happen to believe you are gettting exposure to these nearly for free if you buy Oaktree based on its current earnings.

Disclosure: long OAK, KKR

About the author:

Bram de Haas
Bram de Haas is the managing editor of The Black Swan Portfolio

Visit Bram de Haas's Website


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