Liquidity

The bottom line is unambiguous. Liquidity can be transient and paradoxical. It’s plentiful when you don’t care about it and scarce when you need it most. Given the way it waxes and wanes, it’s dangerous to assume the liquidity that’s available in good times will be there when the tide goes out.

What can an investor do about this unreliability? The best preparation for bouts of illiquidity is:

• buying assets, hopefully at prices below durable intrinsic values, that can be held for a long time – in the case of debt, to its maturity – even if prices fall or price discovery ceases to take place, and

• making sure that investment vehicle structures, leverage arrangements (if any), manager/client relationships and performance expectations will permit a long-term approach to investing.

These are the things we try to do:

And the worst defenses against illiquidity – or, better said, the approaches that make you most dependent on the availability of liquidity – are (a) employing trading strategies under which you buy things because of how you think they’ll perform in the short run, not what they’ll be worth in the long run, (b) being focused on what the market says your assets are worth, not what your analysis shows them to be worth, and (c) buying with leverage that exposes you to the risk of a margin call in a declining market.

One of the great advantages of investing in performing debt is that if our credit judgments are correct, the return will come from our contractual relationship with the issuers – from the interest and principal they’ve promised to pay us – not the operation of the market. At Oaktree, trading is what we do to implement portfolio managers’ long-term investment decisions. We generally consider it a cost of doing business, not something we engage in to make money.

There are two benefits to this approach:

• we aren’t highly reliant on liquidity for success, and

• rather than be weakened in times of illiquidity, we can profit from crises by investing more – at lower prices – when liquidity is scarce.

We’re not immune to occasional periods of illiquidity; our holdings become just as hard to sell as anyone else’s. But with the proper structure and approach, it’s possible to turn such periods to our advantage rather than just endure them.