Street Capitalist: Event Driven Value Investments

I’ve only recently been turned on to Howard Marks of Oaktree Capital, but so far I like a lot of what he says. You can find his latest memo The Long View here. Today’s NYTimes features an article about the inclusion of private capital allocators in Geithner’s bailout plan:

Mr. Marks is a former banker who became a pioneer in the graveyard of Wall Street. He is one of the biggest players in distressed investing — putting money into risky investments that few others will touch.

But he and other potential investors are wary of the risk in this case.

With its plan to shore up banks that was announced on Tuesday, the Obama administration hopes to entice investors like Mr. Marks, who has $55 billion at his command, to buy troubled assets from the nation’s banks and enable them to make the loans needed to jump-start the economy…

But Mr. Marks and other investors like him said they were in no hurry to wade into this mess. Distressed investors — “vultures” is the Wall Street term for them — aim to buy investments on the cheap in hopes of reaping big returns.

Yet even for the vultures, the risks — political as well as financial — seem daunting. Some worry about being seen as profiteers who benefit at taxpayers’ expense, even though the economy could get worse unless they swoop in.

“You have to ask whether this is an attractive deal,” said Mr. Marks, the chairman of Oaktree Capital Management, a big money management firm in Los Angeles. It all depends on the price, the terms and the risks, he said. Wall Street, of course, wants what it always wants: a lot of potential profit on the upside, and not much risk of losses on the downside. But as Treasury Secretary Timothy F. Geithner outlined his sweeping rescue plan on Tuesday, the questions kept piling up.

What kind of assets would the banks sell, and at what price? What role would the government play? And, of course, the big one: what are these investments really worth? The banks themselves are struggling to place values on them.

Washington Hopes ‘Vulture’ Investors Will Buy Bad Assets (NYTimes)

I think the main sticking point of the plan has to do with the pricing of assets. Geithner’s terse presentation yesterday did little to remedy that aspect and we saw markets fall. This makes me think that maybe they still haven’t figured out how to do it, and until they do there will be some hesitancy by private market participants. Michael J. de la Merced and Zachery Kouwe do bring up the IndyMac plan, where the government basically offered to step in and take on losses after a 20% decline.

While this plan may appear good on paper, it still poses an issue for institutional fund managers. In order to get paid, these managers need to have positive returns. A loss of 20%, which may seem like only a little, can actually be a lot when you realize that many of these guys were down 30 to 50% for 2008. Losing 20% would only increase that gap and make it more difficult to earn fees.

I’d like to point you all to a recent interview with Marks (LA Business Journal):

Q: You recently sent out a memo called “The Long View” with your thoughts on the turmoil in the financial markets. What do you think was the cause?
A: If you have to single out one thing, (leverage) was probably the greatest part. There’s an old saying in Las Vegas that the more you bet, the more you win when you win. But they always leave out the part about the more you lose when you lose. That’s what leverage is. Leverage does not add value to an investment – it doesn’t make it a better investment; it only magnifies the outcomes.

Q: And the long view?
A: These things never change. It will always be the case that when borrowed money is too easily available and people do not concern themselves with the downside, they will leverage their activities to levels where if something goes wrong they won’t survive. One of my favorite quotes in the world is from John Kenneth Galbraith. He says that one of the outstanding characteristics of financial markets is “the extreme brevity of the financial memory.”

Q: Why did you decide to stay in Los Angeles? Is there a benefit to being away from a financial center like New York?
A: The main reason that I stayed is because this is a great place to live. But we often theorize, especially at times of chaos, that it’s a help to be outside New York because you can see the real outline of things better from the outside than from the inside. New York is so overwhelmingly an investment community that I think it’s easier to have a broad perspective if you’re observing it rather than in the middle of it.

Q: What does it take to excel in investment management?
A: You obviously need to be to some degree numerically facile. You have to have a certain perceptiveness and an ability to look at a picture and see more than the average person sees. It’s so easy to see that the average person will do average. And if a client wanted to do average, they can put their money in an index fund. You just can’t swallow the same story that the average investor swallows and expect to be above average.

Q: Like what?
A: For one example, there’s an article by Charlie Ellis that I think was called “Winning the Loser’s Game.” What I took from that article was the way to succeed in investing – just like the way to succeed at being a B-level tennis player, which I am – is to not make mistakes. The champs win by hitting winners; the B player at a country club wins by not hitting losers. So that resonated with me and that’s one of the things we do. Oaktree’s motto is that if we avoid the losers, the winners take care of themselves.

Pay attention to that last answer, I think it tells us a lot about how to think successfully when looking at opportunities right now. When I discussed Geithner’s new plan, I noted that even a 20% loss may be too much. Marks seems to affirm that with his tennis player analogy, the idea is to dodge losers all together rather than simply limit how much damage the losers can do to your portfolio. I’m also reminded of Warren Buffett’s rule: Rule No.1: Never lose money. Rule No.2: Never forget rule No.1. That’s likely to be the main reason that there’s still a high level of skepticism being offered by investors right now of these new bailout plan. Until more information is released, it’s likely that we’ll continue to be in an environment with shaky confidence and little involvement from private investors.