Oaktree Capital Group’s Third Quarter: Down but Not Out

Oaktree Capital Group (OAK) reported relatively weak earnings on the back of falling asset prices and light deployments in the third quarter.

Results by the numbers

What happened this quarter?
There were a few things to highlight from Oaktree's third-quarter numbers:

• Distributable earnings continue to outpace the firm's adjusted net income and economic net income as its realized fees from seasoned investments paper over accruals from its less seasoned funds.
• Uncalled commitments grew to $20.1 billion, and "shadow AUM" (capital which represents potential fee-earning AUM) grew to a record $17.2 billion.
• Oaktree shed roughly $3 billion in AUM in its open-end funds, mostly due to falling asset prices rather than investor redemptions.
• For perspective, CCC, BB, and B-rated bonds declined 8%, 4%, and 6%, respectively, during the third quarter.

What management had to say
On the conference call, Oaktree management offered some interesting insight into how they see the company developing over the next few quarters. In his prepared remarks, Jay Wintrob, the company's CEO, noted that it expects "management fee revenue and fee-related earnings ... were at or near a cyclical low" this quarter.

It's easy to forget that Oaktree is somewhat counter-cyclical in that bull markets help it realize gains (and thus fees), but hurt its ability to invest on behalf of its clients.

Notably, only about 10% of the company's $16.8 billion raised in its closed-end fund products in the last 12 months has been invested to date. There's a lot of room to add to fee income in the short-term, and incentive fee income over the long-term, provided that the company sees meaningful opportunities for its clients.

Bruce Karsh, Oaktree's Chief Investment Officer, seems confident a turn in the credit cycle is coming sooner rather than later. In response to an analyst's questions about deployments he opined that "when the opportunity really strikes, which we expect will happen over the next year or so, couple of years, that's when you'll see very, very significant deployments of capital."

He also pointed out that the company was "encouraged in the third quarter with what we saw in terms of the potential for expanded opportunities in the distressed world, but our pace of investment didn't change materially," referring to a broad decline in junk bonds, leveraged loans, and riskier assets that generally allow Oaktree to start putting client capital at risk.

Looking ahead
The seeds Oaktree planted during and just after the financial crisis have been harvested. Its pre-crisis Opportunities Funds, which peaked at a net asset value of roughly $25 billion in 2010, now have a combined net asset value of just over $2 billion. Oaktree needs to plow new fields for its next harvest, but it won't begin to do so until the markets turn in its favor.

Sidelined capital may hurt its earnings in the short term, but its long-term results will be guided by its ability to generate outsize returns for its clients. That requires patience from Oaktree. Oaktree's shareholders should be patient, too.