In Howard Marks’ October 11, 2023 memo to Oaktree Clients entitled Further Thoughts on Sea Change he says “(T)hanks to the changes over the last year and a half, investors today can get equity-like returns from investments in credit.” The emphasis in bold and the underlining is Marks’ own emphasis.
I know what you’re all thinking, “was Marks inspired to write this memo after reading Bob Flynn’s Hard Money Monday piece entitled A Mispriced Asset Class and published on September 18, 2023? So I’ll only say this once, it’s my policy not to comment on our readership!
Marks goes on to say, again the bold text and underlining is his own:
“In other words, expected pre-tax yields from non-investment grade debt investments now approach or exceed the historical returns from equity. And, importantly, these are contractual returns.”
“To me, this means allocators should ask themselves, ‘What are the arguments for not putting a significant portion of our capital into credit today?”
“(I)f the developments I describe really constitute a sea change as I believe–fundamental, significant, and potentially longlasting–credit instruments should probably represent substantial portion of portfolios…perhaps the majority.”
Why, then are investors slow to reallocate away from levered investments like real estate and towards credit instruments, like hard money loans? I can think of two possible reasons:
Inertia - the distribution machinery of the financial system creates inertia after fee-based products are constructed and sold.
Recency Bias - It’s hard to walk away from asset classes that have been so good to you for so long. Long-term equity like expected returns from credit instruments are still below the ZIRP (zero interest rate policy) induced returns enjoyed since the great financial crisis.
Link to Marks’ Memo: https://www.oaktreecapital.com/insights/memo-podcast/further-thoughts-on-sea-change