Howard Marks Says to Expect 5% Returns Now If You Start From Scratch

across all asset classes. Frankly, co founder of oak Tree Capital Management. Uh, Howard, in your memo, you really outlined conditions that would necessitate being more cautious. Are we setting up conditions that are similar to what we saw in two thousand six two thousand seven, that are particip precipitating a pretty big downturn? Well, Lisa, it's easy to say we are seeing risky behavior in kind, but I don't

think at all in degree. I mean, the conditions of oh six seven were uh exceptionally excessive and gave rise to, of course, the worst UH financial experience of a lifetime. UM, I don't think we're nowhere near in that territory. Now, yes, I mean the private sector and especially the financial sector is nowhere near as levered as it was at that time. And uh they in many cases the leverage where you

was used to invest in subprime related mortgage backed securities. Uh. And I don't think there's an analog to those now. So I'm not saying that we're looking at that. All I'm saying, and maybe I didn't make it clear enough, although I think I did, is that is that there is a time for caution and there's a time for aggressiveness, and they're different, and it's important for a professional investor

to make the distinction. And I believe that in relative terms, this is a time when one should emphasize caution over aggressiveness. And to be clear, even though you are saying caution, you're not saying and you specifically said that, you are not saying that this is a nonsensical bubble. Uh. It just there is high risk and valuations are high. So how do you proceed with caution? Can you give us an example of a type of asset that would be

an appropriate by at this time? My point is that within each investment strategy, there are aggressive ways to pursue it and defensive ways to pursue it. Uh. An example, one of our activities is distress debt. The higher you are in the capital structure, the more dependably you make money. But when things go well, the less money you make. So do you want to be high in the capital structure and have a very high probability of making money or low in the capital structure and maximize the return

in good outcomes? And I would say that if in a time for caution, you would move towards senior securities, increase your probability of making money, decrease the absolute payoff when things go great. So you're you're willing to pay higher prices for better secured assets even though the absolute return will be substantially less. Right, Well, what you what you call higher prices? I would say, we're willing to accept lower prospective returns for for greater safety. That's what

it's all about. If the conservative investor accepts lower expected returns as the price for greater safety. There are times when that's highly appropriate. There are times when that's highly inappropriate. Our job is to figure out which this is. So. UM, I've heard a lot of pension funds in particular say that they are seeking returns and safety from this sort of a bulliant environment in private debt markets, and there seems to be quite a lot of cash flowing into

private debt. Has it gone too far? And is it keeping companies alive that perhaps shouldn't be. I can't say too far it's gone far. The point is everybody says, oh, you should do this, We were the only ones who have thought of that. Every If everybody is saying you should do this because we're the only ones who thought of it, then it's really obviously not as novel a solution as they're suggesting. So so the eye da private lending UH is not undiscovered. Money has flowed in. I

can't tell you whether it's an appropriate amount or too much. Clearly, the market is more competitive to make loans than it used to be, and when market is more competitive, that implies lower prospective returns. UH. I still think, however, that private lending is more appropriate today than than buying public securities because the public money can't get to the private

lending opportunities. UH. And I think that the public quest for high returns in a low return world has caused a lot of money to flow into senior loans and hi your bonds and so forth. And that is less true about uh, the private dead market. But I'll add one thing. When you move away from public markets, which nowadays we kind of call beta markets because the return, uh, your return is determined by the turn of the market

in large part. To alpha markets, where your return is largely a factor of the skill of the manager, you are accepting a new kind of risk which is substantial dependence on the skill of the manager, which is different than being in public markets, are being in an index fund. Uh. You know, talking about index funds, you talked about the threat of all of the money that moved in moving out in tandem. UM. I hear a lot about cash on the sidelines, and I'm not sure exactly what they're

talking about. I think to a large degree they're talking about private equity funds that have all this dry powder lying around. To what extent will that cash on the sidelines buffer any declines, Well, it depends on where they are and whether the cash on the sidelines is so always say flexible. For example, we raised money for distress debt fund in the expectation that there would be an

opportunity for distress which has not materialized yet. Admittedly, um, and you know, if there is such an opportunity, we're gonna swing into actually gonna put that money to work. This is something we've done in the past. Well, we hope to do it in the future if there's we hope there will be an opportunity, and we hope to

do a good job with it. But given the nature of the investment business, if uh, if let's say, uh, to follow your argument, money flowed out of e t F s and they had to sell the high flyers that have done so well based on e t F buying and they had to become sellers, and that drove them down. We couldn't buy that because we can't take the money we raise for distressed debt funds and buy public equities. So uh. You know, in in the institutional

investment business, we talk about something called buckets. Which bucket is your money for and our bucket is for private distress debt. We can't take that money and buy put it into a different bucket, which is public equities. So if the if most of the dry powder is in private equity and private debt and so forth, anybody who says, oh, you know, if the market goes down, those private equity

guys will just go in and buy them up. It's unlikely because people don't step out of their bucket that often. So this is fascinating. Does that mean that there's more of a floor under prices of private debt, say, or distress debt than there is for equities. Well, of course the private debt or distressed debt guys would say no, no,

we're gonna let it drop before we buy. But clearly, the more buying power there is on the sidelines, the more there's a floor, the less uh things will will drop unremittingly, you were talking about how you don't think that there is the same degree of leverage at investment banks that there was leading up to the two crash. I am hearing more about leverage being used by hedge funds, in particular to buy equities and investment grade credit. How

concerned are you about this? Have you been hearing about this? The willingness to use more leverage after the market has risen making people feel good is indicative of, in my opinion, the need for caution. UH. If people are using leverage today who didn't use leverage five years ago, well, is it is today a better buying opportunity or a worse buying opportunity? Is it safer today or risk here? I would say it's a worse buying opportunity. It's risk here.

So why are you using leverage today that you didn't use five years ago? The answer is, given the low prospective returns in all markets, it's hard to make money today, so more and more people resort to leverage. Leverage does not make an investment better. It only magnifies the results. It magnifies the gains if there are gains, and losses if there are losses. And uh So, the question is why would you use leverage today that you didn't use

five years ago. It's by the way, you know, in Las Vegas, Lisa, they say the more you bet, the more you win when you win. Now, you can't argue with that statement, but but any intelligent person should see the fallacy. Uh you know you're talking about the private equity and then in the cash being raised. I'm wondering, you know, we have heard about the record amount of

money new record funds for buyouts or private debt. Do you think that the worst case scenario for these is that returns will be much lower, or that it could potentially be even worse than that. The most likely negative repercussion is that returns will be hard to come by and maybe lower than investors have in mind. There's always the possibility of negative returns, uh, but that would require uh,

something nearly cataclysmic, you know. I think that. I think that in oh eight, when the global financial crisis was raging after the Lehman bankruptcy, I believe that the private equity font in general, the funds of oh five, six, seven, maybe eight, we're looking at the prospect of losing money. It happens that the government did a great job of bailing out the financial sector, which reopened the credit window, which enabled those companies to refinance their debts and push

them off. And also, of course, the government's bail out brought back the economy and brought an end to the to a significant recession. And the combination of those things meant that those funds will now have moderate, I believe, high single digit returns, and everybody will say, oh, not so bad, and the returns on those funds will not be bad. I believe they could have been worse, but

for the things that went right. So talking about returns just last day, I want to touch base with you on what you expect to be appropriate expectations for returns for say, pension funds at this point. What's an appropriate market if you if if if you walked into a pension fund today which had no investments, and you were given a pile of cash, and you invested today intelligently, prudently but not shrinking from risk, I think you could expect to make something in the vicinity of five in

the in the in the coming years from today. UM. If you take more risk and everything goes right, you'll make more, and vice versa. UM. The problem is, most pension funds need seven and a half to make the math work to make today's assets turn into enough to

pay tomorrow's benefits. Uh. And I think that making seven a half from today will be quite a challenge and will necessitate two things substantial risk taking and and good outcomes, which means that there is a bigger risk of negative outcomes and UH, much lower than even To respond to the Las Vegas people, the more you bet, the more you lose when you lose, So you can't have it both ways. And I think that most investors see that

today's low return environment necessitates substantial risk taking. But substantial risk taking, if it runs into bad outcomes, will will lead to disappointment. That's all we can say for sure. Poward Marks, thank you so much for joining. Thank you, Poward Marks, co founder of oak Tree Capital Management. I can hear Chris Salman singing this song. Chris Salman, the chief investment officer of the California State Teachers Retirement System. I believe he's got a little bit more than two

eight billion dollars under management. Chris, you're on your bicycle now you have one in your office too. I know, I wish I was. I actually tore the meniscus in my knee dancing at my daughter's wedding. So I am off my bike summer, but surgery. I'll be back soon, hopefully. Well it was allah. It was all on a good cause, as they say, exactly. I was dipping her. I I have father daughter dance. I got to dip her and boom out with my knee. I didn't drop though, So

it's okay. It was wonderful. Well good, Yeah, that that's that's sort of like the investment philosophy, right, you know, you take the risk and then you hope that nothing bad happens and you bounce back. Good for you. Agree with Howard Marks. But I have a couple of other points to raise. Well, I want you to raise them. I just want to offer people the context for that California State Teachers Retirement System, which of course is the second largest US pension fund, you earned thirteen point four

percent in the fiscal year ended June. Well done, there you go. That does that make up for the for the bad years? You know? Well, look at this tim we made ten percent over five years. We've made just about seven percent over the last twenty years net of fees. That includes two very nasty recessions. So well, that's that seven and a half bogey, right the seven and a half percent the hurdle. No, it is below that, but

it's right out about seven. We're lowering our assumption rate from seven and a half seven in the corner last year seven percent this coming year. So you said that you had some some responses to Howard Marks's comments where he basically said that going forward, if pension funds were to invest new money today, all of their money knew, not including older legacy investments. That they could probably reliably get a five percent return without taking excessive risk and

risking potential losses. Do you agree with that? Let me frame the way, and I think for your investor listeners that would help to frame that. Think about two thousand, sixteen and seventeen as a vintage year. So your IRA contribution this year, your money, if you invested it, as you're saying, this year new money, what's a realistic expectation for that over the near term? Five percent might be acceptable The differences I invest every year again and again

for thirty years. So right now my portfolio, I have investments that are over twenty five years old that were made in the at the end of the nineties, where they're going to have a double digit return, and I think seven percent over the next thirty years is a realistic number if you use today as a starting date.

And that's where Howard's coming from. Capital asset prices are expensive, whether it's equities, public securities, and private securities are almost priced to perfection, and so we recognize that new money going to work this year may not have that great of our return. This vintage year for private equity, this vintage year for real estate, you can't expect to buy a building at these prices and have a really high return. But as he pointed out, when prices dropped, and that's

when Howard loves to invest. When when prices go down, then he'll come into the market, and so will we. I often say we're countercyclical. We have thirty year money. We don't have to buy at the top. We can wait and be patient and and look for lower prices. And that's been a big discussion of my staff. I was just with a group of c I O s up in Canada last week. That was our key discussion was asset prices being perfection. How much dry powder should

you hold back? How cautious should you be? Are you holding back? Well? Right now, we're over two percent in cash, and my staff met last week and is talking about potentially raising that. We've been taking profits, Lisa, in this US equity market since the start of the year. Every time it hits the new high, we just shave off a little bit of that profit. We've been putting that in Europe and in Asia, but also building up our our de risking assets, assets that that do better or

hold value when the markets go down. Um so those assets didn't do well last year because the market was up so so strong. But we're trying to balance that portfolio. You've heard me say a year after year to the to the listeners. It's all about rebalancing your asset allocation. Don't let your equities run, rebalance into the less risky assets.

And I think that's what Howard's saying. Well, Chris Alman, you know you you spend a lot of time listening to hundits and experts, and you know you read all the reports. I mean, what you're what you're proposing sounds pretty reasonable and you don't necessarily need a PhD to figure this out? Or do you? No, you don't. I listen to you. You're the pundits expert. Don't do that. You know that I listen to you. I ride my bike to work sometimes I and I listen to you guys,

so and I hear and you're right. But my point is, every time you ask, Chris, every time you ask someone went to sell, no one ever has an answer. Oh exactly. But but look at the stage advice from people like Warren Buffett. You buy when everybody is nervous, and you sell when everybody is greedy. So right now things are priced to perfection. But even as Howard, he put out a newsletter last week where he said it's it's they're at it again again, but he admits he's often early.

We're at the we're in the late stages of this economic expansion. But it could last for another year or even two years. You don't know when it will crack. So let's talk ab at that. Because we have heard from some pensions, particularly in UH in Canada, they have been investing directly in companies, buying them directly, basically competing with private equity companies. You know that Cowper's is considering doing the same. What about Calistas. We're looking at the

idea of teaming up with people. We don't think we want to start from scratch um. We want to team up with people that are already in the marketplace. And this is part of recognizing as Pen was hitting me with lower return environment. We can make or return out of private equity, but if we can reduce our costs a little bit of investing in private equity, that enhances

our return. So the idea of going and buying mid sized companies directly instead of the old two and twenty private equity model is much more attractive, and we've recognized the spread and private equity has come down. You're not getting three basis points are full three over public stocks, probably only getting a hundred and fifty or one and half percent over public stocks, but you're still getting a

premium over public markets. Chris just quickly. Is the investing environment for let's say, environmentally friendly companies or companies that respect the environment and so on, socially responsible? Is that a key theme or is that something that was just a buzzword and has gone away PIM I think we're going to see today and into the future. I would describe it as managements that actually think bigger and broader than just the risks that appear in the next ninety days.

Managements that look out three to five years and think about a broad section of material risk to their business. Those companies are going to outperform other companies, says the man who rides his bike to work. Chris Alman. Always a pleasure. We love speaking with you. Chris Alman is Chief Investment Officer of the California State Teachers Retirement System, with more than two hundred billion dollars under management. It's

based in Sacramento, California. Now let's turn our attention to Sprint. I want to find out what's going on there. We've got John Butler. He is an expert when it comes to telecom and telecom equipment, and he is joining us now. He's of course from Bloomberg Intelligence and John Sprint up a ten percent. That's the stock right now. What are they doing? What what's causing this big move higher? Well? Sprinted? Okay, in the quarter, you know, it was steady as she

goes um. Frankly, you know, they always do a very good job about sort of managing investor expectations and giving people the sense that they're writing the ship, and they are, but it really is a cost cutting thing for them more than a top line story. At this point. What I think is driving the stock up is CEO Marcello Clare was asked about potential combinations Charter, Yes, and he told people to expect something coming soon. Um in the

near future, I believe was the term he used. Uh, what are some of the what are some of the possibilities in John Butler's Well, Before I answer that, I'll just say I hope he's right, you know, Sprint has been on the block for a while. Um Soft Bank and in particular CEO uh Massa Yoshi San owns eight percent of Sprint and he has really tried to monetize that asset for a long time now, so tried to sell it. Yeah, and it feels like a house that's

been on the market a little bit too long. You know, it begins to get people wondering as to aging to Yeah, what's really wrong there? But you know there's a convergence now happening between cable and telecom or it's looming more than anything. You see a T and T buying Time Warner getting into content. Verizon has shown interest there through a O L and Yahoo, both of which you have a lot of content, and there's been talk that they're

kicking the tires and media land. So you know, the potential for a cable company to buy Sprint or Sprint to buy a cable company has been high on the rumor mill um. You know, there's again potential, there's bundling potential. They're right where people can buy their wireless, their cable, their broadband all from one provider. You know, I have to say, John and I this just shows the narrow

lens with through which I see the world. But here Sprint, and I think, wow, They're the biggest issuer in the high old bond market and the one point three trillion dollar US higher bond market. They have more than twenty four billion dollars in the main index that people track, And this just makes me wonder. I mean, first of all, would any buyer have to assume that date debt? And

how much of an obstacle is that to purchase? And second of all, if it doesn't fall through, is there chance that Sprint could go into a spiral and sort of fail to pay the mounting UH interest payments that it owes. We'll start by saying, thank god, I'm not our credit analysts. We have a telecom credit analyst named Steve Flynn who who knows the details better than I do. But I will say if someone did acquire Sprint, they

would probably have to acquire that debt. And I think Sprint is on a track now where they're sort of out of danger in terms of making those payments. Things can change overnight and telecom, as we all know, but based on the current trajectory um, I would say they're in pretty good shape for now Apple, what do you expect? You know, the current quarter doesn't matter. People are really all eyes are on September, uh, the September quarter, which

is their fiscal fourth quarter. Um, they have the launch of the new iPhones coming, and just to sort of at the table, we're expecting three new i phones. So we'll get sort of a standard feature update of the iPhone seven and seven plus that are on the market now. So the iPhone seven s and the seven s plus will have a similar screen, probably offer wireless charging, truly wireless,

or waterproof ports, and maybe a better camera. That's typically what you see with you know, those kind of feature upgrades or what you see with that sort of talk

here where you just get modest upgrades. But it is the tenure anniversary of the iPhone, and there will be hopefully a third iPhone called the iPhone X or the iPhone eight as I've been calling it, which will be a much bigger device, rumored to have a five point eight inch screen, no bezels or those little side bars that frame the screen on the side, So they're going bezel lists, which will give you more real estate there. And um, you know there's been talk of Component Delays.

John Butler, Senior Telecom Services and Equipment Analyst for Bloomberg Intelligence. Always our pleasure to speak with you. Thanks for listening to the Bloomberg P and L podcast. You can subscribe and listen to interviews at Apple Podcasts, SoundCloud, or whatever podcast platform you prefer. I'm pim Fox. I'm on Twitter at pim Fox. I'm on Twitter at Lisa Abramo wits one. Before the podcast, you can always catch us worldwide on Bloomberg Radio