Capital Talk: Oak Hill Advisors

This New York-based asset manager’s eye for detail is apparent in its head office. Works of notable contemporary artists adorn the walls, several of which appear to nod at the firm’s dedication to an evidence-based and multi-dimensional approach to investing. Entering the office, employees and visitors are greeted with a view of Argentinian artist Leandro Erlich’s Single Cloud Collection, a sculpture that creates the illusion of a captured cloud through layering.

The executives of Oak Hill Advisors try to think about investments in a similar way – looking beyond a flat image – tracking a wide variety of data to determine the potential success of a deal. 

In the US, the credit firm’s strategy has applied this data-led analysis to residential mortgages, tracking up to 75 million properties throughout the country using a proprietary tech system. 

In Europe, the firm has focused on having a clear picture of the continent’s various economies and their relative strengths and weaknesses, finding opportunities in companies with macro-troubles at home but potential in other markets. 

For those European investments in particular, Glenn August, the firm’s chief executive and senior partner, argues that investors must look at the bigger picture. “Some people are afraid of certain countries or certain regions. They say we don’t want to invest in Southern Europe, but a lot of Southern European companies have investments in Northern European businesses and US businesses, so doing deep value analysis and understanding the value are critically important,” he says.

ORIGINS

Oak Hill Advisors manages $24.5 billion in assets, a long journey from its origins in the credit book Glenn August ran at Robert Bass’s family office, Acadia Partners.

August joined Acadia in 1987, shortly after receiving his MBA from Harvard University. That business eventually became Oak Hill Capital Partners, the private equity firm, from which Oak Hill Advisors spun out as a dedicated credit investor in 1998.

The firm is now majority-owned by its management, with Bass and private equity firm General Atlantic having taken a minority stake in the business in 2011. Bass is still a significant backer, having put money into each of its funds. Last April, the wealthy investor re-launched his family office as Acadia Investment Management, named after Acadia National Park, to organize his investments into a single portfolio. 

Oak Hill Advisors now has over 200 staff, including 14 partners. The firm has offices in New York, Los Angeles, Fort Worth, Sydney and London, as well as a new outpost in Houston, Texas, which opened after the firm took over the business development company of NGP Capital. The firm is also planning to open an investor relations office in Hong Kong within the next six months.

EVOLUTION

Oak Hill has closed several funds over the last few years, including its latest US Distressed Mortgage Fund at $1.2 billion last year, of which about 62 percent of the capital is invested. In 2012, the firm closed its European Distressed Credit Fund at $1.35 billion and has called about 65 percent of the money. That fund should finish investing in September 2015 and is already up 16 percent, net of fees, since inception. Oak Hill’s US Distressed Credit Fund finished raising money at $1.125 billion in 2008 and is now in its harvest period. The fund was up 20 percent and is the number one ranked fund of its vintage, according to Preqin.

The firm has also raised over $2.5 billion dollars over the last three years for a multi-strategy credit fund to invest in a variety of instruments including high-yield, bank loans, stressed and distressed debt, structured products and some European credit. This product is structured as an open-end, long-only fund.

The firm’s senior partners look at Europe as a region still rich in potential. This, combined with their view that when the cycle turns more US distressed opportunities will come to market, is why Oak Hill plans to raise $2 billion or more for a global distressed fund in 2015. 

August expects the fund to begin by investing in Europe, but with a global mandate, the firm will also be able to include US assets when the market ripens.

Says William Bohnsack, the firm’s president: “We think the opportunity set in Europe is likely to be interesting for many years and while we think it’s still early for a large scale deployment of US distressed capital in 2015, we think that there are certainly indications that sometime in the next few years there ought to be a pretty exciting distressed opportunity.”

FINDING FOCUS

Although the firm invests in a variety of credit instruments, Oak Hill has been particularly focused on its residential mortgage fund, as well as its securitization business which includes residential mortgage backed securities (RMBS).

August expects expanding room for private mortgage investors to carry on growing: “We think that there is a significant evolution going on in the role of government in supporting mortgage finance,” says August. “We see government ultimately reducing its role in mortgage finance and private capital increasing.”

Oak Hill currently manages about $3 billion in mortgage strategies. “We have the ability to analyse 75 million mortgages across the country and we think there are opportunities in some of the legacy RMBS, which we call RMBS 1.0. We think there is also opportunity in what we call RMBS 2.0, which is the next generation of RMBS,” August continues.

He also likes what’s happening on the regulatory front, and in particular the qualified mortgage rule, which he thinks will limit the ability of many banks to provide mortgages, thus creating further potential for alternative lenders to step into the gap.

“There is opportunity where certain mortgages can’t meet securitization requirements on a temporary basis. We think the opportunity to buy them with attractive valuations is quite interesting. We also think the originators in the US, because they were so successful as rates came down and all the extraordinary volumes and refinancing, there is an extraordinary amount there in the origination community and we can leverage some of our relationships with the originators, plus our own technology, to identify new ones that we want to help source,” August explains. 

Oak Hill doesn’t originate mortgages internally, though August claims the in-house technology helps the firm better gauge which areas will become attractive investments in advance.

The firm invests across the US and does big-picture analysis on different property markets to identify segments to target. “The residential mortgage business is a very local business. The housing market is very local and that’s where technology really adds value because you can analyse each local market. You’re not just doing zip code analysis, which many firms do, you’re actually going much deeper into understanding the community.”

Using the firm’s system, Oak Hill’s team looks beyond single homes for sale or in default, it analyses which homes in the market will likely be for sale down the line. It also tracks factors like school district trends and crime rates. “It’s a multi-variable model that analyses all of these factors. And to date, we’ve bought over $2 billion of mortgage loans in the US,” August says. 

In a conference room, there are maps of California and Florida mounted to help the residential team analyse these markets. Says August: “It’s all about understanding how the courts process foreclosures, what the foreclosure laws are, what are the different protections. Each state has different mortgage rules that are hard to understand and that’s critical.”

His own corner office is stacked with data and analysis reports tracking factors influencing the housing finance market.

EUROPE: PRESENT AND FUTURE

Painstaking research into local market conditions is not restricted to Oak Hill’s US mortgage strategy. For examining prospects in Europe, it has investment professionals focused on individual countries, too. 

“We think there is opportunity in Europe for many reasons. One is the uneven macro-economic environment of each country. Secondly, it’s that the banking system is fraught and challenged with many old loans, where many were not adequately marked to market and now the ECB is going through a quality review to get greater integrity of valuations,” says Robert Okun, Oak Hill’s chief investment officer of US credit and senior partner.

“The banks are clearly retrenching as opposed to being active investors and thirdly, the capital markets in Europe are much different than they are in the US,” he adds.

Another difference between the US and Europe is that the expiry dates of 2012-14 loans in the US ended up getting refinanced and pushed back to 2018-2020. “In Europe, you still have a meaningful maturity wall that needs to be dealt with and these companies that need refinancings and capital requirements given a weak economy,” August says.

Through its most recent fund and other strategies, Oak Hill has about $4 billion of capital in Europe. “We’re very excited about the opportunity across not just distressed, but in many cases private debt financing, because we think many of these borrowers need customized solutions to deal with either debt refinancings or new capital requirements,” August says.

Among European countries the firm is tracking are Spain, France, the UK, Italy and Germany with 14 major jurisdictions in total. “The point is that each of those locations have their own idiosyncratic needs and laws associated with them and that’s really how we’ve been finding a lot of different opportunities in Europe,” Okun says.

The firm has been investing in Europe since the early 90’s and opened its London office in 2005. “But a lot of our team has been there for over 15 years, so we have deeply established relationships with the banks, the intermediaries and the sponsors and the fact that we can legitimately provide customized solutions for these sponsors is very helpful,” August continues.

Oak Hill hasn’t participated in many of the large bank portfolio sales that have attracted a lot of attention from other private debt players. “When you have large portfolio trades, you typically attract more capital because it’s much easier to put $200 million into a portfolio trade than to generate four $50 million transactions,” August notes.

“Our view is that those $50 million transactions can afford you a very attractive opportunity to customize what the borrower needs and what you want as an investor,” he says. Oak Hill’s transactions vary widely in size anywhere from $50 million to $350 million.

“We also believe that having the ability to make a $200-$300 million investment is itself a competitive advantage, because companies will often need that amount of capital. From our perspective, it’s about customizing an investment to the needs of the borrower and our own needs as investors.”

GOING BESPOKE

Most of the firm’s clients are large pension funds, sovereign wealth funds, insurance companies and large family offices. “More than half of our capital comes from outside the US and we raise commingled funds around specific strategies and specific market opportunities, we’ve also raised some multi-strategy types of funds, and, increasingly, a part of our business that’s been driving growth has been in developing customized portfolios for some of our large clients,” Bohnsack says.

“Especially in today’s markets, we see the largest investors in the world looking for real partnership relationships with their managers. They don’t really care if something is called bank debt or high yield or stressed or distressed. They want to give capital to managers that can look across product strategies and really focus on where they are getting attractive risk-adjusted returns and, in particular, what you see is a lot of private equity investors who are looking to shorten duration,” says August.

He argues that private equity returns have fallen over the last few years and there is concern that the asset class won’t experience much growth in the years ahead, so some investors are looking to alternative credit to provide them with similar returns, a shorter duration and more liquidity.

“At the same time, you see some core fixed income investors that are looking for incremental yield in a world that’s not offering very high yields, so you are really getting investors from both private equity and fixed income looking to alternative credit as a really attractive opportunity,” says August.

Of the firm’s $24.5 billion in assets, over $11 billion is dedicated to bespoke mandates.

Sovereign wealth funds are a rich source of business for Oak Hill. “The sovereign wealth funds have become a very important part of our business and it’s a fairly tight knit community. If you develop a reputation as a good partner, it makes developing the next relationship that much easier,” says Bohnsack.

He recalls a time when a large Asian sovereign wealth fund was looking for a multi-strategy credit firm. The fund interviewed 22 firms, then whittled that list to a final group of six. “Robert and I flew halfway around the world a few days before the Christmas holiday” for the presentation, Bohnsack says. The firm landed that mandate along with another provider and was allocated twice the capital given to the other firm.

CULTURE

August says the firm has a flat hierarchy, where he encourages team-work and many eyes on each transaction from all levels of the organization. The firm’s 14 partners are invested in one partnership, not in their individual funds or businesses, while most investment professionals, down to the level of vice president, also have personal investments in the funds. Typically, about four to six people make a decision on any given deal.

“It’s a people business. Culture is incredibly important at the firm and how you work with your clients is incredibly important. We’re not made up of silos. We’re very much an integrated firm,” August says. “We really want people to share ideas. We believe that our bank loan business helps our distressed business which helps our private debt business and so on. And you want to have a culture that supports that,” August says.

The same culture underpins that relentless attention to detail. Whether it’s processing data on millions of mortgages, or making sure a new opportunity gets looked at by as many colleagues as is necessary, Oak Hill Advisors tries to focus on the intricacies. Like the cloud sculpture in the lobby, the idea is to build up the layers until the emerging edifice is to everyone’s liking. 

Clearly this is labour-intensive. But then again, Oak Hill’s business is to find value in credit where others missed – hardly something you can do on the fly.

OAK HILL IN EUROPE

Alexandra Jung and Doug Henderson are co-heads of European investments. Both are based in London and drive an essential arm of the firm’s focus and strategy. Jung focuses on the distressed side while Henderson looks at performing credit, though as they explained to PDI, in Europe, the two can go side-by-side.

Where to look for rescue financing and distressed opportunities in Europe? Jung doesn’t hesitate: “It’s Spain, it’s Greece, it’s Portugal. It’s Italy – it’s more and more Italy,” she says, adding: “But what we shouldn’t forget is that though France isn’t a periphery nation it is facing a very difficult macro environment and we’re seeing more and more companies in France needing capital or restructuring.”

The woes of the eurozone’s peripheral members are well-known and the opportunities they offer canny investors are showing promise.

On the distressed side of things, which is Jung’s end of Oak Hill’s European strategy, the firm looks at companies in countries dogged by macro-economic problems and with limited access to the capital markets. “We’ve focused either on providing rescue funding for companies in need of capital or playing leading role in restructuring and capitalisations,” says Jung.

For Henderson, looking at performing credit opportunities, the focus is on Europe’s underserved mid-cap corporates. “Generally, in Europe, private debt is more and more financing and disintermediating banks in the mid-cap and small mid-cap space, all the way down to SMEs,” he explains.

Both agree that the bank market, which dominates Europe, is in line for disruption. “[The European debt market] has always been a bank led market,” says Jung. “Our high yield market is, I wouldn’t say in its infancy, but definitely in its childhood. It’s growing and it’s starting to replace the banks as the provider of capital for credit but companies have been relying on banks here – over 80 percent, I would say.”

IN COMPLEMENT

Covering both performing and distressed markets is an important part of Oak Hill’s approach in Europe these days. And it came to the fore in the firm’s investment in the leveraged debt of Spanish pizza company, Telepizza. “That was something that we participated in across several of our funds, including the European distressed fund, and in all different parts of the capital structure: first lien and second lien and mezzanine debt,” says Okun in New York. “We were buying that at a massive discount and we were able to participate recently in a transaction where we were able to refinance and restructure the company and also continue to be supportive of the company.”

Spain’s economic woes hit Telepizza.

But when Oak Hill looked at the company in 2012, the team found that parts of the capital structure looked more attractive than others – “where the parts that we were invested in did do well and we got paid off at par, as part of the restructuring. We reduced debt a little bit, changed equity ownership a little bit and gave the company the room that it needs to succeed through an economic environment that’s been a bit troubling,” Okun says.

“What also makes it a good example, is that you can’t just focus on where a company is domiciled. Telepizza is domiciled in Spain, but they have a substantial European non-Spanish business and a substantial Latin American business. When you look at the valuations of the company, each market was performing differently. You need to look across the market at the value opportunity in each market,” says August.

Telepizza was an example of the dual performing and distressed strategy they employ. Says Henderson: “Performing credit is a separate strategy but it’s very tied into our stressed and distressed credit investment activities. If you look at what’s happened since 2008, there’s been a lot of companies migrating out of the performing into the distressed markets. More recently, with very strong capital markets over the last 18 months, some stressed and distressed companies have restructured and migrated back into the performing space post-refinancing. So having the two businesses integrated under one umbrella helps quite a bit in terms of the kind of things you see and the opportunities you can take advantage of.”

One of the firm’s largest investments over the last year was a Spanish real estate company called Metrovacesa, which recently executed a substantial refinancing deal. August notes that even though the company is Spanish, its largest investment was a minority stake in a French REIT called Gecina.

That stake was sold to a consortium led by Blackstone and the company used the proceeds to make a debt repayment worth over 80 cents on the dollar, according to a Reuters report at the time. Oak Hill bought the Metrovacesa debt when it was trading much lower than the final recovery.