Oaktree: Solid Play for Risk-Takers

| About: Oaktree Capital (OAK)

Oaktree Capital Group (NYSE:OAK) raises most of the funds it invests in companies, credit, and real estate from institutional investors—including public pension funds—and charges them hedge-like fees for the privilege. The company has a professed devotion to a value-oriented investing discipline, and a willingness to share the rewards with outsiders. The rewards have been bountiful lately, partly because Oaktree has been reaping the crop of lucrative returns sown in scarier times.

As it's cashed-out funds raised before the financial crash, and deployed in its aftermath, their strong performance has translated into handsome incentive compensation, most of it paid out quarterly to investors. Over the last 12 months, Oaktree has paid out $4.52 per unit in distributions, for a trailing yield of 8.8%. Quarterly payouts rose from 55 cents per unit in November, to $1.05 in February, $1.41 in May and $1.51 last month, after a quarter that delivered a 90% year-over-year gain in distributable income.

A lot of that is due to Opportunities Fund VIIb, the largest ever distressed debt fund, that raised $10.9 billion by mid-2008, invested much of it soon after Lehman bit the dust, and vultured its way to an annual gross return rate approaching 24% before beginning an aggressive liquidation this year. The resulting cornucopia of incentive compensation is likely not sustainable in the near term, so it's probably better to think of Oaktree as a 7% yielder with strong potential for capital appreciation.

Even as Oaktree enthusiastically harvests investments in distressed debt, it's raising plenty of dry powder, while nibbling on pockets of dislocation in Europe, shipping, power generation, and real estate. The next time those pockets of dislocation turn into a general bummer, Oaktree will be ready to pounce. The market certainly didn't pounce on equity in the asset manager when it became public in April, 2012. Units priced at the bottom of the suggested range and in a lower quantity than had been hoped. In the next two months they lost nearly 20% of their original value. They then rallied 65% into May before retreating a bit in the course of the summer.

One heavyweight hedge fund that didn't sleep on Oaktree was David Einhorn's Greenlight Capital, which reported a 5% stake soon after the IPO and still holds nearly 4% of units outstanding. Other prominent hedge and mutual funds with strong long-term records are on board as well, including a stake of more than 11% for Fidelity funds in the aggregate. They may be attracted to Oaktree's own excellent reputation and results—its closed-end funds are up 23% in the last year. The firm has been racking up incentive compensation in funds, that haven't yet been liquidated, at an impressive rate.

That source of future distributions has grown 14% in a year's time to $1.2 billion, even as Oaktree recognized a record $542 million of incentive income. The balance sheet features $1.1 billion in cash and government securities, and another $1.1 billion in own-fund investments, against total liabilities of less than $1.1 billion. Add in the accrued incentives not yet reaped and it certainly looks like the assets alone are worth all of Oaktree's $2 billion market cap.That may mean investors aren't paying much at the moment for Oaktree's excellent brand, top-notch clientele, and the attractive long-term growth opportunity.

This is a cyclical play without an energy MLP's depreciation and amortization tax deferral benefit, and with potential for much greater volatility, in both, distributions, and the unit price. But investors are getting paid plenty for that risk, are in great company and can look forward to more paydays set up by clear-headed risk-taking when others are panicking. We're adding OAK to our Aggressive Portfolio.