Key Points from Oaktree’s Quarterly Letters

The most recent issue of The Roundup by Oaktree delves into the world of investment risks and opportunities. Experts at Oaktree discuss the increasing demand for mezzanine financing, potential entry points for special situations investors, the limited competition in the market for unrated asset-backed finance investments, and the rising need for specialized life sciences lenders. Furthermore, the publication includes an excerpt from Howard Marks’s 2024 year-end letter to clients.

Howard Marks, the Co-Chairman of Oaktree, emphasizes in his letter that predicting trends in investor psychology is an impossible task. He points out that even the most knowledgeable pundits did not foresee the significant stock market returns in 2023 and 2024. Marks highlights the tendency of investors to become more optimistic after a few good years, which could be seen as positive sentiment that might support the markets for a while. However, he also warns that continued double-digit stock market returns increase the likelihood of a market correction. Marks suggests that non-investment grade credit currently presents a better risk/return opportunity compared to the S&P 500. He also draws attention to the combination of factors in the current market, including an extended economic recovery, prevailing optimism, high equity valuations, low risk premiums, dysfunctional governance, and geopolitical uncertainties. Marks advises investors to consider emphasizing defensiveness over aggressiveness in their investment strategies, with increased allocations towards lending strategies over ownership strategies.

Jordon Kruse and Matt Wilson, Co-Portfolio Managers of Special Situations at Oaktree, discuss the opportunities arising from higher interest rates for special situations investors. They mention that the rise in interest expenses negatively affects healthy companies with weak balance sheets, creating opportunities for investors to add value by enhancing financial and operational performance. Kruse and Wilson point out that senior loan coupons have averaged close to 9% since 2023, a significant increase from the rates in 2020. They predict that interest rates are likely to remain elevated above the lows seen in the past decade, potentially leading to distress in the credit markets. The managers suggest that special situations investors should focus on accessing bargains and improving businesses through financial and operational enhancements to capitalize on this environment.

Raj Makam and Christina Lee, Portfolio Managers of U.S. Private Debt at Oaktree, shed light on the increasing demand for mezzanine financing. They explain that borrowers of various sizes are turning to mezzanine financing due to its flexibility in providing junior capital. Makam and Lee suggest that mezzanine financing can be a valuable tool for companies looking to raise capital without diluting existing ownership stakes. They emphasize the importance of understanding the risks associated with mezzanine financing and conducting thorough due diligence before making any investment decisions. In conclusion, the experts at Oaktree provide valuable insights into the current investment landscape and highlight the opportunities and challenges that investors may encounter in the near future.