Oaktree's stock stages an impressive rebound

Oaktree Capital Group LLC has more than recovered from its disappointing IPO. Its recent secondary offering was oversubscribed, raising $431 million, compared with the undersubscribed IPO, which raised $380 million. Its stock is now trading at more than a 20% premium over its initial public offering price.

The transformation for the Los Angeles money manager to a public company has added to the riches of Howard Marks and Bruce Karsh, two key Oaktree founders who each made more than $155 million selling shares of their Oaktree stock in the IPO in April 2012 and secondary sale in late May.

Although Oaktree had been in business for 17 years before the IPO, consultants were worried that Oaktree officials might be forced by the pressures of Wall Street to grow fees and profits, sacrificing the firm's conservative investment philosophy that in the past has limited fundraising, the size of its funds and capital deployment until suitable investment opportunities were found.

When money managers go public, there sometimes is a push to offer a constant stream of new strategies even when its unclear they will be successful, said Michael Rosen, principal and chief investment officer of institutional consultant Angeles Investment Advisors LLC in Santa Monica, Calif.

“Oaktree is a case where it is true that things have stayed the same; it is a testament to Howard and Bruce,” Mr. Rosen said.

But the pressure by Wall Street to see Oaktree's assets under management grow has not disappeared.

While Oaktree saw its second-quarter profit soar to $56.6 million, double from a year earlier, assets under management declined 3% to $76.4 billion at the end of the second quarter. Distressed debt strategies, on which Oaktree made its reputation, account for $21.8 billion, more than a quarter of its AUM.

“There is certainly concern about the trajectory, the outlook for AUM growth,” said Robert Lee, an analyst with Keefe, Bruyette & Woods in New York.

Oaktree officials attribute the decline in AUM to the firm's making almost $5 billion in distributions of profits back to investors from closed-end funds in the second quarter and almost $8 billion since the start of the year.

At the same time, company leadership has been cautious in starting new funds.

Mr. Marks, Oaktree's chairman, said in an interview that while the macro outlook on the economy is decent, especially in the U.S., asset prices are elevated and prospective returns are unusually low. “With many investors behaving in a pro-risk manner to access the higher returns they want or need, it's essential that we not forget to incorporate prudence in our investment approach,” he said. “Thus, for the last couple of years, Oaktree's mantra has been, "move forward, but with caution.'”

Mr. Marks said Oaktree raised a new $5 billion distressed debt fund in 2012, but so far has invested only around 10% of the capital because it has not found suitable investments at the right price.

“We have started to deploy it, but there's not that much to buy,” he said. “There is just not that much distressed debt around.”

Mr. Marks said Oaktree won't offer investment funds simply to grow the firm.

“I've spent 45 years in this business, and my partners and I have built up a certain reputation,” said Mr. Marks. “I am not going to spend the next 15 years presiding over the dismantling of that reputation. To us, there's no confusion at all: It's our job to put the client first. We are 100% certain that putting clients first in the short run is the way to maximize value for Oaktree's shareholders in the long run.”

KBW's Mr. Lee said despite investor pressure to grow, Oaktree has managed over the long term to be successful from a performance standpoint and a fundraising standpoint.

“I think it's commendable that if they don't feel it's the right time from a cyclical standpoint to be able to put capital to work with attractive return profiles, then they are not going to raise money and they are not going to push investments,” Mr. Lee said.

Oaktree's largest strategy, closed-end distressed debt opportunity funds, have had strong performance. The funds in aggregate had an internal rate of return of 23% for the time period between Oct. 28, 1988, and June 30, 2013, according to Oaktree data. That span includes seven years before the launch of Oaktree Capital Management LP, when Mr. Marks, Mr. Karsh and other key associates were at money manager TCW Group Inc.

In comparison, the Cambridge Associates LLC. U.S. Private Equity index had an IRR of 14.4% from the fourth quarter of 1988 through March 31, 2013 - the most recent available information.

But that success did not help the firm in its April 2012 IPO, when it sold less than 80% of the available shares for $43 a share, the low end of the price range projected by the company.

Mr. Lee attributed the poor start to bad timing, selling in a poor IPO market.

He said by the time of the secondary sale in late May, the company had showed solid earnings growth, gaining the confidence of investors.

Analyst Michael Kim, managing director of Sandler, O'Neill + Partners LP, New York, said unlike a traditional money manager, where it is expected that assets are going to grow each quarter, at Oaktree there are going to be periods when older funds are paying out but newer funds have yet to start.

“They can have a great business, but their assets may go down before they go up,” he said.

Mr. Lee said he believes shareholders in the company will tolerate that as long as they believe Oaktree will grow assets over the longer term.

“If investors (in the stock) think the company is in a secular decline, that's not acceptable,” he said.

But he said company investors would be willing to tolerate shrinking AUM if they are comfortable with the fact that it will stabilize and then rebound in the future.

Mr. Marks sees an opportunity for Oaktree in institutional investors' need now for riskier asset classes.

“Before the crisis, you could make more than 6% on a five-year Treasury note — in other words, you could have both a significant return and complete safety,” he said. “Today, you have a choice: return or safety. People who aren't satisfied with 1% on a five-year Treasury note have to take on incremental risk to make more.”

Generally, institutional investors accept the fact that they cannot get all their needed return from traditional stocks and bonds, he said. “They're turning to alternative investments: That's good for Oaktree,” he said.

Oaktree has raised $4.3 billion in new strategies since going public, said John Frank, managing principal. One of those is strategic credit, which invests in debt securities such as bank loans that are riskier than high-yield securities but less risky than distressed debt. In an earnings call with analysts Aug. 6, Mr. Frank said $1.5 billion has been committed for the strategic credit strategy, with $2 billion expected by year-end.

Mr. Marks founded Oaktree with Mr. Karsh, the firm's president, and four other partners, all of whom had left TCW Group Inc. in 1995.

He said going public was part of a generational transfer, giving him and other owners a way to put a value on their equity interest in the company and sell some of shares if they wanted.