Market Perspective From a Cool-Headed Veteran

• ByTim Melvin, RealMoney.com Contributor
• On 12:31 pm EST, Thursday November 13, 2008

Howard Marks, chairman of Oaktree Capital, is one of those investors I pay attention to on a regular basis. Marks' firm is one of the leading distressed-investing firms, and it has done well over the years. He has been in the investment business since 1969 and running portfolios of high-yield and distressed assets since 1978. There is not much Mr. Marks has not seen in the way of market cycles and changes.

He was one of those who warned early about the fallout of the credit crisis. On Wednesday I came across a copy of his most recent letter to investors, written in the midst of the October meltdown. It was, to say the least, interesting reading.

He noted that October was one of the worst periods he has ever seen in terms of severity and the range of assets affected. He also noted that the negativity was the most widespread he has ever seen in his career. He also added that in his opinion the price declines were not the result in deterioration of the assets or companies but that of technical factors and market psychology. He pointed out that throughout his career the market has swung between fear and greed, and that following the herd will lead to average performance and possibly lead you to disaster at the extremes.

In addition to looking at the negative when everyone else is positive, being a skeptic means looking at the positive when everyone else is negative. Right now, like Mr. Marks, I find that everyone I talk to is negative.

In his letter, he pointed out that that the government appears to be opening up the exchequer to fix the problems. It doesn't have to work, but it should. Of course, this was before Mr. Paulson changed the program in the direction of buying banks instead of troubled assets, but the outcome should be similar. The letter does express concerns about the long-term impact of government ownership of banks, concerns I share. Banks could be become risk-averse and far more socially conscious in their lending and investing practices.

With an unwavering belief in capitalism, Mr. Marks is convinced that new banks and institutions will be formed to exploit the opportunities created by this occurrence. In spite of his concerns, he says that the negatives are on the table, optimism is nonexistent, and the real risk lies in not investing now.

Although Oaktree is primarily a buyer of high-yield bonds, it did make some equity purchases in the last quarter, according to its 13HF filed recently. It added to its already large position in EXCO Resources. EXCO engages in oil and gas exploration in North America. Its operations are onshore, primarily in East Texas, the Permian Basin and Appalachia.

As to be expected in the current weak market for both stocks and energy, the stock has been weak this year. EXCO currently trades at less than 25% of its 52-week high. It is cheap on my two favorite metrics, trading below tangible book value and less than 5 times enterprise value to EBITDA. The company has a debt-to-equity ratio of a little over 1. That is higher than I usually am comfortable with, but Oaktree specializes in credit analysis, so that may provide some comfort. The company recently announced earnings that were better than Street estimates.

Oaktree also made a small addition to its stake in WSP Holdings; the company now owns about 4.5% of WSP's outstanding shares. What you are buying with this is basically a stub interest, since Oaktree clearly controls the firm.

WSP Holdings, headquartered in China, makes tubular products for the oil and gas industry. Its products are used in both the exploration and drilling process for oil and gas. It has operations in North America, Europe and Africa in addition to China. The shares trade right at tangible book and 1.3 times enterprise value to EBITDA. The company has almost no debt and over $270 million in cash. That is more than half the market capitalization of the company.

Other large positions for Oaktree include Time Warner Cable, Alliance Imaging, Portland General and Crown Holding. It also established new positions in the quarter in Key Corp. preferred stock as well Owens Corning.

At the end of his letter, Howard Marks gave some advice that will help us all prosper from the current market turmoil:

Know the value of what you are buying.

If an asset or company's price falls below that value, buy it.

If it drops further, average in.

Make sure you are right about the value.

In times of panic and fear in the markets, it can help to pay attention to those who have been around long enough to keep a cool head. Howard Marks definitely qualifies.

Buzz up!