Why Oaktree Capital (OAK) is Best Positioned for the Rise in the Alternative Investments Industry
Since the end of the 2008-09 global financial crisis, the U.S. asset management industry—despite the rebound in global wealth levels—has underperformed the broad markets. Over the last five years, Morningstar’s index of U.S. asset managers is only up 12.0% annually, while the S&P 500 returned 14.5% on an annual basis. This underperformance is especially pronounced with traditional asset managers with a significant reliance on actively-managed strategies. E.g. AllianceBernstein (AB), Legg Mason (LM), and T. Rowe Price (TROW) were only able to garner annual returns of 5.8%, 8.6%, and 10.1%, respectively, over the last five years, as investors shifted to lower-cost, passively-managed strategies for publicly-traded equities and fixed income.
I expect traditional asset managers to continue their underperformance as they suffer from an ongoing lack of pricing power given investors’ increasing preferences for ETFs and other passively-managed (and lower cost) strategies. Meanwhile, the popularity of alternative investments, especially private equity, private real estate, and distressed credit, continues to rise. Based on my analysis, investors who want to invest in the U.S. financial industry could still find long-term growth opportunities in the alternative investments industry. Within the alternative investments industry, I find Oaktree Capital (OAK) to be especially compelling.
OAK has a market value of $7.8 billion, and an annual dividend yield of 4.5%. Over the last 12 months, OAK has returned about 4%. I find OAK to be a compelling growth play for three reasons.
1. OAK to benefit from ongoing, extraordinary growth of the alternative investments industry
Despite the recent market turbulence, I expect global wealth levels to continue to rise over the next 5-10 years, with a greater proportion of these assets being invested in alternative investment vehicles, such as private equity, real estate, and credit funds. E.g. According to Goldman Sachs, the global alternative investments industry grew at an annual 11% pace during 2005-2013, vs. 5% annual growth for traditional asset managers; yet, alternative investments still only make up 12% (or $7.7 trillion) of the $64 trillion of global assets under management (AUM). I expect alternative investments managers’ AUM to continue to grow at 11% annually; by 2020, alternative investments will make up about 15% of the global AUM pie, worth approximately $14.4 trillion.
This expected growth is being borne out by the willingness of investors to increase their allocation to alternative investments. A recent Preqin survey of over 100 institutional investors indicates that 52% of those surveyed are below their target allocation to private equity/credit, while 45% are at their target allocation. Moreover, 89% of these investors indicated they will increase or maintain their private equity/credit allocation over the next 12 months; with 95% indicating they will increase or maintain their allocations over the long-term.
2. OAK and other large alternative asset managers to benefit from higher market share
Currently, the competitive landscape in the alternative investments industry is still young and fragmented, with significant room for the large, market leaders to gain and consolidate market share. E.g. Within the private equity/credit asset class, the top five firms combined manage just 10% of the industry’s assets. In contrast, the top five firms in the traditional public equity and fixed income space combined manages over 50% of the industry’s assets. OAK—with $103 billion in AUM as of June 30, 2015—is one of the world’s top five largest alternative assets management firm, surpassed only by Blackstone ($333 billion), Carlyle ($193 billion), and Apollo Group ($163 billion). This provides OAK with the scale to hire the best talent, create new strategies and to cross-pollinate ideas, providing the firm with a long-term competitive advantage over smaller alternative asset management firms.
3. OAK has the best growth trajectory among its largest alternative asset management peers
OAK’s distressed credit background is exemplary. Since its distressed debt strategy was incepted in 1988, it has generated a gross internal rate of return of 22.6% on over $38 billion of drawn capital. Altogether, OAK has achieved a gross internal rate of return of 19.6% on over $68 billion of drawn capital over many market cycles, the highest in the industry. OAK’s business model is also more counter-cyclical than that of its peers given its historical focus on distressed debt. E.g. during the 2008-09 downturn, the firm was able to raise $10 billion to invest in distressed credit (ultimately earning a 24% gross internal rate of return) while its peers struggled to raise any funds. Because of this counter-cyclical bias, I expect OAK to do very well within the European and emerging markets debt markets where there are trillions of dollars in troubled bank loans that are waiting to be sold.
By 2017, I expect OAK to earn more than $5 per share, driven by a 15% growth in fee-related earnings, as more than $20 billion in uncalled capital commitments begin to generate fees for the firm. Given OAK’s historical forward price-to-earnings ratio of around 12.5, I expect OAK to trade at $62.50 per share by the end of 2016, for a gain of 25% over the next 15 months.
Disclosure: Neither my firm, CB Capital Partners, nor I hold any shares in OAK.
Henry To, CFA, CAIA, FRM is Partner & Chief Investment Officer at CB Capital Partners. Established in 2001, CB Capital Partners is a global financial advisory and investment firm headquartered in Newport Beach, California, with an office in Shanghai, China and an affiliate office in Mumbai, India. Visit http://www.cbcapital.com and http://www.cbcapitalresearch.com for more information.
