Transcription
This is a very different milking from a year ago. We were still talking about the golden age. There was this promise of all these retail funds. The fears about software haven't been fully realized. How much it has changed for you and how you view this industry in the past year?
Well, in some ways, the industry has matured in that it's accepted that there's downside to private credit, and to credit in particular, and that underwriting standards are critical to investing in credit as well. You know, during the period after the global financial crisis when rates declined and spreads were low, it was really hard to differentiate. There wasn't very much dispersion in outcomes, in investing at high risk credit versus lower risk credit, and so, selectivity and caution was not really rewarded. Today, it is being rewarded.
There is risk that is built up in the system. We saw over the course of the last twelve months cases of fraud, which some call cockroaches. We've seen one person in particular, but yes. And we've we've seen a war. We've seen reasons for true economic volatility. But against that backdrop, we've seen a market that has been quick to shrug off really meaningful changes in the fundamental economic underpinning of the globe.
Is it too quick to shrug it off? I think it's been too quick. I think there are real fundamental economic issues that the markets are not appreciating right now. And I think there's a whole host of reasons why. I mean, I think one is that the fundamental backward looking performance of companies is quite strong. I think another reason is there's tremendous liquidity in the markets following the, the COVID stimulus that was printed. There is a need or a desire to stay invested. And as a result of that, the market looks for reasons to look through the economic data.
Now, for example, when it comes to foreign policy or politics in general. Mhmm. The market believes at this point that Trump won't do anything that will really permanently damage the economy. Right. As reflected in market prices. And if you use that as your barometer, then, as an investor, then you'll say, well, maybe I should just stay invested because I don't think anything that bad will be allowed to happen. And so why go to the sidelines? That's been very apparent in risk markets, for example, with equities trading at all-time highs.
Where else do you see some mismatch between fundamental reality and what markets are pricing? Well, even in private credit, today, spreads have widened out, but they haven't widened to levels that would indicate a significant amount of stress. Fund flows in private credit, although a very small portion of private credit, the semi-liquid BDCs are outflowing. We've seen a bounce off the bottom for publicly traded BDCs. We've seen really no change in the flow picture for institutional interest in BDCs. So, or in private credit, excuse me. I would say that there are indications regardless of where you look, that things are at all-time highs. And when you kind of overlay the Iran war, when you overlay some of the software pain that we would expect to see over the course of the next couple years, it's a little bit of a head-scratcher as to why the markets are as robust as they are.
But this is the thing. If a complete rethink about our society because of AI doesn't change things, if a closing of a strait that controls 20% of the world's energy flow doesn't change things, if a complete disruption to our trade regime doesn't change things, what can? Because many would argue we're just more resilient now, and that's all there is.
Well, we certainly are more resilient, and I think the AI picture has both positives and negatives. It has positives when it comes to capital deployment and investment. There's real economic benefit to that. It has negatives in the form of labor. So right now, the markets are favoring capital deployment over the negative impact on labor that AI may have. I think oil is possibly one area that could tip over the markets. We have seen diesel and gasoline and jet fuel prices up 50 to 80% since before the war. Pain at the pump will impact consumer behaviors at some point. They won't fly as much. But then there's also a rerouting that's happening in energy markets globally, that will cause disruption as well if this war continues and if the supply disruption continues to be the status quo.
And I remember you told Matt and I last time you joined us that oil above a $100, that that worries you, that it could mean that we're headed towards recession. We still are around those prices. Yeah. So what does that mean?
Is your I think we're getting closer and closer. Okay. And the reason I say that is if you look at stocks of refined products in Asia, for example, Asia is probably the hardest hit from the closure of the Straits of Hormuz, where we can measure the stocks in weeks. And that is a problem that will reverberate throughout the global economy. Trade routes around how both crude and refined products are sold will change based on where refinery capacity is versus where the crude feedstock is. And it's beginning to happen now. I think that we are approaching the end of our capabilities to have a protracted war with Iran, and we are turning on the strategic reserves. We are opening the strategic reserves globally. The IEA has already distributed about a hundred million of that $400 million barrel commitment. So that's what's smoothing over oil prices. It could be a lot worse if the strategic reserves were not released. So we're watching that very closely. But if this elevated price action in both crude and refined products continues for, you know, a few more months, it's going to be a huge problem for the economy.
How does this change how you're investing, what you're doing at Oaktree?
Well, you know, Oaktree, as you might know, we are merging with Brookfield Asset Management. And Brookfield's considerable resources globally in infrastructure, real estate, private equity, power, and renewables, is touching so much of the global economy. So right now, we are actually preparing and really building those pipes between Oaktree's credit capabilities and Brookfield's asset management capabilities to really find the right opportunities globally. We're in preparation mode right now. There isn't a tremendous amount of fat pitches or very discounted either equity or debt that makes sense to buy in droves right now, but you have to prepare.
And you assume that will come, it sounds like, that we will get a period of correction of dislocation that you can find the babies with the bathwater.
I think so. I think so. We're looking for good companies with bad balance sheets. And right now, we definitely see some very good companies that we would buy at the right prices. We're seeing deals as well in the AI space that are, when structured appropriately, attractive investments. We are not standing still. We certainly are investing, but we are reserving our dry powder as much as we can.
Are you surprised that with all the concerns about BDCs that there hasn't been more sold to meet liquidity needs that have been priced more attractively?
Yeah. I think the initial trades happened with such high dollar prices that people said, oh, well, you know, nothing to see here. And so there wasn't, like, a cascading effect of further sales. Also, the semi-liquid BDCs have a quarterly redemption queue. So we won't see the June number until sometime in May, probably late May or early June. And I think at that point, we may see another round of selling. But this initial round was quite contained. The prices were quite high. I think those sellers that sold sold their best assets in terms of they didn't sell all their best assets, but they sold out of their best asset pool. So next round might be, who knows? It depends on how problematic the range of redemptions are.
What I'm more surprised about is that the banks have not tightened the screws as much on the lending that they provide to the BDCs. We there certainly has been some tightening, not as much as I would have thought. And there certainly is a little bit of offloading happening in banks right now with trades to the investment manager universe to really derisk the bottom part of their exposures to those types of borrowers.
Well, it also comes back around to this idea that credit spreads are quite tight. Do you think the cost of capital is going to change because of not just the economic risk, but also banks' willingness to lend?
Well, it'll change because rates are, I think, pressured to the upside rather than the downside. One, just given the inflation that we're seeing already in energy prices and should expect to see going forward, I think that that alone puts pressure on rates. Spreads are at all-time tights, and I think that that is a little bit of an overcorrection. It should, I think, just given some of the risks in the economy, I think that should widen. They should widen. But right now, the market with respect to spreads is backward looking, and the performance of these businesses has been quite strong. And then when you overlay the productivity gains from AI, from instituting AI into legacy businesses that are outside of software, it's assumed that profit margins will improve. So investors are actually looking through the market and saying, well, backward looking looks pretty good. Forward looking AI should make profits look better. So maybe it's appropriate that these are at all-time tights.
Armen, just quickly on your BDC because you did have redemptions that exceeded the 5%. Have things come down at all?
Well, it's quarterly. Sure. And I would say that the conversations that we have with our investors are a little bit different than others because Oaktree, as a firm, is really rooted in below investment grade investments on a performing and non-performing basis over a thirty-year period. We are synonymous with investing in a countercyclical way. So our investors don't appear to be quite as concerned about excessive risk-taking in our portfolios because we have entered this period, generally speaking, at Oaktree in our performing credit strategies with either no leverage or less leverage, and a lot of dry powder to actually invest into the cycle. We will be actually investing into the cycle when we see that opportunity present itself. It's just not right this second. And I think that that message actually resonates with our investors writ large across Oaktree.
So when the correction happens, you know you're going to join here and tell us what you bought. Right?
Absolutely. After we do it. After, of course. Yes. Don't want to.