Korva is a scroll of the internet’s best ideas.
Make the next fund smaller
Over its first twenty years, Oaktree sometimes decided a great investment opportunity was coming. It was generally right, because it took the temperature of the market accurately, raised a large fund, invested, and made a lot of money. Its next fund was then smaller, because the opportunities seemed less good.
Most firms in the business do the opposite. When a fund does great, the next one is bigger because they can sell on the back of those results. Oaktree shrank because those results meant things had appreciated and were not so attractive.
After twenty years of that, the firm gained a lot of credibility. People tend to figure that when its leaders call something a great opportunity, they are not just trying to raise money, they really believe it, and they tend to be right. Part of earning that is speaking against your own interest and admitting your limitations and uncertainties.
Why do firms raise bigger funds after success?
Funds usually charge a management fee based on a percentage of the capital committed, so a bigger fund brings the firm more fees regardless of results. Strong returns also draw investors who are eager to commit. Economists Joseph Chen, Harrison Hong, Ming Huang, and Jeffrey Kubik reported in the American Economic Review in 2004 that larger mutual funds earned lower returns, partly because big trades move prices against the fund.
Why do bargains vanish after a recovery?
Distressed investors earn their returns by buying debt at deep discounts to face value. As the economy recovers, those discounts close because buyers return and borrowers look safer. The extra yield that high-yield bonds paid over Treasuries, as tracked by the ICE BofA index, peaked above 20 percentage points in December 2008. By 2014 it had fallen below 5 percentage points.
More from My First Million
