Howard Marks on why the markets are right

Veteran investor Howard Marks says the abandonment of the WeWork float, the poor performance of US IPOs in 2019 and the punishment of bad news in US debt markets are all early signs that discipline is starting to return to financial markets, and investors may no longer be rewarded for holding the riskiest assets.

Mr Marks, the co-founder of $US122 billion ($179 billion) investment giant Oaktree Capital, also questioned the willingness of central banks to take interest rates negative, arguing the tactic risks penalising some groups in the global economy and fuelling populism.

Speaking exclusively to The Australian Financial Review in Melbourne ahead his appearance at the Sohn Hearts and Minds conference in Sydney on Friday, Mr Marks said he did not believe markets had become euphoric, but he is concerned low interest rates are forcing investors to take out-sized risks on low-quality assets.

“I don't think psychology is that excessive. But the point is, even in the absence of a high degree of bullishness, people are investing in risky ways because they feel they have to, to make a good return in a low return world,” Mr Marks said.

He said that “until this year, I think it's safe to say that the riskier the things you bought, the more money you made”.

But there were early signs that they might be starting to change.

The poor performance of companies that have listed this year in the US, including Uber, Lyft, Peleton and Snap, the market’s rejection of the float of controversial property group We Work, and the US debt market’s punishment of companies who deliver disappointing news are all signs of this shift, Mr Marks said.

“In recent years the riskiest assets did the best. This year the riskiest assets are not doing the best,” he said.

“These are all positive signs in terms of market discipline.”

Avoiding low-quality assets

Mr Marks said Oaktree, whose best known Australian deals include the debt-for-equity swap that saved Nine Entertainment (the publisher of the Financial Review), the takeover of surfwear icon Billabong International and the provision of debt to collapsed fund manager Blue Sky Alternative Investments, was focused on avoiding low-quality assets.

In a memo to investors last month, Mr Marks said negative interest rates threatened to "turn a lot of usual processes upside down" by hitting bank profitability, hurting government coffers and distorting the way financial models and algorithms work.

He also argued they could actually have a contractionary effect on economies, rather than stimulatory one, by sending pessimistic signals to households and businesses who might actually save more, rather than spend.

"Most people in the business world believe in free markets, and believe that the free market does best job of allocating resources. But we certainly don't have a free market in money these days, and I think I’d like to see one," Mr Marks said, adding that it is unlikely that  "natural" interest rates, free of central bank interference, would be negative.

He is also concerned that negative interest rates could add fuel to the rise of populist politics, by penalising households and helping what he described as “elites” who are better placed to profit from rising equity prices.

"When the central bank interferes and administers rates, they favour some people and they penalise others. Today savers are being penalised, asset owners are being benefited, borrowers are being benefited," he said.

"There are some very negative consequence to negative rates."

Big changes

This year has marked a big change for Oaktree. In March, Canadian alternative asset giant Brookfield announced it would acquire 61 per cent of the firm in a deal worth $US4.7 billion. Mr Marks, his partners and key staff have retained the remaining staking in the business.

He said they now have a "path to liquidity" but remain fully in charge in the business under the terms of the deal.

"A lot of people, their ego would pop up and they would say well we own 61 per cent, of course we're going to run it. Well, I think Brookfield says, you guys have done a good job until now, you should keep running it. That makes great sense to me."

Mr Marks said he still remained as fascinated with markets today as he did 50 years ago.

"We just came from a meeting with one of the super funds and we spent the hour talking about questions that have never arisen before. To which I worked very hard to try to come up with the answers.

"That’s a great thing."

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This article was originally posted on The Australian Financial Review here.

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