Some general partners just get it. Others just seem to be along for the ride.
Oaktree Capital Management is a firm that usually gets it. Howard Marks-led distressed investing titan recently returned $3 billion from its record-setting $10.9 billion OCM Opportunities Fund VIIb.
The fund had run up against the end of its investment period, and instead of asking limited partners for an extension and reinvesting that capital, Marks and his partners decided to call it a day.
This story, however, goes beyond investment period extension requests. Oaktree’s other reason for returning a portion of the fund was that the market had changed. The distressed opportunity that existed back when the fund started investing in 2008 – when other firms talked about not wanting to “catch falling knives” and Oaktree talked about catching them at just the right angle – was gone.
Back in 2008, risk was high and so was the expected return on capital – targeted gross returns on Fund VIIb were 25 percent or more. But then the market changed – and these days the best returns for that style of investing are likely to be around 13 to 15 percent, according to Oaktree. As Marks told PEI in a recent interview, the firm didn’t want to take capital from the fund and reinvest it in that kind of market. It would rather give LPs the opportunity to invest in new vehicles with returns expectation reflecting a changed environment.
It should be noted that Oaktree has several others funds either in formation mode or recently closed, so it isn't exactly without dry powder to keep chasing deals.
Still, it’s a telling position to take, and it illustrates why Oaktree consistently stands out from the crowd.
The move also speaks volumes as to how Marks and his colleagues see the medium-term future. It says the distressed investment cycle isn’t coming back for a while yet, at least not with the same opportunity set that was briefly available post-Lehman Brothers bankruptcy. Extension period? No thank you.
Extension periods are fraught with problems and a pain to negotiate. In not asking for one, Oaktree is doing itself and its LPs quite a favour. The firm has illustrated once again that in addition to looking after itself, it is very much working for its limited partners.
The bigger question is of course this: who else should be following the firm’s example? According to some, the overhang of uninvested private equity capital is enormous. Should chunks of it be handed back?
Individual managers will be answering this question with a raft of factors in mind. Take a listed manager for example. When a sharp drop in fee income is bound to put pressure on the share price, handing back commitments is likely to seem all the harder.
Once again the message here is “watch this space”: as more funds mature, limited partners stand to be reminded of which GPs really get it, and which do not.