When people refer to a "bond guru," many investors assume it's Bill Gross, the co-founder of the world's largest bond house, Pimco. Gross is certainly a heavy hitter in the bond world, but he is far from the only bond guru. While I'm predominantly an equity investor, I keep a close eye on Oaktree Capital's Howard Marks.
Marks is a genius when it comes to investing in distressed debt. But Marks' investment philosophy and how he thinks about risks and investment value are what set him apart in my book. Speaking of books, I very highly recommend Marks' book The Most Important Thing, which was released last year. I have read hundreds of investment books, and this one easily ranks in my top five, along with The Intelligent Investor by Ben Graham and Margin of Safety by Seth Klarman.
Followers of Marks religiously await his "memos to clients," letters which eloquently articulate his thoughts and perspectives on investing. His book takes years' worth of memos and organizes them into an investment classic. Marks never intended to write a book; when asked why he chose to write one, he said it was because Warren Buffett sent him a letter asking him to write one. Need I say more?
So when the folks at Oaktree buy equities, I pay close attention. Keep in mind that for a bond fund, equities will always constitute a small portion of assets, but I do find it telling that in this era of super low interest rates, Oaktree is adding equities. After all, these bond kings are trained to be very alert to capital structure and risk of capital loss.
Oaktree's largest equity position is the cable company Charter Communications (CHTR). Charter is an interesting pick: The company continues to report losses, yet the stock is up 33% in 2012. I haven't looked deeply at Charter, but obviously the folks at Oaktree understand something that most people don't. George Soros was also a buyer of Charter in the second quarter.
Another name in the Marks portfolio is the independent oil and gas exploration-and-production company Exco Resources (XCO). This is a name I've kept on my screen because one of its largest investors is Wilbur Ross, one of the most astute distressed investors on the planet. Ross bought bankrupt steel mills a decade ago and cashed out big when steel demand picked up several years later. Several years ago, he did the same thing with coal.
Exco shares trade for $7; before the recession, shares traded for $35. Like the giant natural-gas company Chesapeake Energy (CHK), the play seems to be on owning natural-gas assets at a fraction of what they are worth. Gas is trading at a historic low, and shares of Chesapeake and Exco are scraping bottom as a result.
Consider that in the second quarter of 2012, natural gas prices fell more than 15% from the first quarter and nearly 50% year over year. Yet Exco managed to increase operating cash flow on a sequential quarter basis, and year over year, cash flows dropped by 37%, compared with the 50% drop in the commodity price. The company is doing a stellar job of reducing operating costs, and it offers a 2.2% yield. By keeping costs lean, Exco is creating significant upside if gas prices start climbing this winter.
Investors like Howard Marks are trained to look for value in distressed situation. Both Charter and Exco are significantly levered businesses in distressed industries, yet both are in a position to ramp up profits in the years ahead. Perhaps now is the time to look closer.