Companies like Oaktree Capital Group (NYSE:OAK) are known for having messy and complicated financial statements. But one balance sheet line-item known as "net accrued incentives" gives investors a quick proxy for understanding their earnings from quarter to quarter.
In this segment from Industry Focus: Financials, join The Motley Fool's Gaby Lapera and Jordan Wathen as they discuss how to evaluate alternative asset managers, and some items investors should pay attention to.
A full transcript follows the video.
This video was recorded on April 24, 2017.
Gaby Lapera: To go back to the original question that was asked by the listener -- as you guys have seen, these firms can be very difficult to understand, because they're investing in a type of asset that is not really all that commonplace, so you have to understand a little bit about the assets in order to even decode their balance sheet or income statement. The second part of that question is, there can be drastic variability in yearly results, and that the profitability is highly dependent on assets under management. When you're looking at investing in one of these firms, what are some of the things that you should look for? I think the best way to do this is pick one, since they're all so different from each other, and dig in. We talked about doing Oaktree.
Jordan Wathen: Yeah. The important thing that you have to remember when you invest in the asset management company is that it's really only as good as its funds are. An asset manager that runs a bad fund won't be in business very long, especially not charging 1.5% on assets, plus 20% incentive fees. The world doesn't want to invest in an underperforming fund that charges an above-average fee. So, one way to get a really good idea of how a business like Oaktree is performing is to look at the balance sheet. Look at net accrued incentives. This reflects how much Oaktree will receive in incentive income from its funds -- basically, fees that it earns for generating good performance minus any bonus compensation that it owes its employees as a result of those returns. What you'd really like to see is this net incentive income, or this accrued incentive income, increases over the course of time.
Lapera: Is there ever [a case of] "This has increased too much?"
Wathen: No, there's no such thing as that number increasing too much. If anything, that would mark something like a cyclical peak. So, if, let's say tomorrow, the debt markets fall out, Oaktree is going to raise tens of billions of dollars and put it to work almost immediately, and within the next couple years, as the economy recovers, you would see that incentive income come up. Then, over time, as those funds are liquidated, they would pay off their investors, and the money would come back to them for generating those superior returns. If anything, you have ebbs and flows in it, but no, there's no such thing as too much.
Lapera: That's actually a really good point that you just made. It's a very cyclical business, much like the financial markets at large. But the interesting thing about alternative asset managers is that they often tend to do well when the market is doing poorly, because they act as hedge funds.
Wathen: Right. Oaktree has a reputation for being the company that doesn't want to attract assets just to attract assets. If Oaktree gives you a call and says, "We're raising a new distressed debt fund," it's because they see opportunities, or they see a world in which they will have opportunities in the next few years. Because of that, they're one of the few asset managers that even runs $100 billion or more. But, they're part of that select group that can really make a phone call and raise $10 billion overnight. I mean that almost literally, because they earned that credibility with investors, and because their returns have been so good over time.
Lapera: Yeah. I think the other thing to look at when you are investing in alternative asset managers is who the management is, because that can make a huge difference. In Oaktree, it's definitely noticeable.
Wathen: Right. They have this company culture that the investor comes first, and the shareholders will be taken care of before that. Actually, if you look at Oaktree's balance sheet, you'll see it has about $6 a share in net accrued incentives that it's earned from these funds, because it calls money when it actually sees good opportunities, not just because it wants to raise a fund and charge more management fees. It's just not that kind of business.