Oaktree’s Marks weighs in on interest rates and ‘malinvestment’

Speaking at PEI Group’s inaugural NEXUS 2024 event, Howard Marks warned that investors should brace for lower returns.

Private markets firms and investors should learn from the distorted investment behaviour brought on by decades of low interest rates and not expect the same return prospects for private markets in the near term, according to Oaktree Capital Management’s co-founder and co-chairman.

Speaking at Private Equity International’s inaugural NEXUS 2024 summit in Orlando on Wednesday, Howard Marks said that declining interest rates over the last 15 years has had the “most important” and “profound influence in the market”.

Referring to his December 2022 memo Sea Change, Marks likened the effects of low interest rates to moving walkways in the airport. “If you get on the walkway and walk a normal pace… [you] zip through the airport. But the walkways do the work for you.”

In much the same way, declining and low interest rates “made progress extremely easy”.

“They stimulate the economy, they make consumer demand grow, they make businesses more profitable, they make assets more valuable, they reduce the cost of capital for those who borrow and they make financing more readily accessible.”

He noted that low interest rates also alter investment behaviour, reduce perceived opportunity cost and “encourage risk-taking, leading to potentially unwise investments”.

“People want to achieve a good return. They enable deals to be financed readily and cheaply, including, of course, some maturity. They encourage greater use of leverage, increasing fragility of companies, and perhaps all systems. And they introduce optimistic behaviour to raise the groundwork for the next crisis.”

He called this “malinvestment”, using a term popularised by Austrian economists, which brings on a period of near stringency, tight money and economic contraction. Referring to his Easy Money memo in January 2024, he said that investments are made that shouldn’t be made, where “the investment process becomes all about flexibility and aggressiveness, rather than thorough diligence, high standards and appropriate risk aversion”.

Marks added: “Einstein defined insanity as doing the same thing over and over again and expecting a different result. I think another version of insanity is doing the same thing in a different environment and expecting the same result.”

The environment at the time an investment is made compared with when it is concluded is “enormously important”, he said. Strategies that produce superior performance in a period of declining and ultra-low rates won’t necessarily continue to be the most successful ones in the years ahead, he added.