Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How Wealthy Families Use Oaktree's Distressed Debt Funds
Transcript
- Lucas: Luna, I want to talk about a corner of the market that most individual investors never touch, but where ultra-wealthy families have been parking serious capital for decades: distressed debt. Luna: Distressed debt — so buying the bonds of companies that are in bankruptcy or close to it. That's the 'vulture investing' we hear about, right? Lucas: Exactly. And the firm that practically defined the space is Oaktree Capital Management, co-founded by Howard Marks. In 2025, Oaktree closed its largest distressed debt fund ever: Oaktree Opportunities Fund XI, raising 18.9 billion dollars. That's the biggest closed-end fund in history, full stop. Luna: 18.9 billion dollars — and that's just one firm. What's the pitch to a family office considering allocating, say, 5 to 10 percent of their portfolio to this strategy? Lucas: The core idea is that you're buying claims on companies at a deep discount to their intrinsic value — typically 40 to 60 cents on the dollar. The distressed company's bonds are trading as if it's going under for good, but the distressed debt manager believes it can restructure the company, swap debt for equity, and emerge with a controlling stake worth far more. Luna: So the return doesn't come from interest payments — it comes from the restructuring. You're essentially acting like a private equity investor but through the bond market. Lucas: That's exactly right. And historically, top-quartile distressed debt funds have delivered net internal rates of return in the 12 to 15 percent range, with relatively low correlation to the S&P 500. For a family office trying to diversify away from public equities, that's very attractive. Luna: But the liquidity is a totally different animal. These funds typically have 8 to 10 year lockups, sometimes longer. You can't just call your banker and redeem. Lucas: No, you can't. And that's the trade-off. The illiquidity premium is real. When you commit capital to a fund like Oaktree's, you're effectively agreeing to be patient. In return, you get access to a strategy that has generated higher risk-adjusted returns than almost any other alternative asset class over the last 30 years. Luna: Let's talk about the 'vulture' stigma. There's a perception that distressed debt funds profit from others' misery. How do wealthy families justify that to themselves, or to their beneficiaries? Lucas: It's a fair question. The counterargument is that distressed debt funds provide liquidity to a market that would otherwise freeze up. When a company is in Chapter 11, someone needs to buy the bonds, provide debtor-in-possession financing, and help the company restructure so it can emerge as a going concern. Without that capital, more companies would liquidate, and more jobs would be lost. Luna: So it's not just about returns — there's a functional role in the credit ecosystem. Lucas: Exactly. Howard Marks has written extensively about this. He says distressed debt investing is 'the most socially useful form of arbitrage.' Whether you buy that or not, the numbers speak for themselves. Oaktree's track record since the 1990s shows that their funds have rarely had a losing vintage year. Luna: But not all distressed debt managers are Oaktree. If a family office wants to allocate, how do they even get access? Most of these funds are closed to new investors, or have huge minimums. Lucas: True. Oaktree's minimum for institutional investors is typically 25 million dollars, but family offices often come in through feeder funds or fund of funds structures. There are also registered funds — interval funds and tender-offer funds — that offer daily or quarterly liquidity, though they usually invest in less distressed, more performing credit. The trade-off is lower returns for more liquidity. Luna: And what about the current environment? We're in mid-2026, credit spreads are tight, defaults are low. Is this a good time to commit to a distressed debt fund, or are we late to the party? Lucas: That's the classic question. The best time to invest in distressed debt is when there's blood in the streets — 2008, 2020. Right now, default rates on high-yield bonds are around 2 percent. But Howard Marks himself has said that the biggest risk in distressed debt is investing too late in the cycle. That said, his latest fund closed in 2025, which was already a late-cycle environment. So the managers are finding opportunities, just not as many as during a crisis. Luna: So the returns might be lower than the banner years, but the strategy still offers diversification and a cushion if the economy turns. Lucas: Exactly. And for families with a long time horizon, a 5 to 10 percent allocation to distressed debt can smooth out portfolio volatility. It's also worth noting that distressed debt has a low correlation to both equities and traditional bonds, so it really does serve as a portfolio diversifier. Luna: You know, Lucas, conversations like this — the ones that go deep into a specific strategy — are exactly why so many listeners tell us they value the show. And if our money conversations have helped you think about an allocation differently, we want to mention something. Lucas: Yeah — the show is completely ad-free, and that's only possible because some of our listeners choose to support it directly. If you find value in episodes like this, you can buy us a coffee at buy me a coffee dot com slash fexingo. It's a simple way to keep the conversation going. Luna: And we truly appreciate every bit of support. Now, back to distressed debt — one more nuance I want to get into: the difference between senior secured bonds and unsecured claims. Lucas: Great point. In a bankruptcy, not all debt is created equal. Senior secured bondholders have a claim on specific assets, like factories or real estate. Unsecured bondholders are lower in the capital structure. Distressed debt funds often buy the senior secured debt because it has a higher recovery rate — typically 60 to 80 percent — versus unsecured, which can be 20 to 40 percent. Luna: So the strategy is really about picking the right layer of the capital stack, not just buying any distressed bond. Lucas: Exactly. And that's where active management matters. Oaktree's team of credit analysts does deep fundamental research, often meeting with management, reviewing documents, and attending court hearings. It's not a passive strategy. You're betting on the manager's ability to navigate the legal and operational complexity of a restructuring. Luna: What about taxes? For a high-net-worth family, investing in a distressed debt fund held in a taxable account — how do the returns get treated? Lucas: That's a key consideration. Distressed debt funds generate a mix of interest income, capital gains, and sometimes what's called 'original issue discount,' or o i d, which is taxable as ordinary income even if you haven't received cash. So the tax drag can be significant. That's one reason many families hold these funds inside a trust or an insurance wrapper, like a private placement life insurance policy, to defer or avoid current taxation. Luna: So it's not just about the return — it's about the after-tax return. And that ties back to episodes we've done on tax efficiency strategies. Lucas: Absolutely. And that's also why family offices often work with tax advisors to structure the allocation in the most efficient vehicle. If you're in a high tax bracket, holding a distressed debt fund in a taxable account could significantly reduce your net return. Luna: One more thing: how do distressed debt funds perform during a rising rate environment? Because we've seen the Fed raise rates, and that typically hurts bond prices. Lucas: It's a mixed bag. Rising rates can increase the cost of borrowing for distressed companies, making it harder for them to service debt. But the fund itself is buying bonds at a discount, so the duration — the sensitivity to interest rates — is often lower because the bonds are already trading at a deep discount. The bigger driver is the credit cycle, not the rate cycle. Luna: So it's more about the health of the corporate sector than the level of interest rates. Lucas: Exactly. And right now, corporate balance sheets are relatively healthy, but there are pockets of stress — particularly in commercial real estate and certain consumer-facing sectors. That's where Oaktree and others are finding opportunities. Luna: If I'm a family office considering this, what's the first step? Do I call Oaktree directly? Lucas: You could, but most family offices start by talking to their investment consultant or a private bank that has a relationship with Oaktree. The consultant can help you evaluate the fund's track record, understand the liquidity terms, and decide whether it fits your overall portfolio. They'll also help you negotiate fees, which for Oaktree are typically 1.5 percent management fee and 20 percent carried interest. Luna: And that's pretty standard for the space. So the takeaway for our listeners: distressed debt is a serious allocation for serious investors. It's illiquid, complex, and requires a good manager. But for families that can handle the lockup, it offers compelling long-term returns and real diversification. Lucas: And importantly, it's a strategy that has been used by the wealthiest families for decades. If you're looking for a way to differentiate your portfolio from a typical 60-40 stock-bond mix, distressed debt is worth a close look. Luna: Lucas, great conversation. I think we've given our listeners a solid framework to think about this. Lucas: Agreed. And as always, we'll be back next episode with another deep dive into the strategies that drive the world of high net worth.