Oaktree Capital Management (NYSE:OAK) reported second-quarter results after market close on July 26, turning in a financial performance that was well below last year's record second quarter. But it was also in line with expectations for what CEO Jay Wintrob and chief investment officer Bruce Karsh describe as "late in the credit cycle."
In recent years, debt buyers have displayed a much higher tolerance for risk, pushing up the prices they are willing to pay, even for distressed or highly leveraged debt assets. This has resulted in fewer opportunities to deploy capital for Oaktree, cutting incentive income as its portfolio managers have been net sellers of assets, growing Oaktree's "dry powder" available to deploy.
But this approach is exactly what has made Oaktree so successful for many years: a rigorous focus on managing risk, and not getting caught up in chasing gains late in market cycles when things can quickly get ugly. Let's look at the results for the second quarter, and what management says about the future.
A solid second quarter as the cycle turns
Oaktree reported $213.3 million in revenue on a GAAP basis, down sharply from $634.1 million, and GAAP net income of $0.44 per share, down from $1.83 last year. On an adjusted basis, revenue was $273.5 million, down from $704.4 million, while adjusted net income was $0.51 per share. It's important to note that revenue isn't the best measure of financial performance for a financial asset manager like Oaktree, as the big swings don't directly correlate to its financial stability or health of its business.
Oaktree reports a number of other metrics that help give context to its performance. Distributable earnings were $0.69 per share, down from $1.65 last year, while fee-related earnings per share were $0.30, down from $0.37 year over year. Economic net income was $0.68 per share, versus $1.05 year over year.
Assets under management -- a key measure for Oaktree -- were $121.6 billion, up $530 million year over year and slightly up from the first quarter, while management fee-generating assets declined $1.1 billion to $100.5 billion. Incentive-creating assets were $33.3 billion, up $1.94 billion from last year, and flattish sequentially.
Distributions to closed-end fund investors were $8.8 billion, down from $10 billion in the first quarter, while net outflows from open-end funds were $3.6 billion, slightly less than last quarter's $4 billion. Just as it did last quarter, Oaktree continued to emphasize risk-adjusted returns.
On the earnings call, Wintrob said: "Looking back over the last year and a half, our closed-end fund strategies have harvested $19 billion of proceeds while investing only $11 billion, which we believe has been the right thing to do given the favorable selling and financing environment for distressed debt, emerging-markets debt, and European and U.S. private equity assets. We'll continue seeking investment opportunities around the globe and deploying capital across all our strategies in a disciplined and cautious manner, with a focus on controlling risk and limiting downside."
Oaktree's weaker financial results did impact the distribution. The company will pay out $0.55 per share this quarter, down from $0.96 in the first quarter and well below last year's $1.31 after a record quarter.
Looking ahead: The cycle will turn (eventually)
While management was steadfast in its description of the market as being "late in the credit cycle," it also acknowledged that "late" doesn't guarantee it will turn quickly, creating the kinds of distressed-asset opportunities Oaktree is known for finding during credit downturns.
But management also isn't wavering from a strategy that has paid off, and isn't overpaying to acquire higher-risk debt assets. Karsh said:
...we may be in the late innings of a ball game that could go on into an unknowable number of extra innings. What we also observed today despite investor uncertainty is the tolerance for risk. The divergence of returns by rating highlights the strong demand for risk that exists in the credit markets.
So long as debt investors prove willing to pay a premium for debt, Oaktree seems likely to remain a net seller for the foreseeable future, and that will weigh on its financial results. And while the market cycle could still take some time to turn, when it does, it will likely happen incredibly quickly, and right when almost nobody expects it. With substantial financial resources both at the fund level and on the balance sheet, Oaktree is ready to act quickly when the market presents the right opportunities.
With history as our guide, Oaktree investors who ride out the market's cycles and give Oaktree's portfolio managers time to take advantage should be duly rewarded.