Howard Marks: There Are No Opportunities in Distressed Debt Today

Howard Marks (Trades, Portfolio) is best known as an investor in distressed debt, an asset class with a high level of perceived (and actual) risk. The role of the distressed debt investor is to sort through the opportunities presented to them and to separate the no-hope scenarios from those where the market is being overly pessimistic. However, these are becoming rarer. In an interview with Bloomberg on Sept. 17, the guru talked about the lack of opportunities in distressed debt today, and why he believes this has happened.

Not like 2008

Marks began by saying he does not believe the markets are currently in a bubble, and certainly not one comparable to the crisis in 2008 that was precipitated by the collapse of Lehman Brothers. He does, however, think the credit boom has increased the supply of risky debt out there:

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“But there’s been a great deal of debt issued, there’s been a battle to be the person who buys that debt. The battle has taken the form of bidding down the quality and the safety. So there’s a lot of risky, aggressive debt that’s been issued in the last five-plus years and when that collides with a weak economy, I think there’ll be great opportunities.”

Investor appetite for debt has been exceedingly large over the past several years, which has bid up the prices for even the riskiest securities. This is a problem for distressed debt investors like Marks because it makes it harder to find cheaply priced bonds that are worth taking a chance on:

“Opportunities are very few today. I wouldn’t even use the term ‘seeing opportunities.’ Investing in distressed debt is a struggle today. The economy is too good, the capital markets are too generous. It’s too hard for a company to get into trouble. If they get into trouble, the capital markets are happy to bail them out. So it’s a struggle today and it would be misleading to talk about where there are opportunities - they’re practically nonexistent...It’s very, very hard to put money to work in distressed debt.”

As Marks is often fond of saying, this is a prime example of “too much money chasing too few deals.”

China

Later in the interview, Marks was asked about Chinese debt and whether he believes there are better opportunities outside the U.S. He said he believes there are, though it is harder to predict how distressed companies will act in China compared to other major markets:

“They have troubled companies, they have a future, the loans - if you can buy them at the right price - should be worth more sometime down the road. Will you get it? Will they apply the rule of law? One of the reasons why our investing has been successful in this country over the last 31 years is that Bruce Karsh is a lawyer [Karsh co-founded Oaktree with Marks], understands the process and knows how to project the outcome based on the rule of law. Will it apply in China? We believe so. We’re taking baby steps to explore whether it does”.

I often discuss how important it is for value investors to be fluent in the language of accountancy, in order to understand financial statements. What is focused on less often is the importance of fluency in the language of corporate law, particularly when investing in distressed debt, bankruptcies and turnarounds. This problem is further compounded by the differences in the Chinese legal system versus that of the U.S. and Europe. Still, Marks clearly believes it is possible for international investors to develop an edge in China.

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