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Oaktree still sees chance in China's distressed debt, co-founder says

Howard Marks optimistic but warns of risk in Beijing siding with Moscow

Howard Marks, co-founder and co-chairman of Oaktree Capital Management. (Photo by Takenori Miyamoto)

NEW YORK -- Oaktree Capital Management co-founder Howard Marks anticipates more opportunities for the firm's mainstay business of investing heavily in discounted distressed debt. During the debt crisis of developer China Evergrande Group, he captured two prime assets taken as collateral.

But the Russian invasion of Ukraine has made the future of Chinese investments a bit uncertain. Marks, a co-chairman at Oaktree, stressed in an interview with Nikkei that he is optimistic but warned of disappointing results if Beijing sides with Moscow. He is particularly wary of the possible negative impact on Sino-American relations.

Edited excerpts from the interview follow.

Q: Oaktree has been investing in China since around 2015. You have had a constructive view of the Chinese economy for many years; have your thoughts changed now?

A: Very strict lockdown in order to prevent a wave. Smarter people than me have been debating what you should do, and I would not claim to be able to have a good idea. I'm not a public health professional, so I don't know.

Obviously, right now, because of the lockdown, they have a headwind.

But they're also a very powerful central government in terms of the actions they can take.

In their controlled economy, they have a lot of tools they can use to boost the economy.

Q: The People's Bank of China took an accommodative stance in April, lowering the deposit reserve ratio for the first time in four months.

A: I think that they've been trying to reduce the stimulus to get their debt and leverage under control but if they have the banks lend less money, that can accomplish that but it also slows the economy. Now that they have a lockdown, I think they're back to lending aggressively, which means that they'll still have the overleveraging.

They've made the decision that they're going to support economic growth and not apply discipline in the financial sector.

Q: Oaktree made a large loan to Evergrande Group, which defaulted on its debt. You reportedly seized the collateral.

A: When we made the loan, we determined that we need security. Our loan has collateral. Most offshore lenders didn't. Right now, it looks like the right decision. We made a large loan to Evergrande secured by two very strong assets. We hope to come out well.

We're active in nonperforming loans in China. We have been expanding our activity for ... we've been there for, I think, six or seven years. We've been expanding. We've been succeeding. We have good results.

Q: In your March memo titled "The Pendulum in International Affairs," you pointed out that the Ukraine crisis is prompting a swing back from globalization and the onshoring of production. How do you see the impact on the Chinese economy?

A: I think that some business that would've taken place in China will, or elsewhere in Asia, will come here. The biggest example is semiconductors, and China's not the biggest supplier of semiconductors. It's really [South] Korea and Taiwan. But other factors will determine the short-term trends in China more than onshoring, offshoring. I hope that China acts to preserve its role in the community of nations. I think if they side with Russia, then that'll be a disappointment.

We'll continue to [invest] as long as we have good results. The global tensions make you wonder how this is all going to play out with China vis-a-vis the U.S., etc. So far, everything relating to our business in China is going fine.

I think we're still valued partners over there, and we value the opportunity to invest over there. But you have to say that recent events cast some doubt on the situation, but we are optimistic. But we understand that some matters have yet to be proved.

Q: What investments do you find attractive?

A: We're not big common-stock investors, and we're not technology investors. Those are the two areas that boomed and then have busted. The things we do, I think we're in good demand and continue to be in good demand. Most notably, we are credit investors. We are active in high-yield bonds. That's where I started in 1978 with Michael Milken.

In the boom of post-COVID, the yield on high-yield bonds got down to 3%. Most investors, our clients, are mostly institutions, and, for example, a pension fund needs 7%. But so if you need 7%, you can't buy high-yield bonds for 3. Today, the average high-yield bond yields 6.8.

If an investor can get 6.8 from a credit instrument, from a good company, I think there's going to be strong demand for them. Because that's a healthy return with a high probability of success. People always think about, how much money could I make, what could the return be? But they should also think about what's the probability of success? The beauty of investing in debt or credit is that you have a high probability of success.

Q: Are you concerned about the future of the U.S. economy?

A: What I think is that the Fed will overcome inflation eventually, but it'll have to raise interest rates substantially. It'll have to shrink its balance sheet, which will absorb money from the economy. Most people think it will produce a recession. [Then-Fed Chairman] Paul Volcker showed in the early '80s that you can get inflation under control and how, but it's painful. When you overstimulate, as we did, we gave out too much money in the pandemic and the Fed bought too many bonds and continued for too long, so you overshoot and then you correct.

Q: When do you expect the U.S. economy to enter recession?

A: Oaktree does not bet on forecasts. One of our rules is that we do not make investment decisions based on macro forecasts. I caution people, don't bet on my forecasts. I don't even believe my own forecasts, but I would guess maybe 2024. Could be sooner, could be later.

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