Interview with Frank Carroll and Tim Jensen, Managing Directors of Oaktree Capital Management, L.P.
Oaktree was formed in 1995 by Howard Marks, Bruce Karsh, Larry Keele, Richard Masson and Sheldon Stone. Their goal was to develop a pre-eminent organisation dedicated exclusively to alternative and non-mainstream investments focused on superior investment performance through risk control, loss minimisation and consistency. Prior to forming Oaktree, the founding principals worked together at Trust Company of the West (TCW) since the mid-1980s, where they established Oaktree’s oldest and largest investment strategies: high-yield bonds, distressed debt, convertible securities, principal investments and real estate. Since its formation, Oaktree has built a broad array of synergistic investment strategies, including power infrastructure, emerging markets equities, mezzanine financing, value opportunities and senior loans. As a result of a conscious decision in 1998 to expand its investment focus abroad, Oaktree has also established step-out strategies dedicated to non-US investment opportunities, such as European and Asian principal investments, Asian real estate, European high-yield bonds, European senior loans and Japanese equities.
Today, Oaktree has over 590 employees and offices in 14 cities located in ten countries.
What is your firm’s investment philosophy? What are the different strategies that you employ to achieve your stated goals?
All of our investment activities operate according to the unifying philosophy that follows:
The primacy of risk control
Superior investment performance is not our primary goal but rather, superior performance with less-than-commensurate risk. Above average gains in good times are not proof of a manager's skill; it takes superior performance in bad times to prove that those good-time gains were earned through skill, not simply the acceptance of above average risk. Thus, rather than merely searching for prospective profits, we place the highest priority on preventing losses. It is our overriding belief that, especially in the opportunistic markets in which we work, if we avoid the losers, the winners will take care of themselves.
Emphasis on consistency
Oscillating between top-quartile results in good years and bottom-quartile results in bad years is not acceptable to us. It is our belief that a superior record is best built on a high batting average rather than a mix of brilliant successes and dismal failures.
The importance of market inefficiency
We feel that skill and hard work can lead to a "knowledge advantage," and thus to potentially superior investment results but not in so-called efficient markets, where large numbers of participants share roughly equal access to information and act in an unbiased fashion to incorporate that information into asset prices. We believe that less efficient markets exist in which dispassionate application of skill and effort should pay off for our clients and it is only in such markets that we will invest.
The benefits of specialisation
Specialisation offers the surest path to the results we and our clients seek. Thus, we insist that each of our portfolios should do just one thing — practice a single investment specialty — and do it absolutely as well as it can be done. We establish the charter for each investment specialty as explicitly as possible and do not deviate. In this way, there are no surprises; our actions and performance always follow directly from the job we were hired to do. The availability of specialised portfolios enables Oaktree clients interested in a single asset class to get exactly what they want; clients interested in more than one class can combine our portfolios for the mix they desire.
Macro-forecasting not critical to investing
We believe that consistently excellent performance can only be achieved through superior knowledge of companies and their securities, not through attempts at predicting what is in store for the economy, interest rates or the securities markets. Therefore, our investment process is entirely bottom-up, based upon proprietary, company-specific research. We use overall portfolio structuring as a defensive tool to help us avoid dangerous concentration rather than as an aggressive weapon expected to enable us to hold more of the things that do best.
Disavowal of market timing
Because we do not believe in the predictive ability required to correctly time markets, we keep portfolios fully invested whenever attractively priced assets can be bought. Concern about the market climate may cause us to tilt toward more defensive investments, increase selectivity or act more deliberately, but we never move to raise cash. Clients hire us to invest in specific market niches, and we must never fail to do our job. Holding investments that decline in price is unpleasant but missing out on returns because we failed to buy what we were hired to buy is inexcusable.
Can you tell us a bit about the different portfolio managers overseeing the emerging markets strategy and their backgrounds?
Frank Carroll and Tim Jensen are co-portfolio managers of the emerging markets strategy. Both have worked at Oaktree for over a decade, focusing on emerging markets. Prior to joining Oaktree, both worked in various capacities in emerging markets for ten years or more. Tim’s background includes working as an analyst at Ardsley Partners and as a portfolio manager at Morgan Stanley Investment Management in their Singapore office. Frank’s earlier work experience was in trading at Salomon Brothers and later at Columbus Advisors. They bring deep experience and complementary skill sets to their roles at Oaktree.
Can you tell us about the qualitative and/or quantitative research and analysis that goes into your investment decisions? How do you determine your exposure to different sectors at different points in time?
As classic bottom-up investors, our approach is more art than science. The portfolio managers work with a team of ten analysts. The analysts follow one or more industries across the emerging markets universe. The analysts are very focused on understanding their industries, knowing the managers of the companies they follow and analysing financial statements with the goal of deriving reliable cash flow projections. The analysts strive to identify companies trading at attractive valuations. Exposure to different sectors is driven by bottom-up opportunities rather than top-down or thematic investing. If analysts identify attractively-valued stocks and believe that these companies will deliver results better than the market consensus, we will tend to build up a larger net long position in that sector. However, the investments are generally quite diversified and large industry and country concentrations are avoided.
Is your research performed at various locations or is it centralised?
Research is performed in Stamford, Singapore, Hong Kong and on the road at company visits. We have worked hard over the years to ensure that information flows freely within the group. Analyst visit notes are posted to our internal blog and archived in our database. We have daily morning meetings in Stamford and Singapore and the portfolio managers communicate extensively with the analysts via email and telephonically. Analysts are encouraged to share information with other team members, particularly when they cover related industries. The purpose of research is to generate strong investment ideas, so we try to ensure that the product of the research effort is shared internally and reflected in the portfolio in a timely manner.
Has there been a core management/strategy shift in light of the financial downturn to implement key leanings?
We believe that the financial downturn validated our hedged investment approach and that we did not need to change our core management policies or our strategy. We learned a few new lessons in risk management during the downturn, including the need to reduce gross exposure decisively when volatility spikes as in August 2008. But we view changes we made after the downturn as evolutionary in nature and not as a dramatic shift.
As the firm has grown larger over the years, how have you optimised in terms of structure/hierarchy? How has the development of the firm's structure contributed to the success?
As the firm has grown over the years, we have worked to improve our systems and to ensure strong lines of communication within the group. Frank and Tim make a point of travelling with team members on company visits and of spending time in the Asian offices on a regular basis. Teamwork is very important to the research and portfolio management process and good systems processes can strengthen teamwork.
How do you foresee the amount of stress laid on tightening regulations across the hedge fund industry to affect your firm?
Oaktree has always placed a strong emphasis on regulatory compliance. We work hard to understand new regulations as they are enacted and we adapt our policies and procedures as applicable. We have seen many regulatory changes over the course of our careers and we expect to see many more in the future.
Can you give us your outlook on the emerging markets both in the near and medium term? Any sectors that you are particularly interested in at this point in time?
In the near term, we believe that valuations are a bit rich. The markets need to adjust to less expansionary fiscal and monetary policies in China and a number of other key emerging markets. Developed market stresses and slow growth may diminish near-term export opportunities. The medium- and long-term arguments supporting emerging markets as an asset class are well understood at this time. Consequently, valuations have moved up and look somewhat rich relative to historic averages. However, given the likely faster economic growth and the growing size of these economies, we would expect to see continued inflows into the asset class over time.
What is your outlook on China and Brazil – do you think these markets will maintain the momentum through 2010?
We were very positive towards China and Brazil coming into 2009. We believed that China had the financial strength and the political will to support growth and we think the Chinese fiscal and monetary stimulus programs were instrumental in supporting emerging markets last year. We were positive towards Brazil given its solid financial position and commodity exposure. The situation is less clear-cut today. China has signalled its intention to moderate economic stimulus, including slowing lending growth and more modest fixed asset investment growth.
We believe this moderation is necessary and positive for long-term economic development. However, markets have to adjust to this change. Chinese equities have been underperforming emerging markets for six months. Brazilian equities had a spectacular year in 2009 and need some time to adjust to a moderation of growth in Chinese demand for commodities. In addition, valuations are less attractive than a year ago and there may be some jitters ahead of this year’s presidential election. In the long term, China and Brazil remain our favourites among the BRICs, but the markets may need some time to discount these changes.
How do you think the Greek debt crisis will affect markets within Central & Eastern Europe? Do you foresee a knock-on effect?
We believe the Greek debt crisis will have a negative impact on Central and Eastern Europe. In a more benign outcome in which the EU supports Greece financially in exchange for fiscal austerity measures, growth will slow. We believe that any such resolution would be extended to the other peripheral European countries with stressed budget situations and austerity would lead to slower EU economic growth – that would be negative for Central and Eastern Europe. In the less likely scenarios of Greek withdrawal from the EU, or even default, contagion would have a far larger negative impact. As Kenneth Rogoff and Carmen Reinhart have shown in their study of post-financial crisis countries, the outcomes can consist of slow deleveraging over an extended period of time with attendant slower economic growth, default, devaluations or rampant inflation. None of these choices sound promising for smaller economies that have tied their economic futures to the EU.
Out of the countries that are currently on the periphery (Vietnam, Indonesia, South America, Sub-Saharan Africa), which do you think will be the up-and-coming emerging markets in the medium term?
Our investment approach is driven by a bottom-up process and we do not spend a significant amount of time focused on picking up-and-coming countries. At any given time, we may invest in companies domiciled in frontier markets, but this is not a core part of our strategy. We will also invest in companies that may derive their growth from frontier markets but which may be listed in a more developed emerging market.
We believe that Indonesia’s mineral wealth, particularly its coal, leaves it well-positioned for the long term. Vietnam is currently experiencing some economic issues but has very exciting long-term prospects. We think Sub-Sahara Africa includes a wide range of economies, some very interesting and some rather depressing, but we hope mineral wealth can be married with better governance to improve economic performance in the long term.