Q&A: Oaktree Capital's Howard Marks

Q: What do you find most concerning about the global investment environment?

A: We are in the extended stages of an economic expansion and a bull market and this has been abetted by central bank monetary policy. Growth rates are very low all around the world, as in inflation. Interest rates and prospective returns are very low, and I would say the degree of uncertainty is quite high. What are the implications of being so late in the stages? What are the implications of slow growth – is it temporary or secular? What are the implications of negative interest rates? And what are the risks in this environment? You ask what my main concern is. Pretty much everything. We are not at a critically dangerous stage in any of these regards, it’s just uncertain.

Q: Moreover, you’ve written recently about a rise in populist tension…

A: If you go back 50 years and you look at the first few decades of my career, we were in a period of economic growth worldwide – rapid enough that it lifted all boats and it made everybody relatively happy. That’s not happening anymore. There was also a much higher degree of civility in all regards, especially in politics. That’s not there anymore. In the US, in the first half of my career, the two parties worked together for the betterment of the country. That’s clearly not happening now. Some people are being lifted a lot by monetary policy and an asset bubble, and others – people who don’t have technical education or capital – are not being lifted all. So you have greater economic disparity than ever and the people who are not being favored are expressing their unhappiness.

Q: Is the Federal Reserve running out of options on stimulating the economy?

A: In response to rising mortgage defaults in September 2007, the Fed made its first rate cut by 50 basis points, in the vicinity of 5%. It became 10% over the balance of the cycle and ended up close to zero. This had a stimulating effect and the sum of all government actions enabled a recovery. Now we are starting from 2%, not 5%. That suggests some limitations on policy. If we start at 2%, can they still cut by 5%? Can rates go to negative 3%? Who is to say? There has been a lot of quantitative easing and central bank balance sheets have been expanded a lot. Can they expand some more? We are in virgin territory and my main worry is that when you are in virgin territory you can’t say with confidence how things will go.

Q: You previously identified nine reasons why people claim the situation is different this time around, including the belief that continuous quantitative easing can lead to permanent prosperity and federal deficits can grow substantially without becoming problematic…

A: What they all have in common is they are generous interpretations. That tells you the bias of the market. If the market is held aloft by nine pillars, all of which are optimistic – if there are nine ways in which people say this time it’s different and they are all to the optimistic side – then you have to think that asset prices might be high relative to fundamental values and the market might be susceptible to a correction in that optimism if those pillars don’t turn out to be valid.

Q: Is modern monetary policy (MMP) – which in part advocates larger deficits – a fallacy?

A: It is underpinned by the belief that, for example, if the government runs a deficit or borrows money to build infrastructure, which has a rate of return in excess of the cost of capital, that’s a good thing. But would the debt increase be for high-return productive infrastructure or for giveaways, entitlements, raises for personnel for hiring, which are not high rate-of-return expenditures? It is very important everybody realize that governments and businesses do their accounting differently. If the government borrows money and builds and airport, that’s considered a deficit. If a business borrows money and builds a factory, that’s considered an investment. Government accounting is too punitive to governments. Yes, if governments borrow money to build high-return infrastructure that is probably a good thing for society, but I do think that MMP is being taken too far.

Q: What are your thoughts on the China-US trade war?

A: I think war is a scary word; I would say rivalry. In the 1940s, the US had a real war. In the 1950s, 1960s and 1970s it had an ideological war, a cold war. We’ve never had, in the last 100 years, a real economic rival. And now we do. I think China has expressed intentions to achieve great economic progress and some of Donald Trump’s actions are designed to deter that. They are not merely aimed at the balance of payments and technology sharing and trade policies.

Q: Are these tensions likely to escalate?

A: The economic rivalry has been growing for some time and above the surface of the lake it doesn’t appear as though there was much confrontation. Clearly, Trump is happy being confrontational and unpredictable. He feels the rules need changing. He believes that China has been pushing economically and the US hasn’t been pushing back. He would say that China’s incredible progress in recent decades is in part a result of them getting their way and us not responding. When two sides are both pushing in a rivalry, you get developments that are not placid.

Q: Assuming economic growth continues to be sluggish, is the wave of capital entering private markets likely to slow?

A: The one event most likely to make it stop is when these investments start to look unsuccessful. Investors are willing to take more risk because the promised returns on safe investments are inadequate to meet their needs. A US pension fund needs a 7.5% return every year. Nobody thinks you can get that from mainstream stocks and bonds, so they go into alternative, private and riskier investments. Negative interest rates push people up the risk curve involuntarily. They won’t stop until there are signs that the risk they were pushed into taking was excessive for the return.

Q: Does that mean the shift in focus from public markets to private is cyclical rather than structural?

A: I think it’s cyclical, the search for return. You can’t get the return you need in safe instruments, so you move into riskier instruments. The movement of capital into those markets brings up the prices of assets and brings down the prospect of return. Then you must take the next step to a riskier asset to get the return you hoped to get with the first step. Clearly, moving from public liquid instruments to private illiquid instruments is another step where you can further pursue the returns you want at the cost of taking on a further risk. The change might be structural in the sense that, if you go back to when I started in this business 50 years ago, people only did liquid. Now there is a comfort level with illiquid and people are putting lots of money into private equity and private debt. We are probably not going to go back to 50 years ago when people only did liquid. But they might do more of it X years from now because they will be able to get returns closer to what they need.

Q: What impact are these conditions having on Oaktree?

A: I would say the inadequacy of returns on stocks and bonds has increased the availability of capital for alternative investments and that is good for our business. However, we are not taking very much of it because we don’t think this is the time to expand that business. The onrush of capital into these asset classes, which renders them less attractive, has caused us in recent years to increase our caution.

Q: Wouldn’t you want to accumulate capital for strategies like distress?

A: We have a large fund we raised a few years ago that we are investing but it’s challenging because there is so little distress in the world today. The economy is good, and the capital markets are generous. Why would there be distress in anything other than energy? We have a large fund, we are investing it at a moderate pace, that’s all we can do today. But the idea of preparing clients or assembling capital for a distressed opportunity X years in the future is probably a good idea. I once wrote a memo 20 years ago entitled ‘You cannot predict, you can prepare.’ If that’s true, what does preparing today amount to? Assembling capital might be part of the answer.

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• North America
• GPs
• Investments
• USA
• Howard S. Marks
• Oaktree Capital