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Howard Marks and Oaktree’s 2010 Performance – Marketable Securities

Before we cover Howard Marks’ cautious outlook, here is an excerpt from Oaktree’s year-end letter:

Review of Oaktree Performance – Marketable Securities


As often occurs in Oaktree portfolios during recovery years, our U.S. high yield bonds lagged behindtheir benchmarks. This resulted primarily from our usual underweighting in CCC-rated bonds, distressed debt and financial institution paper. Our composite returned a very respectable absolute return of 12.3%before fees (11.8% after) but trailed the 13.9% gain of the Citigroup High Yield Cash-Pay Capped Index.

The drag of quality was less pronounced with regard to European high yield bonds, and the bank debt holdings that had held us back in 2009 caught up in 2010, adding to our performance. Thus our composite gained 16.7% before fees (16.1% after), ahead of the 15.4% return on the BofA Merrill Lynch Global High Yield European Issuer Constrained Index ex. Russia (hedged).

Senior loans – also known as bank loans or leveraged loans – constitute our newest marketable securities strategy. These rank ahead of subordinated high yield bonds, and their interest rates float with LIBOR orEuribor. In 2010 our composite of U.S. senior loan accounts returned 8.9% before fees (8.3% after)versus 10.0% on the Credit Suisse Leveraged Loan Index. Here as in high yield bonds, we underweight the riskier loans that are well represented in the index. As to the closed-end senior loans funds which are in liquidation, the unlevered fund returned 7.1% before fees (6.5% after) and the levered fund returned 9.0% before fees (8.3% after).

Our European senior loans outperformed their benchmark by a fair margin. For example, our European fund for these loans rose 10.1% before fees in euro (9.3% after), compared to 8.5% on the Credit Suisse Western European Index.

Improving on the performance trends in straight debt, all of our convertible strategies outgained their benchmarks by wide margins. Our composite of U.S. convertibles accounts (we called them domestic convertibles until going global taught us that the word “domestic” has different meanings depending on where one sits) returned 19.4% before fees (18.8% after) versus 16.8% for the BofA Merrill Lynch All U.S. Convertibles Index. Convertibles continued their recovery from the undervaluation relative to equities caused by the collapse of convert arbitrage funds in 2008, and they also benefited from investors’ increased desire for yield. Thus our U.S. convertible composite outperformed the S&P 500, which rallied strongly in December to gain 15.1% for the year.

Our portfolios of non-U.S. convertibles also reflected the above trends. Thus they continued their incredible string of outperformance, with a composite gain of 12.0% before fees (11.2% after), dramatically ahead of the 6.4% gain on the JACI Global portfolio of non-U.S. convertibles and trouncing the gain of only 2.8% on the MSCI EAFE hedged index.

Finally, as is often the case, our high income convertibles (or “busted” convertibles) were again our top performing marketable securities strategy, a few basis points ahead of the other U.S. convert portfolios. The high income composite returned 19.4% before fees (18.9% after) versus 14.3% on the Citigroup High Yield Market Index. Searching among the unloved paid off again.

In high yield bonds and senior loans, where most all of our decision-making is with regard to just one dimension – creditworthiness – our relative returns were held back by our insistence on limiting risk. In convertibles, we picked up considerable ground through adherence to our philosophical insistence on balancing upside potential with downside protection, and through some effective stock-picking.

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