Oaktree dials back return expectations on credit

Oaktree Capital Management said the persistently-low interest rate environment caused it to pare back return expectations on some of its debt products, but it vowed to avoid riskier investments to juice returns.

Central banks continue to keep interest rates at unprecedented lows, even in negative territory in some places. That translates to squashed returns even in the distressed credit space where Oaktree plays via credit funds and direct lending programs.

“When central banks take the rate to zero, all other rates emanate from that,” Howard Marks, co-chairman, said July 28 on the firm’s second-quarter conference call with Wall Street analysts. “We’ve adjusted downward our clients’ expectations as to what [return] our strategies can provide.”

Back in the 1990s in an environment of higher rates, Oaktree generally expected 25 percent to 30 percent annual returns or even higher for distressed debt, he said.

“We’re not saying 30 any more – we’re hoping to get 15,” Marks said. “We’re targeting 15 percent in our investment decisions and still believe we can do that. We may fall a little short of that, but that’s our goal.”

Oaktree hasn’t cut back its hurdle rate of 8 percent because its LPs depend on that return, especially since returns in the public equities and public bond market have leveled off, he said.

Oaktree has introduced a suite of products expected to generate a 10 percent return, which “looks like Nirvana” to investors, he said.

Some of those include strategic credits, direct lending European credit solutions, mezzanine, enhanced income and real estate debt, he said.

“Believe me, nobody stood up and cheered for 9 percent 30 years ago, but that’s the way things are today,” Marks said. “It is what it is.”

Bruce Karsh, co-chairman and chief investment officer, said Oaktree’s LPs understand it’s not going to lower its credit quality standards and take on a lot more risk to boost its returns.

“It’s most important to them that we control and manage risk,” Karsh said.

Fundraising, deployment

With $3 billion in fresh capital raised in the second quarter, Oaktree totaled a combined $11.2 billion for Oaktree Opportunities Fund Xa and Fund Xb.

The firm also raised additional capital for Real Estate Opportunities Fund VII, bringing its total committed capital to $2.4 billion. European Principal Fund IV held a first close at about $937 million, and its European Capital Solutions strategy held an interim close at about $335 million.

Over the balance of 2016, the firm expects additional closes for Opps Xb, Real Estate Opportunities Fund VII, European Principal Fund IV, and European Capital Solutions. Also, the firm expects first closes for Infrastructure Fund I, Real Estate Debt Fund II, and one or more separate accounts for its new Real Estate Value Add strategy. Oaktree is also preparing a comingled emerging markets debt total return fund.

Second-quarter adjusted net income increased to $142.6 million from $85.3 million, on higher incentive income, fee-related earnings and a boost in investment income.

During the second quarter, Oaktree deployed $2.4 billion of capital, the most in the last five quarters.

Action Item: Read Oaktree’s results, http://bit.ly/1lg44Vd

Photo: Jennifer Hoffman of Buffalo, New York, poses for a picture under the Angel Oak tree in Charleston, South Carolina September 24, 2013. REUTERS/Randall Hill 

Correction: This story has been updated to correct a historical reference to higher interest rates in the 1990s, not the 1980s; also to fix an incorrect dollar amount for European Principal Fund IV.