Oaktree Strategic Credit Fund
S
Oaktree Fund Advisors, LLC
09/06/23
Monthly
12.5% of Investment Income; 12.5% of Capital Gains
1.25%
Permanent Capital
Brookfield Oaktree Wealth Solutions LLC
Ernst & Young LLP
Sullivan & Cromwell LLP
Strategy
Oaktree Strategic Credit Fund (“the Fund”) primarily aims to generate stable current income, with the potential for long-term capital appreciation.
The Fund seeks to meet its investment objective by investing at least 80% of total assets in public and private debt opportunities. This strategy plans for an “all-weather” dynamic allocation to private and public credit opportunities in response to changing market conditions.
In what Oaktree calls “benign” market conditions, the Fund will aim for a higher allocation to private credit to mitigate risk and generate income.
In “dislocated” markets operating under stressful conditions, the Fund will increase allocations to public investments to capitalize on asset mispricing.
Targeted public debt investments are discounted senior debt securities such as high-yield bonds and senior loans in dislocated markets. One example would be the purchase of a hospitality company’s debt which has been undervalued when travel dropped during the pandemic. Oaktree does not expect such assets to make up more than 30% of its portfolio. The remaining 70% will be invested in private loans including:
a majority of financing allocations to Small and Midsize Enterprises (SME), by originating bespoke loans to primarily founder-owned businesses as well as engaging in syndicated financings for private equity-owned businesses (ie. leveraged buyout strategies).
to a lesser extent, investments in Opportunistic Credit which will generally be liquid and may be used to provide liquidity for new investments and its share repurchase program, while also presenting an opportunity for attractive returns.
Most of the Fund’s investments will be in private US companies, but Oaktree expects to invest in European and other non-US companies. To be regulated as a BDC, Oaktree must invest at least 70% of its assets in private U.S. companies.
Style
| Value | Core | Growth | |
| Large | |||
| Mid | |||
| Small |
Fit Check
Investors must have either:
- a gross annual income of at least $70,000 and a net worth of at least $70,000, or
- a net worth of at least $250,000.
Sophisticated investors willing to take moderate risks for better than average gains should prefer this investment vehicle. Common Shares offered through this prospectus are suitable only as a long-term investment for persons of adequate financial means such that they do not have a need for liquidity in this investment.
The target Portfolio Companies are Small and Medium Enterprise firms residing within 25 of the United States and 8 foreign countries. Persons willing to support middle-market Enterprise for good gains may well enjoy working with Oaktree Strategic Credit Fund.
Portfolio Snapshot
As of April 30, 2023
Score Breakdown
BULLS SAY
Excellent risk management to offer downside protection via a) secured debt arrangements, b) floating rate terms on debt placements to portfolio companies, and c) significant geographical and industry diversification
Favorable income terms early after just 3 quarters of operations at 8.89% distribution rate, and a growth expectation.
Alignment: Oaktree provided seed capital and later acquired more stock during its first year amounting to 4 million shares worth $93.6 million as of April 30, 2023. With ownership of about 15% of outstanding shares, this shows considerable commitment to the strategy by the investment manager.
BEARS SAY
The Fund operates in a highly competitive market for investment opportunities among middle-market lending where companies are particularly susceptible to systemic risks such as interest rate hikes and periodic reductions in demand, because of their size and typically thin margins.
Key man risk: investment decisions are made at one choke-point: Armen Panossian. The post-acquisition governance terms contractualized following Brookfield’s 2019 of Oaktree may allow Brookfield to make substantial management changes in the Fund’s board of directors and executive officers in the next few years, which may impact Fund performance and objectives, exacerbating key man risk.
The Fund began its operations last year which means that there is limited operating history to assess its potential for performance. It recorded a modest 2.53% net return since inception, and 0.24% year-to-date, suggesting that it may be lagging behind competitors.
Price Tag
|
Fees & Expenses |
Class S |
Class D |
Class I |
|
Minimum initial investment |
$2,500 |
$2,500 |
$1,000,000 |
|
Availability |
Transactional brokerage accounts |
Wrap accounts and through participating broker-dealers and RIA’s |
Wrap accounts, endowments, foundations, and other institutional investors |
|
Transaction fees |
|||
|
Up to 3.5% |
Up to 1.5% |
None |
|
|
Annual fees |
|||
|
1.25% |
1.25% |
1.25% |
|
|
0.85% |
0.25% |
None |
|
|
4.86% |
4.86% |
4.86% |
|
|
2.32% |
2.32% |
2.32% |
|
|
Total annual fund expenses |
9.28% |
8.68% |
8.43% |
To help you compare the cost of investing in this offering with other offerings, Oaktree has provided an example of the projected dollar amount of total expenses that would be incurred over various periods with respect to a hypothetical investment for each class of common stock.
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In calculating the projections above, Oaktree made a few assumptions:
(1) A hypothetical 5.0% annual return, as required by regulation of the SEC and applicable to all registered investment companies. The assumed return is not a prediction of, and does not represent, the projected or actual performance of the Fund. Performance will vary and may result in a return greater or less than 5.0%.
(2) Projections exclude any potential incentive fee on net realized capital gains, assuming a 5.0% return solely from net investment income.
(3) Annual operating expenses and offering expenses remain at the levels set forth in the Price Tag table above. They should not be considered a representation of future expenses. Actual expenses may be greater or less than those shown.
(4) Net return after payment of fees and expenses is distributed to shareholders and reinvested at NAV.
(5) Your placement agent does not charge you any transaction fees.
Managers
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Industry Experience Mr. Panossian boasts over 20 years of experience in management of financial capital.
Career highlights Mr. Panossian joined Oaktree in 2007 as a senior member of its Global Opportunities group. In January 2014, he joined the U.S. Senior Loan team to assume co-portfolio management responsibilities and lead the development of Oaktree’s CLO business. Mr. Panossian joined Oaktree from Pequot Capital Management, where he worked on their distressed debt strategy.
Education B.A. in Economics from Stanford University; M.S. in Health Services Research from Stanford Medical School; J.D. and M.B.A. from Harvard Law School and Harvard Business School.
Full Review
ABOVE AVERAGE
The Investment Manager has skin in the game in the form of stock owned by Oaktree affiliates.
Through an entity called Oaktree Fund GP I, Oaktree provided $40 million in seed capital at inception. Since then, in its first year of operations, Oaktree has acquired more stock amounting to 4 million shares worth $93.6 million as of April 30, 2023. This is a considerable commitment to the strategy by the investment manager, corresponding to about 15% of outstanding shares as of May 22, 2023.
That being said, when testing the alignment of the manager with the interests of shareholders, prospective investors may want to look for stock owned by the individuals running the Fund. The portfolio manager Armen Panossian does not own any stock in the Fund. Nevertheless, given the size of the commitment by the investment manager, there is undeniably an attempt to foster alignment by the Oaktree Strategic Credit Fund’s management team.
To bolster alignment, the Fund also features an incentive fee designed to compensate the investment manager past a certain rate of return. After a minimal annual rate of return of 5% which flows to shareholders, the manager earns 100% of the Fund’s remaining net investment income up to a “catch-up” rate of 5.714%. This is intended to provide the investment manager with 12.5% of net investment income as if the hurdle rate did not apply. For any profits exceeding the 5.714% rate, the investment manager earns a 12.5% share and the rest goes to shareholders. In addition to the performance fee on investment income, the Fund earns a 12.5% fee on capital gains. Most competitive private credit offerings use this same fee structure which does not provide the Fund with a competitive edge in terms of alignment. However, the performance fee does incentivize the fund managers to maximize returns, fostering alignment with investors' interests.
While some placement agents might do so, Oaktree does not charge an upfront transaction fee which means that the total investment amount goes toward generating a return. This is also a good sign for alignment as it means that the investment manager will rely more on performance-based compensation than upfront fees to keep the lights on. The 1.25% and 0.85% annual management and servicing fees on NAV are also in line with industry averages.
AVERAGE
The Fund began its operations last year which means that there is limited operating history to assess its potential for performance. It recorded a 2.53% net return since inception as of April 30th 2023, measured as the change in NAV per share over the period, plus distributions per share divided by the beginning NAV per share. Perhaps more concerningly, the Fund returned 0.24% net since the beginning of the year as of April 30th, 2023.
It is normal for a private credit fund’s NAV to grow at a low rate in its initial year as it raises funds and allocates capital to new investments. While inception-to-date figures are neither impressive nor alarming, the fund’s performance in 2023 suggests that it may be lagging behind competitors. Total return figures below are as of April 30, 2023.
| Offering | Inception Date | Year-to-date Annualized Net Return | Inception-to-date Annualized Net Return | Annualized Distribution Rate on NAV |
| Apollo Debt Solutions BDC Class S |
January 2022 | 2.38% | 0.55% | 8.15% |
| Owl Rock Technology Income Corp. Class S |
May 2022 | 1.25% | 6.28% | 7.97% |
| Oaktree Strategic Credit Fund Class S |
June 2022 | 0.24% | 2.53% | 8.89% |
Given the Fund’s limited operational history, investors may want to evaluate the track record of other funds managed by Oaktree Fund Advisors, LLC. Armen Panossian is the portfolio manager of Oaktree Specialty Lending Corporation (OCSL) which was formed in 2007 and operates as a BDC to execute on a comparable strategy. OCSL’s focus is to provide flexible private credit to sponsored and non-sponsored companies, and also pursues opportunistic public credit. Annualized trailing returns provided by Morningstar as of June 8th 2023 are below. Over various periods, OCSL showed capacity for outperformance and volatility. The referred Industry Index is the Morningstar Credit Services Index.
| Offering | Year-to-date | 1-Year | 3-Year | 5-Year | 10-Year |
| Oaktree Specialty Lending Corp | -2.04 | 4.31% | 21.73% | 13.11% | 1.93% |
| Industry | 8.68% | -1.10% | 2.66% | 8.12% | 13.02% |
Lastly, as an income investing strategy, Oaktree Strategic Credit Fund seems on track to deliver on consistent, regular, above average distributions to shareholders. The Fund started issuing cash distributions in its second full quarter of operations at an annualized rate of 7.45% on NAV. Since then, distributions have flown to shareholders each month and have grown 19% to reach an annualized dividend rate of 8.89% that fares well when compared to competitive offerings launched last year. It is also on track to reach, if not outpace, distribution rates recorded by more established private credit funds such as Blackstone Private Credit Fund and PIMCO Flexible Credit Fund which recorded 9.30% and 8.80% annualized distribution rates respectively in April 2023.
BELOW AVERAGE
The Fund operates in a highly competitive market for investment opportunities among Small and Medium (middle-market) Enterprises. Because of their size and typically thin margins, SMEs are particularly susceptible to systemic risks including: interest rate hikes, periodic or seasonal reductions in demand, tightening of the capital markets, foreign exchange risk repatriating earnings, and other issues. The Fund aims to mitigate volatility/reduction in cash-flows by negotiating floating interest rates on debt placements to Portfolio Companies (92% of exposure) and by arranging placements as Secured Debt (>90%).
The Fund also diversifies its investments across 47 business sectors (NAIC codes) and across 25 States and 8 foreign countries.Its sector dispersion is also effective in mitigating market risk. The most prevalent industry in its portfolio is the software industry and it only amounts to 12% of aggregate NAV. Every other sector amounts to less than 10% of the portfolio’s fair value. See the Portfolio Snapshot section above for more info. Diversification between private and public debt also contributes to mitigating systemic risk.
Notwithstanding these mitigation efforts, any severe systemic downturn could stress Portfolio Companies to an extent, diminishing cash-flow returns to the Fund and producing losses in Net Asset Valuation and in distributions to the Shareholders. Most of its investments do not have a readily available market price, and are valued at fair value as determined in good faith by the Board of Trustees.
HIGH
You may have noticed that the Dealer Manager of the fund is Brookfield Oaktree Wealth Solutions. Oaktree, which already manages a whopping $160 billion in assets, was acquired by Brookfield Asset Management in 2019. Brookfield is a leading global alternative asset manager with over $750 billion in assets under management post acquisition. Both entities currently operate their respective investment businesses largely independently, led by its existing management and investment teams, pursuant to an information barrier. The Brookfield Oaktree Wealth Solutions entity is the first attempt to simplify client engagement across the organization and unlock cost efficiencies. Brookfield does not intend to unlock further synergies, as of Q2 2023.
Moreover, according to post-acquisition governance terms, if Oaktree co founders Howard Marks (77) and Bruce Karsh (67) cease to beneficially own 42% of the equity they owned after the acquisition or if they withdraw from Oaktree’s business any time up to 2026, Brookfield will have the right to appoint a majority of Oaktree’s board of directors. There is a risk of substantial management changes in the Fund’s board of directors and executive officers and few benefits as a result of this acquisition.
Another source of risk with regards to management is the dependence on its portfolio manager. Investment decisions are made at one choke-point: Armen Panossian, who has oversight to complete diligence to maximize benefit. It is worth noting that Panossian has been with Oaktree for 16 years and that the Fund implements incentive pays and specific employment agreements to mitigate the risk of resignation. Notwithstanding such efforts, a resignation may negatively impact Fund performance and impact Fund objectives, highlighting key man risk.
Lastly, Oaktree Strategic Credit Fund’s investment style implies a lack of investment control which limits the ability of Oaktree to create value with active asset management. The Fund will not hold controlling equity interests in the majority of its portfolio companies, and may not be able to exercise control over its portfolio companies or to prevent decisions by management of its portfolio companies, which could decrease the value of its investments.
AVERAGE
The Oaktree Strategic Credit Fund invests in debt securities that are substantially illiquid with no active transaction market. The Fund does not expect to list shares on a public exchange so this should be considered as a long term investment. Investors must be prepared to hold their shares for a long time.
However, periodic liquidity will be provided through a share repurchase plan, whereby the Fund intends to offer to repurchase investors’ shares at NAV, up to 5% of outstanding shares or aggregate NAV per quarter, at the discretion of the board. In addition to the quarterly limit on redemptions, the board may amend or suspend the repurchase program at any time. Shares that have not been outstanding for at least one year are subject to an early repurchase deduction of 2% of NAV, meaning that shares will be bought back at a price corresponding to 98% of NAV at the time of repurchase.
The Fund commenced its share repurchase program in its third full quarter of operations, conducting buyback offers pursuant to tender offers but no share requests have been submitted since then. This is normal considering the 2% haircut on redemption requests submitted within the first year of holding.
The significant opportunistic credit allocation to high-yield bonds and leveraged loans in public markets makes this strategy uniquely designed to maintain a liquidity cushion for new investments and its periodic share repurchase program. Investors may want to monitor the Fund’s ability to manage liquidity and comply with its share repurchase policy in the future.
BELOW AVERAGE
Changes in interest rates may affect both the Fund’s cost of funding and their interest income from portfolio investments. The fund ties 91.6% of exposed risk to floating-rate debt to mitigate interest rate risk. As interest rates rise, the interest payments on the debt increase, providing a natural hedge against the higher rates. This helps to offset any potential losses that could occur from holding fixed-rate debt during a period of rising interest rates.
It is worth noting that Oaktree was able to increase the share of its floating rate portfolio during the inflationary period from 87.6% at the end of Q3 2022 to 91.6% through March 2023 when the Fed raised rates 4 times over 2 quarters. This alleviates downward pressure on Net Asset Valuation during periods of upward spiral in interest rates. However, it does nothing to mitigate potential default risk on the part of Portfolio Companies, another source of debt risk.
To mitigate default risk, the Fund arranges 92.7% of the fair value of the portfolio as senior secured debt. Senior secured debt is a type of security that is backed by specific assets or collateral, which gives lenders a higher claim to those assets in the event of default. It is a good risk management policy for investors because it provides a greater level of security and increases the likelihood of repayment in case of financial distress.
Notwithstanding these mitigation efforts, including the collateral security on debt placements, SME business is inherently risky, and there is a potential for reductions in Net Asset Valuation and reduction in cash flows from Portfolio Companies which could negatively affect the Fund's ability to service its debt leverage. The Fund may also hold the debt securities of leveraged companies that may, due to any potential volatility in cash-flows of such companies, enter into bankruptcy proceedings.
The Fund intends to use leverage up to a 2x debt-to-equity ratio, as required by the Investment Company Act, which will magnify the potential for loss, but also profits, on amounts invested. The strategy does not state a target leverage ratio. As of March 31, 2023, the Fund was moderately leveraged at a 0.38 debt-to-equity ratio, down from 0.46 at year-end 2023. In 2023, Oaktree increased NAV while paying pack outstanding borrowings under their credit facilities, and still has $490 million of undrawn capacity on their credit lines, which currently bear fairly high weighted average interest rates of 6.21% on its agreement with ING Credit and 7.80% with JPMorgan.
ABOVE AVERAGE
The Oaktree Strategic Credit Fund website is easy to navigate and offers a very thorough repository of information. It regularly updates key performance figures and portfolio metrics in a digestible way, while also providing access to more technical SEC filings and communications for more curious investors.
Oaktree has also created a few educational videos about private credit and BDCs. The Fund also provides a breakdown of the portfolio including top holdings and industries, information regarding key managers, their organizational structure and investment process.
One piece of literature that was missing was a Market Commentary document. Some firms share their shareholder letters. This is a document that is generally updated quarterly and helps understand the management’s perspective on market conditions and trends in the industries where the Fund operates. It helps prospective investors understand how management intends to capture value and respond to moving markets.
Our team also contacted their IR department to fill in a few gaps. The analyst who attended to our request was unable to clarify the extent to which third party pricing service providers and independent appraisers contributed to the valuation of the portfolio’s fair value, as implied in the offering circular. More transparency regarding the valuation methodology would go a long way in enhancing the reliability of performance metrics.
Peer Group
 |
 |
 |
|
|---|---|---|---|
| Vehicle name | Oaktree Strategic Credit Fund (Class S) |
Owl Rock Technology Income Corp. (Class S) |
Apollo Debt Solutions BDC (class S) |
| Minimum investment | $2,500 | $25,000 | $2,500 |
| Holding period | Permanent Capital | Permanent Capital | Permanent Capital |
| Annual management fee | 1.25% | 1.25% | 1.25% |
| Distribution and Servicing Fee | 0.85% | 0.85% | 0.85% |
| Sales Load | Up to 3.5% | Up to 3.5% | Up to 3.5% |
| Inception Date | June 2022 | May 2022 | January 2022 |
| Net Returns Since Inception (Annualized) | 2.53% | 6.28% | 0.55% |
| Annualized Distribution Rate | 8.89% | 7.97% | 8.15% |
| NOYACK® Score |
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