The two credit markets are converging, creating a symbiotic relationship beneficial to both borrowers and investors. Instead of competing, they serve different needs, and savvy investors should combine them opportunistically rather than pitting them against each other.
Default rates are not uniform. High-yield bonds are low due to a 2020 "cleansing." Leveraged loans show elevated defaults due to higher rates. Private credit defaults are masked but may be as high as 6%, indicated by "bad PIK" amendments, suggesting hidden stress.
In the current late-cycle, frothy environment, maintaining investment discipline is paramount. Oaktree, guided by Howard Marks' philosophy, is intentionally cautious and passing on the majority of deals presented. This discipline is crucial for avoiding the "worst deals done in the best of times" and preserving capital for future dislocations.
Aggressive Liability Management Exercises (LMEs), common in the US, are rarer in Europe. This isn't due to a gentler culture but stricter laws where board directors can face criminal charges for insolvency. This incentivizes collaborative restructuring over contentious, US-style creditor battles.
In a volatile market, "busted" convertible bonds are an attractive niche. These instruments have lost their equity conversion value ("out of the money") and trade like traditional debt, providing a yield. However, they retain a small amount of optionality, offering significant upside if the underlying equity unexpectedly recovers.
A staggering 70% of private credit managers have less than a decade of experience, meaning their entire careers have been in a low-rate, bull market environment. This lack of cycle-tested experience poses a significant systemic risk as market conditions normalize and stress appears.
Oaktree sees superior relative value in non-qualified residential mortgage-backed securities (RMBS). The US housing market is under-supplied with tight lending standards. This contrasts sharply with commercial real estate, particularly the office sector. Investors can acquire these non-government backed loans at a discount, offering high-yield-like returns with diversification.