Letter #196: Bruce Karsh and Howard Marks (2017)
Letter #196: Bruce Karsh and Howard Marks (2017)
Cofounders of Oaktree Capital | Howard Marks Investor Series with Bruce Karsh
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Today’s letter is the transcript of a conversation between Oaktree Cofounders Bruce Karsh and Howard Marks. In this conversation, the partners discuss Bruce’s career path from law to distressed debt investing, starting one of the first distressed funds, investing in distressed debt, risk management, and conservative strategies, raising funds for investments during an economic downturn, investment strategies and the importance of understanding market cycles, leaving TCW and starting Oaktree, sharing ownership and success in a business, building a brand, risk consciousness, and maintaining an edge in crowded markets, investing, decision-making, and career development, and market cycles and investment strategies.
Bruce Karsh is the Co-Chairman, Chief Investment Officer, and Cofounder of Oaktree. He also serves as the Portfolio Manager for Oaktree’s Global Opportunities, Value Opportunities, and Global Credit strategies. Bruce started his career in the legal industry, first as a clerk for the Honorable Anthony M. Kennedy, then as a lawyer for O’Melveny & Myers. He then worked for Eli Broad as Assistant to the Chairman of SunAmerica. After Eli’s insurance company became a client of TCW, Bruce was recruited by future Oaktree Cofounder Howard Marks to managed a distressed debt fund for TCW, which was one of the first distressed debt funds from a major financial institution. There, Bruce served as Managing Director and managed the Special Credits Funds.
Howard Marks is the Co-Chairman and Cofounder of Oaktree. Howard began his career at Citicorp, where he started as an equity research analyst before being promoted to Director of Research and then Vice President and Senior Portfolio Manager, where he oversaw convertible and high yield debt. He then moved to The TCW Group to lead their convertible and high yield debt groups. While at TCW, Howard started one of the first distressed debt funds from a major financial institution, hiring future Oaktree Cofounder Bruce Karsh to manage it.
I hope you enjoy this conversation as much as I do!
[Transcript and any errors are mine.]
Related Resources
Howard Marks Compilation (1,343 pages)
Transcript
Howard Marks: Well, thanks very much to the to the audience. And thanks to Bruce, for coming. The format of these things is that I interview an outstanding investor, and there's no reason not to look right at home to my long standing partner of 30 years, Bruce Karsh. Really, one of America's great investors. Let's start at the beginning--for us. Tell us about your early years, how your career progressed from law to investing--and do you still feel that all lawyers want to stop being lawyers? As you told me 30 years ago.
Bruce Karsh: Yeah. So the early years. I guess it started, and I was born and raised in St. Louis, and went to Duke University, was my undergraduate school. Always wanted to be a lawyer when I was growing up. So when I graduated from Duke, I went straight away to University of Virginia Law School, where I was very fortunate to meet my wife, Martha, who now I've been married to her for 36 years. But I had a lot of twists and turns along the way. I was offered a clerkship for then-judge, now Justice Kennedy, when he sat on the Ninth Circuit Court of Appeals out in California. I accepted that clerkship, and based on leaving Martha 3000 miles away, I decided I didn't want to take that risk--I was risk averse back down, and particularly about such things. So I asked her to marry me, and she came out with me to California. I clerked for a year--we had intended to come back to the east coast to practice law, but once you go out to California, it's pretty nice out there. And we decided, well, let's stay here for a couple years and practice, and we can always go back to the East Coast. Judge Kennedy, who I'm pretty close to, even now, encouraged me to come down to Los Angeles. He was in the Northern California area. This was before Silicon Valley. And he said, Well, you're--he used to give me all the business cases. And he says now that he even knew then that I was very interested and inclined in that direction. And he said you should go down to Los Angeles and practice law, it's very vibrant. You practice law for a couple years, and you never know what will happen to you. And he suggested a firm that I go to, which was O'Melveny Myers, big law firm in Los Angeles. And I went down there with my wife, we started practicing at O'Melveny. And three and a half years later, I got a call from a guy named Eli Broad, who was interested--had heard about me from a very close friend and his, a guy named Dick Riordan, who was ultimately mayor of Los Angeles for a couple terms. And Eli wanted me to interview to be his general counsel of his big company, he had an insurance company and a largest homebuilder in California, and it was very well known in the Southern California area. I was in my 20s, but I figured it's worth meeting Eli Broad, even though I thought it was kind of a long shot for someone in their 20s to be general counsel of this big company. He didn't have my resume, he just heard about me from Riordan. And I went into the interview with him--and I told Howard the story before--15 minutes into the interview, he starts describing a position where I should get out of law and be his assistant and help him with investments and mergers and acquisitions and he asked me how much I was being paid at O'Melveny, he said he'd pay me 50% more. And I--the only catch was, he was a pretty difficult guy to work for. But I figured it was worth a shot. So that's how I got out of law. So it was kind of coincidental.
Howard Marks: And working for Eli, at Sun America--you quickly made your first investments in distressed debt. What took you in that direction? It was an unusual field at the time.
Bruce Karsh: Very unusual. Eli had made an invest--through the insurance companies, had gotten involved in a company called Johns Manville, which was a Dow 30 stock that had ultimately fallen into bankruptcy because of asbestos liabilities. And he gave me the file and said, Hey, you're a lawyer. Figure this out. And it was intriguing to me, because there were bonds trading at discounts, and the stock was really like an option. And I came back to him and I said, well, I'd hold the stock, and I'd buy the bonds. And we ultimately did. And I thought it was just a fascinating area. No one really was doing much of it. Ultimately, I ran into two of the real pioneers, Randy Smith and Basil Vasiliou, who were raising the very, very, very first fund that I'd ever heard of, or anyone had heard of. And they were trying to raise $40mn. We passed on it, but it was something that always stuck in my mind, that this is a really cool thing, and something that people should think about. The other thing that was going on, as your recall, Howard, is that in the 80s, you had the LBO craze, And one of the things that we were doing at Sun Americas, we were financing these LBOs. So I was seeing over time, real time, how prices were getting higher and higher, and assumptions were getting greater and greater about growth and EBITDA, and the leverage that was being put was greater and greater on the companies. And so it would all kind of said to me, Gee, maybe distressed securities at some point could end up being a really interesting field, particularly if we ever have a recession. Now, that was a matter of debate back then, as you recall.
Howard Marks: Well, at that time--one thing we're both very attentive to his cycles. And where you are in the cycle really has a great deal to do with what you should be doing at a point in time. But the interesting thing about cycles is after the things have been going well, for 6, 8, 10 years, everybody says, Well, maybe we won't ever have another cycle. Maybe this has been fixed. And wouldn't it be great if we never had a recession again. But then what are you guys in distress debt ever going to do to keep busy?
Bruce Karsh: Right. Well, that was the--when I basically--I approached Howard with this with this idea--Howard was a huge figure even back then--and that was 30 years ago--in the bond management world, and high yield in particular, he was one of the pioneers. And I thought it would be a great--to marry this distressed idea with one of the leading high yield bond businesses, certainly one in the United States and clearly in the western United States. And so I sort of called him up out of the blue, and he said, Yeah, let's get together for lunch. We had lunch in Brentwood, somewhere. I don't know where you took me. But I made my pitch, and you bought it. So I guess my question to you is, what made you--I had done a little bit of this with Eli, and I had sort of an idea, and I think my pitch was, Hey, there are a lot of legal issues involved with bankruptcy, distress, bankruptcy investing, and I'm a lawyer, and there aren't many people like me, who've had a legal background, and also some investing experience, albeit not all that much. And I made my pitch. So why did why did you buy it?
Howard Marks: Well, I think that having started Citibank's high yield bond funds in 1978, which is really the beginning of that world, I had some experience going into a field that most people said, What are you crazy? And they called them junk bonds. And Moody's said they were not a desirable investment. And most investing organizations had a written rule against non-investment grade investing. So I saw the benefits of doing something unconventional. And if you think about it for a minute, doing the things that everybody else wants to do, it's hard to think you're going to find a particular bargain. Doing the things that everybody else fails to see the wisdom of, you have a better chance of getting a bargain--or running off the cliff. So that was number one. And then number two, since I had been in the high yield bond business for nine years by the time you and I connected--every once in a while, in that period--we're not perfect--you buy a bond at 100, it goes bankrupt, it falls to 10. You go on the creditor committee, you work it out, you spend a few years of drudgery, and you get 30. So it wasn't a great leap of faith for me to say, Well, why don't we start a fund to do the 10 to 30 part. And that's really what it what it was conceived as.
Bruce Karsh: And then when when he hired me, this was in ‘87, I was supposed to come up with the business plan, which I did. And by the way, the business plan, as you recall, was that. We were going to look at, basically, high yield subordinated bonds, watch them drop from 100 down to 10, and then enjoy the ride up. Don't buy them until they get down to 10, but then enjoy the ride up. We ultimately, as we got into it, I started doing some different things. In particular, I learned the joys and learned to love bank debt, and the seniority and the control that it provided in the bankruptcy. But my question back to you, Howard, is that I wrote the business plan. I thought it was very sound at the time. But then we had to go out and raise money, which--people had no idea what distressed securities were back in '87, '88. And like I said, Randy Smith tried to raise a fund, he may have raised 30mn or whatever, but it was not on anyone's radar screen. Meanwhile, we were at a very blue chip company called Trust Company of the West in in Los Angeles. And Howard, we were going--and this was all falling on your shoulders, because you were the big name at the at that time, for sure. And we were going to try to raise a fund. What went through your mind? And how, what was your pitch? And how did you educate these institutions to not look cross-eyed at you when you start talking about buying--You're gonna buy companies that are going into bankruptcy? They would look at us really funny.
Howard Marks: Yeah. Well, I think that--but I think that among X people you talk to--if you say, You should do this because nobody else will, some people get it. Maybe most don't get it. But some people understand the benefits of contrarianism. And that was a big appeal. As Bruce says, fortunately, we'd been able to build up a reputation at that point in time both for good performance and for trustworthiness, which I think played a big part in it. And the TCW imprimatur probably helped as well. So we scraped together 65mn on our first closing, outdoing Randy. And that was October the 28th of '88. And we were, by the way, and we shouldn't overlook, we were fortunate to win the seal of approval from Cambridge Associates. And Cambridge is a consulting firm that is the leading consulting firm for foundations and endowments. And they put us on their list. And we got a lot of names from that. And then the Common Fund figured us out and came into our second close and put us at 96mn. And we thought we had all the money in the world.
Bruce Karsh: Howard raised almost all the money. I was happy because Eli came in, personally and with his insurance company, Sun America. So that helped give me a little credibility, that a fairly well respected investor, like Eli Broad would be willing to endorse this. But basically, it was Howard put that whole thing on your shoulders and got us to 96mn, which doesn't sound like a lot at this point. But back then, we were instantly--probably the second largest fund, there was one other that raised a little more than us, and certainly one of the top three investors in the burgeoning field of distressed securities.
Howard Marks: One of the interesting things to note, as a side note, is that that other fund, which was 104mn, as I recall, to our 96mn, that was the only fund they ever raised. So it's not enough to raise it once. You have to have to have staying power.
Bruce Karsh: Well, when I got into it, and really tried to apply the business plan that I had written to the environment, I found that I didn't love the risk reward involved with buying subordinated bonds, because they hadn't dropped sufficiently enough in price to feel like it gave me the margin of safety that was necessary. So back in '89, one of the first things I did was I went to a bad bank that was set up by Mellon Bank back then called Grand Street National Bank, and bought my first bank debt, remember that? Ideal Basic, a cement company. It was secured by Cement Plans, paid something like 72c on the dollar, and learned it's kind of nice to be senior, it's kind of nice to be secured. Ultimately, that debt never missed a coupon and paid off at par.
Howard Marks: If you think about a balance sheet, a capital structure, like a tree, it dies from the bottom. So if there's a financial problem, first the equity loses its money. And then among the creditors, the subordinated bonds are in the first loss position. And one of the important things in investing is to invest within your--they always say in football, You should play within yourself, you should play within your capabilities. You must have a plan of operation, which is simpatico--I don't know if you use that word anymore--with with your personality. If you're an aggressive guy, you just can't play it safe. If you're a chicken, you just can't play it risky. And we're both conservative investors. And I think, Bruce, when he found the idea of the ideal basic trade, like the fact that the bank loan is basically in the last loss position. So everybody else has to lose all their money, pretty much, before you start losing. And it--so obviously, you take less risk. In theory, you do a lower return. But in truth, I think in our experience, that conservative position enables you to do it more strongly.
Bruce Karsh: And that first fund, Howard you'll recall, that there was a energy collapse in the late 80s. And so what did we do in the first fund, sort of waiting for the environment to come our way, was basically play around in the oil patch: drilling rigs, buying debt secured by drilling rigs, whether it was Reading and Bates or Zapata. Also there was a utility that had issues because of nuclear problems. Public Service in New Hampshire, bought some of that, had secured debt there. Basically kept it very, very safe. Grinded out some pretty good returns. And then in late '89, early '90, we could tell that something was going on in the economy. And this is when I turned to Howard and I said, Boy, it would be great to have a lot of money right now. Now a lot of money back then was like a couple hundred million dollars. But again, I put the horse on Howard's back, and I said Can you raise us a lot of money because I think there could be a great opportunity here, particularly if defaults in the high yield bond markets pick up.
Howard Marks: Well, and in fact, the LBOs that Bruce described as having taken place in the LBO boom of '85-90, were generally financed with 95% or 96% debt. So there was just a tiny cushion of equity at the bottom. And once you got through that, in terms of the diminution of value, you would start having defaults quickly. So we went out to raise Fund II, and we raised, as I recall, 280mn, which was a lot, and I don't know how we did that, frankly--I have no recollection. But--
Bruce Karsh: It wasn't me.
Howard Marks: But then if you look even further, what I really can't--
Bruce Karsh: It was actually 400mn in total--II, IIB--Oh, sorry, I gave away the punch line. I'm sorry.
Howard Marks: But what I really can't remember, if you look back, and maybe you can, is, in our business, in the fund business, the norm--private equity, venture capital, what have you--the norm is, you raise a fund, you can't raise the next fund until that fund's normally 80% invested. So we raised Fund II, but we put in their language--we asked for the ability that if while we were investing Fund II, if great opportunities come along, we should be able to raise Fund IIB, even if II hasn't invested yet. And I don't remember where we got the nerve to ask, and I don't remember why anybody said yes. But they did.
Bruce Karsh: Well I do. Let me tell you why. This could have been the very, very first Howard Marks memo. Because he wrote--I mean, he's a brilliant writer, as you know. But even back then he was a brilliant writer. And you crafted a memo, probably on one page, because you like to get everything on one page, and laid out the case for why investors should give us money in this B tranche. And it was brilliant, and we found some takers, and--
Howard Marks: So we raised two--as I recall it, memories are not perfect--but as I recall, we raised 280mn for the Fund II, and 240mn for Fund IIB, so we raised Fund II in July of '90, and then in the Fall, we said Yes, there's gonna be more defaults, and defaults were starting to happen. So we raised 240mn for Fund IIB in December of '90.
Bruce Karsh: And I put that money to work very quickly. The markets in '90 and '91 we're in a very deep recession was unfolding, which by the way was accompanied by SNL failures, Gulf War, very serious recession in the real estate industry...
Howard Marks: And the government mounted a jihad against high yield bonds. Drexel Burnham, Michael Milken went to jail. And when they took out the leading investment bank for high yield bonds, that meant there was nobody around to do exchange offers and--
Bruce Karsh: Default rates in the high yield bond markets spiked to double digits two years in a row. It was really a great time to be a distressed investor. And by the way, we had much more money than virtually anybody else. I mean, this was, I think, that period really put us on the map. Those returns were--you know better than me, like 40% or something.
Howard Marks: 45% a year on those funds. Without using any leverage. So if you're ever tempted to compare the returns versus private equity, for example, which I would say in those days probably aspired to the same thing, but was using 5x leverage. So this is--now this is an interesting thing. Who here has learned about the efficient market hypothesis? Okay. I think it's--I think you can state on the face that if the markets are efficient, it should be impossible to ever make 45% a year without using leverage. So I think that this record proves that there are, let's say, at minimum, there are exceptions.
Bruce Karsh: Can I make one other point. In this environment, I decided, and Howard and I would always confer on these kinds of issues, but I decided, Hey, maybe this is not the time necessarily to be safe and secure, and stay senior, and buy something at 70 that's just gonna go to 100. Maybe now's a good time to buy something at 10 and 20--the original business plan. And we did that in spades. And that's one of the reasons we got the kind of returns we got. Because really, and truly, bonds were selling at five and 10 cents recovered 30 and 40 cents.
Howard Marks: But this goes back to cycle cycles. And I don't know if they teach a course here on cycles, Chris, probably not, but I mean, one of the greatest lessons you can learn is to observe and learn from cycles. Now, that happens to be a plug for my next book, which will be on cycles. But I think it's very important. And the point is that as--in the environment, in the world, as the economy gets better, and companies report better results and securities appreciate, what happens is people become more enthusiastic, and more bullish and less risk averse, and they buy, buy, buy. Then, what happens eventually, things soften, the economy comes down, corporations report worse results, markets decline, people get depressed, sell, sell, sell. So what are they doing? If you think that's an accurate representation? They're buying up here, with the greatest fervor, I mean, obviously, they're buying all along, that's why the market's rising, but they have the greatest fervor here, that's what makes a top. And then they sell down here. And that's what makes a bottom. And clearly, that's the opposite of what you should do. So it's extremely important that everybody understand where we are in the cycle, and what behavior is called for. You should not act consistently throughout the cycle.
Bruce Karsh: Now I want to ask Howard a question, because we had a great run in II and IIB, and then we raised our next series of funds, III and IIIB, and those did quite well. In fact, those were double. I mean, we had almost--
Howard Marks: 780mn.
Bruce Karsh: Plus a separate account of 100mn. So we had really almost $900mn, which was--now all of a sudden, you're talking real money, even back then. I mean back then it was huge--
Howard Marks: I would say as Everett Dirksen would say, but nobody would get the reference.
Bruce Karsh: Yeah, okay. And we did a nice job putting that money to work. And then it was time for--so everyone's loving us. We are their favorite manager, best performing funds, great IRRs, they're throwing dollars at us. Now all of a sudden, Howard, it's not so hard to raise the money. But we made an interesting business decision,
Howard Marks: For Fund IV.
Bruce Karsh: For Fund IV. And I think it's worth kind of talking about what went through our mind--and it really dovetails with your notion of cycles.
Howard Marks: So for Fund IV, on the back of this great success, we went to people and we said, For every dollar that you had in III and IIIB, you can put in 50c in IV. And Fund IV was $386mn.
Bruce Karsh: It could have been four times that. Easily.
Howard Marks: Yeah. And there were not many opportunities for Fund IV. Having a smaller fund permitted us to take advantage of the ones that were there, and we had a decent return--in the 20s--but not what it had been. The key is, there's a great temptation. If you have a great fund, you make the next one bigger. Because the higher, the bigger the fund, the more your fees, the more your potential carried interest. I think that the--
Bruce Karsh: That was a huge decision on our part.
Howard Marks: The great success of Bruce's funds--II, IIB, III, IIIB--put us on the map. But I think that action in IV created our reputation.
Bruce Karsh: It really did. The clients stood back and said, Wow, these guys are taking a quarter of the money they could take. And they're telling me they're doing it because they want to keep the returns high. They share--they're looking out for me. They care about my interests more than their interest, because their interest would be to raise the most money possible. And I think, from a business perspective, that was a huge thing. And I think it helped us as we started Oaktree, and Oaktree's next, right?
Howard Marks: And so we started Oaktree in '95. And the neat thing is we did not have a budget, we didn't have a profit plan. We never--nobody ever said how much money we think we're going to make. What we said was, We've done a good job for the clients, we've produced good returns. If we can keep doing that, we'll have a success. Period. That was the whole discussion.
Bruce Karsh: The mantra was Put the clients first. The client's interest always comes first. And that was the reputation we developed over time. Now I've got a question for you. Oaktree was your idea. You came to me and asked me, Hey, how would you feel? What motivated you, besides Nancy?
Howard Marks: Well--
Bruce Karsh: His wife.
Howard Marks: Yeah, my wife gave me a big kick in the pants. But no--but the truth is, I think that we had positive reasons and negative reasons. I think the positive reason was that we thought we could do a good job for the clients. We wanted to have a firm that ran our way. When we were at TCW, we were one division of a company with 50 divisions run 50 different ways. Aggressive, defensive, top-down, bottom-up, forecasting agnostic, every which way. And I had a senior position there, and I didn't want to shill for businesses I didn't believe it. And we had a--as you can see, we had a feeling for how money should be run, and we wanted to have an organization that ran that way. That was the positive reason. And of course, we thought we could make money, because at TCW, they got half the fees, and we didn't think--in a business like Bruce's, we get 20% of the profits. And if there's a management fee and they do the marketing and the market support and the accounting and the legal and the premises and every--Okay, they get their percent of it. But when--if Bruce can turn $10 into 20, and you get a $2 carried interest on the profit, why should they get half of it? And that's where they drew the line at: half. So we left. And we thought we could make more money. So those are the positive reasons. And the negative reasons were that we could not--we wanted to become owners of that firm, in a substantial way. And they didn't want to share that. So we went out and we did our own. But I want to tell everybody in this room something I think is really important. As Bruce says, I was the boss. And--
Bruce Karsh: I haven't said it.
Howard Marks: In this group.
Bruce Karsh: Can I say my piece first and then let you talk?
Howard Marks: Yeah, sure.
Bruce Karsh: So I was asked about my relationship with Howard, which is 30 years now. And I said, Well, he was my boss. He hired me. I said, But he was the world's greatest boss. I mean, just so constructive, optimistic, always encouraging, and never--if I made a mistake, which of course, everyone makes mistakes--would never get down on me for--just the world's greatest boss. And I would tap dance to work every day. And that culture that he set, and that we ultimately set together, has permeated throughout Oaktree. And it's really, I think, created some real business success for us. But when he came to me and said, Hey, how about being my partner, and starting Oaktree? And we've--I said, Sure. Are we equal partners? He said, Yeah--
Howard Marks: Well actually, the way I tell it--Bruce said to me--he's not such a teddy bear, as he seems.
Bruce Karsh: Come on!
Howard Marks: And I said, Well, how about starting our own firm? He said, Sure, come with me with proposed economics. And I went to him--I thought it over for a couple of days, and I went to him and I said, Look, here's what we do: I'll get 40%, you'll get 25%, and our other colleagues will split 35%. And Bruce said, No, no. We should be equal. And I thought about it for a minute, and I said, Yeah, you're right. And that was the best decision I ever made. If you can--and it's a great lesson for business, because there's a tendency for each person to want to keep more for themselves. But the truth is, that's not always the right decision. And our joint decision to be equal partners was the best decision that we ever made.
Bruce Karsh: And the point I wanted to make is, when he was my boss, and then when we were partners, we've had--enjoyed the same relationship throughout. It's just, it's been a joy. And I think it really has contributed greatly to the success of our enterprise. But I mentioned that, earlier, that in 30 years, we've never had an argument. We have business disagreements, certainly, but never an argument.
Howard Marks: And it's by hashing out our business disagreements that we get to better answers than either of us could come to by ourselves. But this business about keeping more for yourself--when we went out on the road to try to convince--we had--so we had $7bn under management when we left TCW. And our hope was that we would bring it over. So we went around to the TCW clientele, and we tried to win them over. And one of the questions they asked was, Well, what is your attitude towards sharing the ownership of the firm with other employees? And I told them a story that I got from a kids book, when I was reading to my son, that the sun and the wind are having a argument about which is more powerful. And they can't settle it. So they say, Well, you see that guy walking along the mountain ridge--he's wearing a coat. Whichever of us can get the coat off that guy is the more powerful. So the wind blows and blows and blows and blows and blows. And the stronger it blows, the tighter the guy holds the coat. And then the sun shines his warming rays, and the guy takes the coat off. And it's really just an example that--I mean, business can be an incredibly positive place. And we've had an incredibly positive experience. And sharing, and integrity, and straightforwardness, and as Bruce says, Putting the client first--makes it incredibly rewarding. And we've been successful, professionally and monetarily, but I think both of us would say that the greatest thing has been the opportunity to be successful on the high route.
Bruce Karsh: Yeah. Definitely. Definitely. That's--I guess, when we started Oaktree, Howard wrote our investment philosophy and our business principles. And sharing the fruits broadly was one of our key business principles. In fact, we were one of the very first of our type [of] firm to really broaden the ownership of the equity--we did it after our first year in business.
Howard Marks: There were five of us who owned it when we started it. At the end of the first year, we made that 18. Two years later, we made it 26. And a few years after that, 35.
Bruce Karsh: And I remember you saying at the time, I want to have less and less of a growing pie. And ultimately, that's what happened.
Howard Marks: And that's how you make it grow--is by owning less and less. Now, on the other hand, remember I said--we were Princeton's office. And I said, I'd like to see everybody in the firm
Bruce Karsh: No one can speak to him, no one will know.
Howard Marks: Nobody will know. And I said, like them, I said, I want everybody in the firm to be an owner. And Bruce said, he said: No. He said, The people who can really make a difference should be an owner. So, from the beginning, we've had 25-30% of the people at Oaktree have been the owners. The day that we sold stock to outsiders, first through a private offering and then by going public, we had about 120 owners, as I recall. If you look at the other firms that went public early in the alternative investing business wave, they had three or four owners--a couple of months before the their IPOs. And I think that has made a big difference. We've had very low turnover. We have happy people. And we have a camaraderie. And nobody is afraid of getting stabbed in the back. There's not a lot of currency in gossip. Everybody understands that team success produces success for them. And one thing I'm very proud of is: we do not keep individual balance sheets. There's this expression: You eat what you kill. And I don't--we don't care for that. And we don't say, This person made us $300mn and that person made us $400mn, and that person made us $200mn, let's pay them in proportion to their profits last year. We pay on the success of the company, the team, and the individual's contribution--not just quantitative, but qualitative also. Not just this year, but over the years, and what we see for the future. And obviously, we do it because we think we're right.
Bruce Karsh: Culture meant so much to us when we were starting out Oaktree. Look, we both made a lot of money at TCW. If we wanted to, we could probably could have retired then and there. But if we're going to build a firm, we want to--and we're going to work hard, and we're going to spend a lot of time there--we want to do it with people that we really liked and respected and enjoy their company. And we wanted to, literally, continue to tap dance into work every day. And that's something that we put a lot of time and effort into in the early days.
Howard Marks: And in our business, there are a lot of people who are really smart and can make a lot of money-- and they're a pain in the ass to work with. And we've had a No--shall we say--No idiots policy. And we've stuck to that pretty well. And we--there was a point in time where we had to part with somebody, because we concluded that we had made a mistake under that policy. And we did it, and Boy, the organization loved it. Because they said, this is--we really put our money where our mouth is. And this was an individual who was making us a lot of money. But we concluded that it was wrong for the culture.
Bruce Karsh: Can I come back to something I mentioned--I mentioned that Howard penned the investment philosophy of Oaktree and the business principles--day one--which I'm not sure we changed a word of in 20--almost 22 years now. So I've been told by several people that Howard Marks is the greatest Brand Builder in our business--and he's built a tremendous brand: Oaktree. And I think it dates back to the early days, the investment philosophy and the business principles. My question to you is: Was that conscious? Did you set out for that? Or, what prompted you to put that down in writing? And have you thought about a lot of what you've been doing as building the Oaktree brand?
Howard Marks: Well, I would say that building a brand sounds cynical, or manipulative. But building a reputation, building a standing, is what I wanted to do. And I--for some reason, I never felt that all I wanted to do was make money. But I felt that I wanted to have: 1) build money--make money the right way, 2) have a great experience, and 3) associate with people who are worth associating with.
Bruce Karsh: Looking at the investment philosophy, the very first one was: control risk. And the great thing about having that as our number one investment principle in our investment philosophy is that everyone at Oaktree buys in. And that's huge. Howard mentioned that at TCW, we had learned that people were managing money all different ways. Some cared about taking maximum risk, and others--there are all different ways to do it. But at Oaktree, we all bought into the philosophy of--remember my first letter to investors. I quoted Warren Buffett, my hero. And he had two simple rules of investing: never lose money on any investment and don't forget rule number one. And so everyone bought into that. And it's really made a difference.
Howard Marks: And it's great to have an explicit creed for everybody to follow. And every employee knows what the essence is, and the route to success. And every client knows what the route to success. And we don't promise that we can shoot the lights out in the good markets, we promise that we will do very well in the good markets, but protect them in the bad markets.
Bruce Karsh: And that's why I don't--I didn't take the comment about building a brand as being cynical, because to me, the brand that's built is risk consciousness, putting the clients first, all those kinds of positive things was the connotation.
Howard Marks: Well, and I think the answer to your question--What was the motivation--is that I, and we, wanted people to know what we stood for. What do you stand for? And I think, by the way, in the--it's great if you go into a business career and you stand for something other than making money. And so we put it out, and it has helped us immeasurably, that clients say Oh, well Oaktree is this, this and this, but they're not that and that. And that's the mix we want. Well anyway, obviously, we can go on for a long time, and we love what we do, and that we do it together. But I also want to have some time to answer your questions. So, who's got the best question? There's the first hand, anyway. Hold it, there is a microphone--I put it right in the middle, Jen.
Audience Member: As time has gone on, distressed investing has become more crowded. And so it may be argued that it's gone from just saying Buy at 10 and sell at 30 to really having to substantiate at what price something's worth. I was wondering if you could talk about how you maintain an edge in this crowded environment?
Bruce Karsh: Good question. Question is how you maintain dis--
Howard Marks: Well, when the field gets more crowded, how do you adjust?
Bruce Karsh: Well, you just have to be more cautious of the risk and be more secure and just be--just be more defensive. Be more cautious. More patient. Those are--a lot of--it's hard for a lot of investment professionals to do that. It's in our DNA. If it's time to sell, we'll sell. If it's time to hunker down, we'll hunker down.
Howard Marks: And another thing I'll add, though, is that--I learned about the Efficient Market Hypothesis literally 50 years ago. And what were the things that contributed to inefficiency: ignorance, failure to understand, lack of data, lack of infrastructure in the market, lack of legal permission, and so forth. And in all of these regards, the world has become more efficient. And I know you don't mean to say that Distressed debt has become more efficient, but not the others. Every field. I wrote a memo in January of '14 called Getting Lucky--not in the campus sense. But--and I talked about the luck that I had experienced in my life. One of which, part of which was to find markets in their infancy--high yield in '78, distressed debt in '88--when others weren't doing them. The world has become much more efficient today. And I spent half the memo on that subject. And it should. It makes no sense that it wouldn't. Knowledge is cumulative. And in particular, in the investment business, if somebody goes into a field at its beginning, and produces good results for 10 years, everybody else says, Hey, let's go into that field. And it becomes more crowded. But, there's no magic formula for continuing to be on top. But number one, I have to think that you must be aware of the process. And number two, though, and I say in the memo, it has gotten harder to beat the competition. The margin of superiority probably has declined. But as long as you're the best in turning $2 into $3, you will be well paid. And I think we still are.
Bruce Karsh: And let me just add one quick thing: Don't give up on distressed debt. There's a lot of corporate debt out there. And we have a saying that supply trumps demand--and we said that before what's his name. But supply trumps demand. And you get a pickup in defaults with the kind of $2tn high yield bond market we have right now, I don't care about all the incremental competitions come in--we can find some good returns.
Howard Marks: Well, in 2007, 2008, our funds had always been a billion or two--we thought there was something coming, and we raised $11bn for what we thought would be a crisis, which did materialize. Number one--and we were able to raise it, because we had always told clients the truth and told them when it wasn't time to invest. So that made it easy when it was time to invest. But they said, Well, we're gonna back you because we believe in you, but where would you possibly find opportunities to invest $11bn? And when the stuff hits the fan, and when the credit market slams shut, and when defaults start to roll in, and there are deep markdowns and rating reductions and forced sales and margin calls--as Bruce says, supply trumps demand.
Bruce Karsh: We invested $5bn and $11bn in three months: October through December, 2008.
Howard Marks: Another question. There.
Audience Member: Good afternoon. My name is Adam [Lipschitz], I'm a junior here. Thank you very much for speaking with us. I have a question for Mr. Marks. Earlier in your career, you spent a lot of time at Citigroup, time and other large institutions. And then--you kind of speak about how you just came up with the idea that it was time to go off on your own. I'm wondering, as college students, when we enter the workforce, How does that--like, when does that light bulb click off that you had had a reputation for several years now, Why at that point you decided it was time.
Howard Marks: There's no magic. These decisions are not easy. Normally, there's something about your job that--hopefully there's something attractive about the job you're considering, and something you want to get away from in the job you have, some way you can improve upon your situation. And eventually, the balance of the evidence tilts in favor of going. As I said before, it helps to have a wife who gives you a good kick in the butt once in a while--I tend to be more contented. And by the way, I was the last of my colleagues to leave Citibank. And everybody said, What's wrong with that guy? What makes him so happy with the bureaucracy? But I think I got the most out of it, and I left at a good time. But there's no magic time. These decisions are not always easy. But I will--I like to tell stories, so I'll tell you one story. I hope this doesn't offend anybody. All humor offends somebody. But there's a flood in a small southern town. And there's always a flood in a small southern town. And they're going around in a rowboat to try to find people to rescue, and they find a guy sitting on the edge of the roof with his feet dangling in the water. And they say, Okay, hop in the boat, we're going to save you. You're okay. He says No. He says, I'm a born again Christian. I put my faith in God, I know God will save me. So thank you very much. You may go on. They go away. They come back a couple hours later. Now the guy's standing on the peak of the roof. They say, Okay, hop in the boat. Now we're really gonna save you. He says, No, I told you before, I have faith that I will be saved. So you needn't worry. Go about your business. Come back an hour later in a helicopter this time, the guy's standing on the chimney, and he's on his tiptoes, and he's craning his neck, and the water's up to here. And they say, Okay, we're going to drop a rope. You're lucky. We're going to save you. He says, No, I've told you before, I will be saved. My faith is intact. Go away. So they go away, the water rises a little bit, the guy drowns. He goes up to heaven, he runs into God. And he says, I put my faith in you. And you let me drown. How could you do that? And God says, What's the matter? Two rowboats and a helicopter isn't enough? The point is, these things come along--there's no sign which says, This is the time. You got to dope it out. You will pass up a few things that you should have taken, you may jump too soon. But you measure the pros and cons, and hopefully you'll make a good decision. Yes, you ask a new one. Right there. Yes.
Audience Member: Hi, my name is James. I'm also a junior, thank you both for being here today. You mentioned the importance of knowing the cycle and where the cycle is--where do you think we are in the cycle today?
Bruce Karsh: Beginning of the end.
Howard Marks: Or the end of the beginning. Well--
Bruce Karsh: Late.
Howard Marks: We're in an advanced stage. We're not--we're not at the bottom. We're not just beginning to recover. We're not in the midpoint. Bruce and I agree that we are in an advanced stage. There are very few bargains around, nobody's negative, the capital markets are extremely generous, you can do unwise deals, poor companies can get funding, you can raise money without announcing a purpose, the market is not acting as a disciplinarian, prospective returns are low, prices are high. So that's not the juicy part of the cycle, that's the extended part. The only thing is, it may be the beginning of the end, but that doesn't tell you where the end is. And we could go on this way a year, two years, three years--we probably think that it's not going to go four years. But you never know! And the business--the idea that I'm only going to buy when time is ideal is impossible. Because you never know when it's ideal. You never know when you're at the bottom in terms of buying, you never know when you're at the top in terms of the cycle. And you just--
Bruce Karsh: You never know what the catalyst would be.
Howard Marks: That's right, That's right. And all you can do is adjust your behavior.
Audience Member: I was just curious, why did you all decide to take the company public?
Bruce Karsh: I'll let Howard answer that one.
Howard Marks: Well, there's a couple of reasons. Number one: when it became possible, starting with the going public of Fortress, in...
Bruce Karsh: 2007.
Howard Marks: February of '07, I think it was. Companies like ours became very valuable. And a year or two before that, we weren't talking about big numbers. All of a sudden, we're talking about big numbers. And, number one--so we could--we were able to do our first deal in '07 at a $7bn capitalization. We had already given away a third of the company, to our colleagues, and we--frankly, we didn't feel like giving away the other two thirds. And we wanted to continue to have a generational transition, and to continue giving stock to our colleagues, as we have. But we also thought it would be nice if we got a public price for the balance, and we thought that a public offering was a way we could accomplish the generational transition. We also felt that while there was the possibility of conflicts of interest or other negative effects from being public, we thought we could manage that. And I think we are very strongly in agreement that we have not had any negative impact from being public. And it's now--
Bruce Karsh: Around the world, it's actually burnished our reputation to some extent.
Howard Marks: That's right. Last question. Yes, you been waiting a long time.
Audience Member: So, disregarding market cycles that relate to those questions that people asked--so when you're advising clients to invest like 50c on the dollar, when you make that kind of decision, was your analysis more of like a common sense... this is how we think about what people are doing, or was it more based on like, academic analysis, like that's your background, in economics--
Howard Marks: No, it was all common sense. Where are we in the cycle? What's right for the client? What's coming? There's no such thing as analysis of what's coming. We don't know anything about the future. And you can't prove anything about the future. But if you've been in business, and you've seen some cycles, and you've gained some experience, and you've gone through those cycles with your eyes open, saying, What are the implications of cycles and for our behavior? Then I think you can reach a point where you say, You know what? It just feels like the power is in the hands of the issuers, not the buyers. It feels like there aren't many sellers, just a lot of buyers. And the market is not acting in a disciplined way--we want to buy when the market is panicked, not when the market is sanguine. So, Buffett says, The less prudence with which others conduct their affairs, the greater prudence with which we must conduct our own affairs. When other people are optimistic, we should be worried. When other people are panicked, we should turn aggressive. And that's what we try to do. But it's--when you read my book, there's a chapter saying that the most important thing is knowing where we stand. And it's all--it's almost all intuitive, subjective, qualitative.
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