Private Credit's Shift: Fairly Priced Market Requires Discipline

Capital Allocators – Inside the Institutional Investment Industry · December 29, 2025 · Listen to Original Episode →

Original Title: Top 5 of 2025: #1: Howard Marks

TL;DR

The growth of private credit, now exceeding $1.5 trillion, has shifted from an undiscovered strategy to a fairly priced market, demanding careful execution and disciplined credit standards to avoid risks associated with increased popularity.
The pendulum swing from investor aversion to strong demand in private credit means the "undiscovered and unloved" aspect is over, making it a reasonable but no longer special strategy requiring careful management.
Private credit's lack of active marking-to-market can obscure true value declines during downturns, potentially leading investors to underestimate realized losses and delay facing economic realities.
The "extend and pretend" strategy, where loan holders grant extensions to struggling companies instead of recognizing defaults, poses a significant risk in private credit, especially as fund lifecycles near maturity.
The increasing cost and reduced availability of leverage due to rising interest rates have diminished the "magic elixir" of private equity, making leveraged acquisitions less effective and exit strategies more challenging.
The historical pattern of investors seeking new asset classes during periods of low returns in traditional markets suggests continued innovation, though fundamental asset types remain ownership and debt.
Sustaining an organization like Oaktree through market extremes requires a disciplined culture focused on risk control and avoiding short-term hyperactivity, prioritizing long-term value creation over chasing fleeting opportunities.

Deep Dive

Howard Marks's discussion on private credit highlights a fundamental dynamic in financial markets: the pendulum swing of investor sentiment and its impact on asset class attractiveness and risk. The growth of private credit, from a niche market to a trillion-dollar industry, illustrates this cycle, moving from unloved and undiscovered to a mainstream, albeit fairly priced, investment. This evolution, however, carries significant second-order implications related to liquidity, valuation, and the potential for "extend and pretend" strategies, particularly in the face of future economic downturns.

The narrative of private credit's rise is intrinsically linked to broader shifts in the institutional investment landscape. Following the Global Financial Crisis, banks, chastened and more regulated, reduced their risk appetite. This created a vacuum that private credit stepped into, offering investors higher yields than public markets in a low-interest-rate environment. This trend was further fueled by the immense popularity of private equity, which was widely perceived as a "silver bullet" strategy. However, the subsequent rise in interest rates has significantly altered the economics for leveraged buyouts, making borrowed money more expensive and harder to obtain, thereby diminishing private equity's magic and creating challenges for asset managers seeking exits.

The expansion of private credit and the concurrent slowdown in private equity exit opportunities raise critical questions about future market dynamics. As capital continues to flow into private credit, underwriting standards are inevitably pressured, even if not yet at the extreme lows seen in prior cycles. This creates a tension between managers eager to deploy capital and the need to maintain discipline. The implications are substantial: when economic downturns inevitably occur, the lack of clear markings to market and the potential for managers to "extend and pretend" by delaying defaults could obscure the true extent of losses for investors. This opacity, coupled with the illiquidity of private assets, means that identifying who is "swimming naked" may only become clear when the market tide recedes, potentially years after a crisis begins.

Marks emphasizes that the core of investing remains understanding risk and value, regardless of market trends. He advocates for a disciplined approach centered on risk control, consistency, specialization, and a long-term perspective, rather than relying on macro forecasting or market timing. The sustained success of Oaktree, he suggests, stems from adhering to these principles and fostering a culture that prioritizes avoiding losers over chasing winners. This philosophy is crucial as the investment industry continues to innovate, creating new asset classes and strategies, but the fundamental principles of ownership and debt, and the inherent cyclicality of markets, remain constant.

Action Items

Audit private credit market: Assess underwriting standards for 3-5 key risk classes (e.g., leverage, covenants, repayment structures) to identify potential deterioration.
Track private credit liquidity: Monitor for "extend and pretend" scenarios by analyzing 5-10 distressed companies to understand potential misvaluation.
Measure private credit valuation accuracy: Compare public credit market price swings to private credit valuations for 3-5 comparable companies to assess reporting reality.
Analyze private equity exit challenges: Evaluate 5-10 recent private equity sales to understand the impact of higher borrowing costs on valuations and deal flow.
Document investment philosophy tenets: Refine and communicate the six core tenets (risk control, consistency, market inefficiency, specialization, non-reliance on macro forecasting, non-reliance on market timing) to 3-5 key team members.

Key Quotes

"The real lesson I learned was that there's always a price that's too high if you held the stocks for five years from the day I got there you lost about 95 of your money in great companies well some weren't so great but what were believed to be great so the lesson I learned was it's not what you buy it's what you pay and successful investing is not a matter of buying good things but buying things well as time passed I rounded that into a belief that there is no asset so good that it can't become overpriced and dangerous and very few assets which are so bad that if it's cheap enough it can't be a good idea that really has summarized what I've done since then."

Howard Marks explains that the value of an investment is not solely determined by the quality of the asset itself, but critically by the price paid for it. He learned this through the Nifty Fifty bubble, where even perceived "great companies" led to significant losses when overvalued. Marks emphasizes that successful investing involves buying assets at favorable prices, not just buying inherently good assets.

"The basic thing is I have to think I have something to write which not everybody else has been writing or talking about or I have to see something differently from everybody else the last thing I want to do is put out a memo that says me too."

Howard Marks describes his process for writing his widely read memos, highlighting his commitment to originality and unique perspectives. He seeks to offer insights that are not commonly discussed or to present existing ideas from a different viewpoint. Marks explicitly avoids contributing to the discourse with redundant or unoriginal content.

"The biggest change was the blossoming of the lbo business which really came on big in '84 '5 the lbo business leveraged buyouts could be done if you had 50 million of capital you could buy a billion dollar company you could borrow 95 of the money that meant that lesser companies could buy bigger companies or individuals could buy billion dollar companies it put a lot of companies in play that really blossomed in the mid 80s in '90 '91 we had our first crisis and many of the prominent lbos of the '80s went under."

Howard Marks traces the significant structural change in the credit markets with the rise of the Leveraged Buyout (LBO) business in the mid-1980s. He explains how high leverage, with 95% debt financing, enabled larger acquisitions and put many companies "in play." Marks notes that this era culminated in a crisis in the early 1990s, leading to the failure of many prominent LBOs.

"So it's the swing of a pendulum it's very pronounced it was the subject of my second memo which was written in 1991 I called it the pendulum I think the memo was creatively titled second quarter performance but to me if you're interested in the short or even the medium term this is the most important dimension do they like them or do they hate them buffett puts it very succinctly first the innovator then the imitator then the idiot the way to sum that up in just a few words is that what the wise man does in the beginning the fool does in the end."

Howard Marks uses the pendulum analogy to describe the cyclical nature of investor sentiment and market popularity. He explains that assets or strategies that are initially unloved and undervalued by innovators eventually become popular with imitators and finally with "idiots" who buy at the peak. Marks emphasizes that understanding this swing is crucial for short to medium-term investing success, echoing Warren Buffett's observation about market participants.

"The important structural things about private credit are the things that I've been discussing liquidity mark to market and are you compelled to face reality with regard to the credit at some point in time when you're sitting on an investment committee and people talking about private credit what are your views about how investors should think about these challenging issues."

Howard Marks identifies key structural differences between private credit and public credit, focusing on liquidity, mark-to-market accounting, and the compulsion to confront reality. He questions how investors should approach these challenges, particularly regarding the valuation of private credit assets. Marks suggests that the lack of daily public market pricing can obscure the true creditworthiness and potential risks.

"Buffett says it best all the time he says it's only when the tide goes out that you find out who's swimming naked so right now we don't know who's swimming naked we don't know what it's going to look like when the tide goes out."

Howard Marks employs Warren Buffett's well-known analogy to illustrate the uncertainty surrounding the current state of private credit and other private assets. He suggests that the true performance and resilience of these investments, and the firms managing them, will only become apparent when market conditions deteriorate. Marks concludes that currently, it is unknown which entities are over-leveraged or poorly positioned for a downturn.

Resources

External Resources

Books

"Gimme Credit" by Howard Marks - Mentioned as the title of a memo that prompted the interview.

Articles & Papers

"The Pendulum" (Memo) - Discussed as a previous memo written in 1991 about market cycles.
"Race to the Bottom" (Memo) - Mentioned as a memo written in February 2007 about deteriorating underwriting standards.
"What Really Matters" (Memo) - Mentioned as a memo written in October 2022 about long-term investment principles versus short-term events.
"The Sea Change" (Memo) - Mentioned as a memo written in December 2022 discussing the structural shift in the interest rate climate.
"Asset Allocation" (Memo) - Mentioned as a memo written in October discussing the two basic forms of assets: ownership and debt.

People

Howard Marks - Co-founder and co-chairman of Oaktree Capital Management, author of memos on investing.
Ted Seides - Host of the Capital Allocators podcast.
Bruce Karsh - Partner who approached Howard Marks to start a distressed debt fund.
Sheldon Stone - Partner at Oaktree Capital Management, first analyst for Howard Marks at Citibank.
Warren Buffett - Mentioned for his succinct put on market cycles and the importance of avoiding losers.
Benjamin Graham - Mentioned for his description of fixed income as a "negative art."
David Dodd - Mentioned alongside Benjamin Graham for his description of fixed income as a "negative art."
Litton - Mentioned as an example of a conglomerate with a high-flying stock that made accretive acquisitions.

Organizations & Institutions

Oaktree Capital Management - Leading global investment firm primarily in credit investments, co-founded by Howard Marks.
Brookfield Asset Management - Majority owner of Oaktree Capital Management.
City Bank - Where Howard Marks started the first high-yield bond fund from a mainstream financial institution.
TCW - Where Howard Marks and colleagues started one of the first distressed debt funds.
WCM Investment Management - Sponsor of the Capital Allocators podcast.
SRS Acquiom - Sponsor of the Capital Allocators podcast.
National Football League (NFL) - Mentioned in the context of a hypothetical example for investment analysis.
New England Patriots - Mentioned in the context of a hypothetical example for investment analysis.
Pro Football Focus (PFF) - Mentioned in the context of a hypothetical example for investment analysis.

Websites & Online Resources

capitalallocators.com - Website for the Capital Allocators podcast, for mailing list, premium content, and university information.
twitter.com/tseides - Ted Seides' Twitter profile.
linkedin.com/in/tedseides/ - Ted Seides' LinkedIn profile.
thepodcastconsultant.com - Website for The Podcast Consultant, providing editing and post-production services.
wcminvest.com - Website for WCM Investment Management.
srsacquiom.com - Website for SRS Acquiom.

Other Resources

Private Credit - Discussed as a growing market with implications for investors and potential risks.
High Yield Bonds - Discussed as an early market Howard Marks worked in, with a focus on yield to maturity.
Leveraged Buyouts (LBOs) - Discussed as a business that blossomed in the mid-80s and later reinvented itself.
Private Equity - Discussed as a strategy that became popular and is now facing challenges due to higher interest rates.
Senior Loans - Discussed as a market that emerged in the late 90s, taking the place of banks to some extent.
Alternative Investments - Discussed as a business that grew after the tech bubble burst when investors sought alternatives to stocks and bonds.
Distressed Debt - Discussed as an area where Howard Marks and Bruce Karsh started one of the first funds.
Nifty Fifty Strategy - Discussed as a strategy Howard Marks was associated with early in his career, which led to significant losses.
Capital Allocators University - An educational program for investor relations and business development professionals.
Memos - Howard Marks' primary method of communicating investment insights.
Investment Philosophy - A written document outlining the six tenets of how Oaktree Capital Management runs money.
Risk Control - Identified as the most important tenet of Oaktree's investment philosophy.
Consistency - Identified as the second tenet of Oaktree's investment philosophy.
Less Efficient Markets - Identified as the third tenet of Oaktree's investment philosophy.
Specialization - Identified as the fourth tenet of Oaktree's investment philosophy.
Non-Reliance on Macro Forecasting - Identified as the fifth tenet of Oaktree's investment philosophy.
Non-Reliance on Market Timing - Identified as the sixth tenet of Oaktree's investment philosophy.
"If we avoid the losers, the winners take care of themselves" - Oaktree's official motto.
"Extend and pretend" - A strategy where a bond issuer is given more time to pay when unable to meet the original terms.
"The Lone Ranger" - A fictional character mentioned as an analogy for the "silver bullet" search in investing.
"The 64 question" / "The 64,000 question" - Old phrases referring to a significant, unresolved question, here applied to the potential for future recessions and defaults.
"Don't just sit there, do something" - A saying contrasted with the investment principle of patience.
"Don't just do something, sit there" - The principle of patience in investing.
"Investing in a low return world" - A title for speeches given during a period of low interest rates.
"The conspiracy against the laity" - Mark Twain's description of professions that invent complex terminology.